Hi, I'm Jimmy in this video
we're looking at an investing
checklist for beginners based
on Warren Buffett's investing style.
Now, I built this investing
checklist largely from
Warren Buffett's letters to his
shareholders at Berkshire Hathaway.
Then I also used some letters
that he had back when he ran Buffett
Partnerships, which was before
Berkshire Hathaway.
I pulled some information from
various. Well.
Now, if you're curious to go deeper
on your own. I really liked a book
called The Essays of Warren Buffett.
And basically what they did in that
book is they broke down Warren
Buffett's letters to the
shareholders and they grouped by
topic.
And it's a great way to sort of
break out different parts of what he
tries to teach.
I've got an affiliate link to Amazon
in the description below.
If you're interested in supporting
the channel and interesting learning
more about the way Warren Buffett
thinks about investing.
OK. So for this video, I've broken
down Buffett's investing checklist
to four main groups when analyzing a
company.
So we have the business
that we have the financials risks
and then a portfolio check.
Now, the key for a beginning
investor is to be able to check
off each of these categories as
you've done the research.
And we think each category is good.
Now, obviously, we could go much
deeper than this if we wanted to.
But I think that this is a great
place to start, especially for new
investors.
Now, we're going to look a bit
closer at each of these four main
categories and we're going to try
to simplify it so a beginning
investor can easily find
out whether or not they think that
each category is good for a
particular investor.
Let's kick it off at the business
section. So broadly speaking, we
can break this business section
into two main categories,
understanding the business and the
company plan.
So how do we know if we understand
the business well enough or how do
we go about understanding the
business?
Well, there are three main things
that a new investor can focus on
to completely understand the
business or to more completely
understand the business.
First, we have the corporate
structure, then we have does
the company have any competitive
advantages?
And then I think the key to this
whole thing is understanding
how the company's cash flows
or better put how money flows
through the company.
Okay. Great.
And I'm sure we've all heard Warren
Buffett talk about each one of these
at some point or another, even if it
wasn't presented in an investing
checklist. Stop.
But the question is now, how do we
do this? Would we find this
information?
And for that, I think the most
important place to start is
the company's annual report.
So in the early part of any
annual report for a company, well,
there's going to be a business
section using
Coca-Cola, which is one of Warren
Buffett's largest and longest
holdings. As an example, if we use
that as an example, their business
section is only about eight
pages long.
But in that, they break down
both the corporate structure
and they talk about the competitive
advantage of the company.
Now, this is a great way
to set up understanding
how money flows through
the company or how the cash flows
through the company.
For that, we can also use
the financial statements, which
we're going to get to in a second.
Now, for the corporate structure,
what we care about there is how did
they look at their business?
So in the case of Coca-Cola as an
example, well, they break it out by
different segments. They have
Coca-Cola bottling and then they
have different regions.
They break it down.
Well, we want to know that because
if one region is doing better than
another, then that allows us
to analyze that region in isolation.
It makes it much easier to
understand the company.
If we know how the business or
how management of the business looks
at the company, knowing that
will help us define whether
or not there is a competitive
advantage. Warren Buffett calls this
a moat.
And then when it comes to the cash
flow, well, let's just illustrate
this real quick.
Just to give an example, using Coke
as an example, let's pretend
that Coca-Cola has 100 dollars
to work with.
Well, they have that hundred
dollars. And the first thing they're
going to have to do is start
creating product.
About 40 percent of that hundred
dollars goes to our goal goes
towards creating the product.
Well, then they have to sell the
product. About 32 percent
of that hundred dollars in Coke's
example goes towards selling
the products, selling general and
administrative.
Well, then they have to pay interest
for Coke. It's about a dollars.
I was about 1 percent of the total
hundred. So dollar goes towards
interest. Then they pay a few
dollars towards taxes.
Well, overall, they end up with
profit margins of about 20 percent,
which in our example is about 20
dollars.
Well, just creating this type of
visualization allows us to
better understand what's happening
with the company.
So if management comes out and says
that they've lower their lowered
their cost of goods by
10 percent or what?
Or increased it by 10 percent.
Well, we know that the number at the
top will get bigger or smaller
depending on what they've done.
This gives us a true understanding
of what's happening with the
business.
And I believe this would meet the
criteria that Warren Buffett has
laid out for.
You need to. Really understand a
business before you invest in it.
And this brings us back to our
checklist.
So in the checklist, we have growth.
And this is focusing on where
we believe the growth of the company
is going to come from in the future.
And then we have management versus
their own history.
And for this well, here we're
looking at in any
any report or quarterly report.
There's a section called Management
Discussion and Analysis.
And in that section, they're going
to lay out their business plan where
they see the growth coming from and
then what they think that type
of growth will provide for the
company.
So our question is, do we believe
in management's plan?
Does it make sense?
Do we think it's realistic?
And then when it comes to analyzing
management versus their own history?
Well, what we can do is we can
look at, let's say last year, a
management discussion and analysis
section and look to see what they
said they were going to do.
Did they do it?
Did it work out the way they will?
Did they over or underestimate
the impacts of their plan?
Well, if we would answer those
questions just a few times.
Just a few years.
Go on, Jim. Going back just a few
years. Well, we can get a much
better understanding of the quality
of that management.
Okay. Now, now, let's pretend that
we've completed everything on this
one checklist for the business
section. And we really like this
company.
If we really like it, we could check
off each of these boxes.
We like what they're doing.
We'd like their plan.
And we think that they have the
ability to pull it off.
Well, we can add a check on our main
checklist for our main groups here.
Well, now we can add a check to the
business section.
Then we move on to the financial
section.
Now, we don't necessarily have
to move on to the financial section.
If we have question marks about
the business section, we
should simply move on.
Warren Buffett says that investing
is a game where we don't have to.
That we can wait for the perfect
pitch. We don't have to swing every
time. If we don't like the company,
we don't like the business itself.
We can simply move on.
We don't have to waste our time
analyzing the financials.
But if we do, let's jump into the
financial section to see what we
should do over there.
Now, the financial section is a bit
easier and a bit faster to go
through. It's more just basic
numbers. It's a simpler checklist.
And here we're going to look at the
income statement, the balance sheet
and the cash flow statement in the
income statement.
Rule two of the most important
things we want to pay attention to
is growth, then profitability.
Now, when we look at growth, once
again, sticking with Coke as an
example.
Well, this is a chart of Coke's
revenue.
And clearly, we can see that Coke
is heading in the wrong direction.
So revenue growth has
been negative.
Now, when we look at the earnings
per share, well, now
this looks quite different.
We're not sure why we'd have to dig
into that. Maybe they bought back
shares. There's lots of ways this
could happen.
But getting an idea
of the growth overall we'll give
it will help us further understand
the business and how they're making
money. Now, what about
profitability?
Now, usually we can see
profitability in the margins.
So for that, we weren't gonna want
to check gross margins, operating
margins and net income margins
using net income margins as an
example.
Well, this is Coke's net income
margins and we could see that Coke's
net income margins actually got
stronger.
Okay, that's a good thing.
Now we sign onto the balance sheet
where we're going to look at two
main categories, liquidity
and debt.
Now, for liquidity, there
are a few ratios or a few important
liquidity ratios that Buffett says
are important.
A lot of it depends on the industry.
But broadly speaking, we're looking
at the cash ratio.
The current ratio, the quick ratio.
And he also likes debt to equity.
Now, debt to equity helps push us
to our debt analysis.
So here we're looking at ratios
like the debt to equity ratios.
But we should also look at interest
coverage.
And another great shortcut
for understanding the balance sheet
and debt in general is to look at
the company's credit rating.
Oftentimes, a rating agencies
will map out what they like, what
they dislike about a particular
balance sheet.
So overall, obviously, we
want debt to be as low as possible
and we want the company to have
at least enough revenue
to cover any interest payments that
they may have to make or when they
have to return the principal of
bonds to their investors want
to make sure they have that cash on
hand. And this leads us to the last
section of financials, and that is
the cash flow statement.
Now, in the cash flow statement,
I think it's best to focus on free
cash flow.
Flag is always preaching the
strength and the importance of a
company's free cash flow.
So for that, we're going to want to
look at the operating cash flow
section of a company's cash
flow statement.
And we're going to look at what we
look at capital expenditures,
how our capital expenditures
trending. Are they trending higher,
lower? How do they compare relative
to the cash flow from
operations?
Those are the two most important
numbers on the cash flow stream.
Ideally, the higher the cash
flow from operations is, the lower
the capital expenditures are.
That means we're gonna have higher
free cash flow.
That's a raft of them.
Okay. Simple enough.
Now, jumping over to our third
section and this one is
risks.
Now the final two sections here,
they're gonna be there a bit
quicker and easier.
So we should move through this whole
thing a much faster.
And under the Risks section, we're
first going to look at self check
and then second is pre
by questions, especially
for beginning investors.
These are questions that we shall
always ask ourselves before we go
ahead and buy the stock.
So under self check,
the first thing we need to ask is
where could we be wrong in our
analysis?
And basically, this gives us a
chance to say, OK, what
if the plan doesn't work or what if
margins get worse?
What if they get better?
Or what if they make a new
acquisition? Does that acquisition
play out?
This is a chance for us to challenge
our own investment thesis
in doing this.
We're going to get a better
understanding of what we
should look for either on the
positive side or on the negatives.
And then we want to ask ourselves,
is anything here too good to
be true?
Maybe their profit margins
are way higher than their
competitors, or they
have almost no debt or the
growth rate is significantly
better than everybody else's.
And this is a good this is an
important point, because
through almost all of this, we're
going to want to compare our company
wherever we're analyzing to
other companies, because if
we don't have something to compare
to, how do we know if something
looks too good to be true?
So at this stage of the game, it's a
good chance to go over and analyze
a few competitors, even if we just
do, let's say, the financial section
for competitors to give us something
tangible to compare our company
to and then into the
pre buy questions.
Well, here the first thing we want
to do is compare our potential
investment to other potential
investments doesn't necessarily have
to be in the same industry.
You might have two investments that
you're considering that you're waiting
for and comparing which
one should get our capital first.
We all have a limited amount of
capital, so we want
to be very careful with where we put
our investments, what where we put
our money to what which investments
we put our money into.
Now, when I was reading through
Buffet's shareholder letters,
I I noticed how often he talked
about the quality
of his investments versus another
investment and or an opportunity
versus another an opportunity.
So I think for new investors, this
is a great place for any investor.
This is a great place forward for us
to consider. Quick, quick question
for us to ask ourselves.
Okay. And then we ask ourselves,
does this investment have the margin
of safety we need to get involved
in? No. I actually did a whole video
on margin of safety, so I got the
links in the description below, if
you're interested.
But assuming that we love
a business and they have solid
financials and we're checking off
each of our boxes and we say, OK,
this is something we want to get
involved with, the concept
of margin of safety is where do we
get involved with enough
upside to make it worth the risk
because every investment in the day
has some risks.
How do we limit that risks as much
as possible?
Once again, hold video on that if
you're interested.
And this brings us to our final and
perhaps most underappreciated
aspect of building a great
investment portfolio for
beginners or really for anybody.
And that is taking a big picture
look at our portfolio.
So first thing we're gonna want to
do is look at the correlation to
our current portfolio.
So if we're considering adding an
investment, how does that investment
fit in to the portfolio as a whole?
If we own three automobile
companies, does adding a fourth
automobile company help all that
much? So we want our
correlation to be as low as
possible.
And in theory, if with
a lower correlation, if one if one
of our stocks fall, well, perhaps
this one won't do as bad.
Maybe it even does a little bit
better.
That being said, this leads nicely
into the next one, which was
are we sure that we have the best
investment type?
So maybe instead of buying stocks,
we should buy bonds or preferred
shares or stock options.
We have to see which one fits our
situation the best.
Now for beginning investors, I think
it makes the most sense to stick
with mostly stocks or bonds.
But if we have a company that we
love and they have great financials,
but perhaps growth isn't where
it needs to be overall,
or perhaps the pricing of the
stock is just too high.
Maybe they have their bonds
are pressed a little bit better.
Maybe that provides the interest
income that we need from
this company. Oftentimes by
companies issue convertible bonds
that can be converted into stock at
a later date.
That might be a great investment.
So pausing to reflect
on do we have the best possible
version of this investment makes
a lot of sense for an investing
checklist.
Okay, so that's our entire
Warren Buffett investing checklist
for beginners.
And like I said, we could go much
deeper into this for more advanced
investors.
So if you're interested in seeing
something like that, please let me
know in the comments below and I'd
be happy to put some like that
together. Do you think that I missed
anything on that?
Buffett would have been.
Had he ever put out an investing
checklist, please let me know what
you think in the comments below.
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