Quan,

What is your process for reviewing an idea?  What do you\nmake sure to read? (documents, news, history of business, industry report, etc?)\n I was impressed by your discussion of CCL, and thought that many of\nthe details you had included weren't readily available in a 10-k or company\ndocument.  How and where do you go to get that type of data (thing like\nunit economics, for example)?

Many thanks,

Mostafa

I used to have a fear that I can\u2019t find enough\ninformation to analyze a company. I don\u2019t remember when that fear went away. But\nthat\u2019s not because I got more information. That\u2019s because my process improved.

One problem I see in a lot of books is the hammer bias. To\na man with a hammer, every problem looks like a nail. I think authors usually\nstart a project with some hypotheses and they look at data and information from\nthat point of view. They give examples and explain by their thesis. But things\nare usually results of many reasons.

Ten\nPoints to Look at

We can easily fix that problem. As Charlie Munger\nsuggests, the cure is to equip the man with as many tools as possible. My tools\nare my investment checklist. I have 10 questions to answer in my research:

-      Competitive\nPosition

-      Product\nEconomics

-      Return\non Capital

-      Management

-      Organization

-      Capital\nAllocation

-      Repeatability

-      Future\nProspects

-      Safety

-      Understanding

And I have a sub-checklist for each item in the\nchecklist.

Twelve\nBooks to Start

My checklist was initially based on ideas from the books\nI read. If I started over studying value investing today, I would read these books:

-      Security\nAnalysis by Ben Graham

-      Common\nStocks and Uncommon Profits and Other Writings by Phil Fisher

-      The\nLittle Book that Builds Wealth by Pat Dorsey

-      Profit\nfrom the Core by Chris\nZook

-      Beyond\nthe Core by Chris Zook

-      Unstoppable by Chris Zook

-      Repeatability by Chris Zook

-      Talent\nis Overrated by Geoff\nColvin

-      Built\nto Last by Jim Collins

-      Good\nto Great by Jim Collins

-      How\nthe Mighty Fall by Jim\nCollins

-      Great\nby Choice by Jim Collins

Security Analysis and Common Stock and Uncommon Profits\nare the best investment books I\u2019ve read. The former gives us a complete\nunderstanding of value of a company. The latter shows us important aspects of a\ncompany to analyze.

The Little Book that Builds Wealth is a good introduction\nto moat. There\u2019s a lot of interesting examples. But there\u2019s a weakness. Pat\nDorsey underrates the role of management. He looks at a moat in static terms. I\nthink we should look at a moat in dynamic terms. That\u2019s why I think it\u2019s\nimportant to read Chris Zook\u2019s books.

Chris Zook\u2019s books are about repeatability. The idea is\nto utilize organizational capabilities to adapt to changes in the market or to repeat\nsuccess in growth opportunities like a new customer segment, a new geographic\nmarkets, or adjacent products.

I find that Talent is Overrated is a good addition to\nChris Zook\u2019s book. Great performers are those who repeat practicing in learning\nzone. That also applies to business. Companies that repeat sharpening their key\ncapabilities will widen their edge over competitors.

I think investors undervalue Jim Collins\u2019 books. He broke\nsome myths about management. I think the books show how to build a great\norganization. It\u2019s helpful for investors to judge management.

Improve\nMy Checklist from Real-life Observation

But more important is practice. Each company is a real example.\nAnalyzing each company helps me realize what\u2019s important to each checklist\nquestion. And I just keep updating my sub-checklist. My process improves after\neach research.

For example, I didn\u2019t have a clear idea about how to\njudge an organization. But overtime, I realized unionization and internal\npromotion are something to look at. It\u2019s helpful to see if the organization is\nsales-driven or research-driven or operation-driven. The distance from front\nline employees to CEO and the company location are also useful.

Reading interviews, earnings call transcripts and compare\nwhat the management said with results also make me better at judging people. I\ncan easily find that Royal Caribbean\u2019s management is quite promotional. Carnival\u2019s\nMicky Arison is honest and blunt. Or Western Union\u2019s management is competent\nbut overly optimistic.

Practice also improves my understanding of moat, even\nthough it\u2019s a topic that economists and investors pay a lot of attention to. For\nexample, I think customer behavior doesn\u2019t get as much discussion as it deserves.\nPerhaps that\u2019s because it isn\u2019t easy to describe customer behavior in a formula\nlike economies of scale or network effects. Many times, customer behavior is explained\nby psychology. Again, a checklist is a powerful tool.

For example, looking at frequency and purchase price is\nhelpful. High frequency with low purchase price is good. Customers are rational\nonly when they first choose a product. Once they are satisfied with their\nchoice, they\u2019ll be loyal. They don\u2019t want to think and choose every time they\nbuy the product. They rely on habit instead. That\u2019s why consumer products are\nsuch a good business.

Low frequency with high purchase price is bad. Customers\nare rational. They spend a lot of time to compare alternatives. That\u2019s why I\nthink selling to business customers is difficult. That\u2019s why I don\u2019t like\nconsumer electronics companies.

Low frequency makes auto part retailers like AutoZone (AZO) a good business. Customers\ndon\u2019t buy often so they don\u2019t know much about price. Auto part retailers don\u2019t\ncompete on price. They compete on service instead. AutoZone focuses on \u201CYes\nrate\u201D.  AutoZone doesn\u2019t want to say No\nto customers. It wants customers to know that AutoZone will solve their\nproblems. So, frequency is low but the awareness is high.

On the contrary, low frequency makes fine dining\nrestaurants like Ark Restaurants (ARKR)\na difficult business. Customers go to these restaurants on special occasions. There\nmight be a lot of planning. Customers may not be loyal. But once the service is\nbad, customers will never come back. So, despite the crisis and rising food\ncost, Ark couldn\u2019t reduce payroll. They must maintain good service.

Among my 10 points, I didn\u2019t find much discussion about\nproduct economics in books. But it\u2019s very important. Strong competitive\nposition with bad product economics is bad. Railroads has strong moat but bad\nproduct economics. They earn only an adequate return on investment.

So, it\u2019s important to see whether costs are fixed or\nvariable; whether the business requires a lot of capital investment; whether\ngrowth requires much capital; whether the product cycle is long or short; or\nwhether cash collection is faster than cash payment; etc. The list of questions\njust keeps expanding as I gain more experience.

I\nDidn\u2019t Get More Information, My Eyes Just Get Keener

As I mentioned above, the information I look at didn\u2019t\nchange. I read all conventional sources. I read 10-Ks, transcripts, and\ninterviews. I try to read all books about a company. I read all articles I can\nfind about a company. I read from the oldest to the most recent article. That\nhelps me see how the company evolved over time.

I do the same thing to customers and competitors. So, it\u2019s\na good idea to analyze end-customer and go up the value chain.

I look at data and information with my checklist (and\nsub-checklist) in mind. I make notes or do calculation with data whenever I see\nsomething relevant. I update my checklist after each research. And I\u2019ll reduce\nthe amount of important information I miss in later research.

Talk to Quan about his Investment Process