Can one simple life saving idea improve investment returns?


Avoid missing something simple but crucial

Checklists can improve investment decision-making and should be part of every investment process.


In December 2009, American surgeon, public health researcher and author Atul Gawande released The Checklist Manifesto: How to Get Things Right, a critical look at the failures in our complex modern world. His insight was that in many industries that have not adopted rigorous checklist based processes, experts are prone to failure due to the fallibility of human memory in remembering routine, mundane tasks and the lack of immediate feedback in skipping steps leading to adverse outcomes.

Checklists are not new and although the application to investing may seem mundane when compared to the lives saved in a hospital setting or the ability for Captain Sullenberger to land US Airways flight 1549 in the Hudson River in January 2009 through the application of standard checklists under extreme pressure, improving investment returns from something simple and easy to implement should not be overlooked.

Market historians will also recognise checklists in the writings of the most celebrated investors. Some of these may be remembered as rules of thumb, others may be more prescriptive, but they are all useful items to consider for an investing checklist. Understand the business. Buy at a discount to intrinsic value. Ensure the business has a wide moat. These are but a fraction of the “rules” Warren Buffett has offered his shareholders to consider in their own activities.

There are books written by and about dozens of great investors with condensed wisdom that has proven value:

  • Buy outstanding companies with compelling growth prospects - Phillip Fisher;

  • Solve the big no brainer questions first - Charlie Munger; and

  • Be careful of leverage, it can go against you - Walter Schloss.

Beyond building a checklist to invest like the greats, there are also more mundane checklists to test the veracity of the accounts and the quality of earnings. Are there discrepancies between accruals (P&L) and cash flows? Are off balance sheet liabilities significant? Have receivable, payable or inventory days changed significantly? Do depreciation rates match asset lives? These are all questions that should probably be asked of every investment as a matter of course, but often these things get skipped. Or forgotten. Or overlooked.

Read any fund manager investment process and it will be full of tests applied to potential investments that look like those of the greats. We look for wonderful businesses, conservatively financed earning high returns on capital, run by capable and honest management and selling at a discount to our estimate of fair value. Using checklists to capture the “big no brainers” makes sense, but for the extra edge investors should consider a more complete set of checklists to capture all those little things that can add up to make a big difference.

Calibre RMS allows investors to build as many checklists as they like and ensure they are applied consistently within their investment process.


Calibre RMS Features

Setting up a Checklist in Calibre RMS allows the team to determine what questions analysts should consider and whether completion of the checklist with a comment on each item is mandatory for the company analysis to be considered complete.

In this example, we want analysts to consider and address five common accounting issues that can sometimes be overlooked when looking at reported accounts and that can be a sign of companies using aggressive accounting to overstate the economic health of the business. We have made commenting on each item mandatory for the company to earn a “pass” on the checklist as a way of ensuring each item has been considered - even if there is nothing unusual that turns up.

You can see many more custom built checklist templates in the Calibre RMS process library below.

Fully customise checklists to your team and process (click to enlarge)

The way Calibre RMS works, a team member creates the checklist, which is known to the system as a Process Step. This Process Step can be added to any Investment Process, and once added will be available to be used with any company in the investible universe. The analysis done here will be saved against that company for reference across the system.


Filling out our Accounting Checklist

The checklist of questions the team has set up is shown below, also showing that the company in question has not yet been rated on this checklist as it has never been completed. The green header bar shows we are in edit mode, about to work with the checklist.


Checklist of questions (click to enlarge)


The analyst uses the checklist prompts to complete the analysis and ensure that attention is paid to each issue. Checklists are often more about confirming these things have been looked at and considered. In this case, four items are as expected, but one - the considerable contingent liabilities for the company - should lead to a consideration about the cost to shareholder value should these liabilities be realised.


Filling out a Checklist (click to enlarge)


The checklist has now been completed and saved to the system. We can now see that the company has passed the checklist process step and we have a record of each item.


Completed Checklist (click to enlarge)


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