Happy Sunday! It's a great day to build your investing framework!
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I had a breakthrough this week.
For the last couple of years, I've been making investments based on a floating framework in my head. Because I haven’t taken the time to write it down, my decisions have been more about emotion and popular opinion than reason and a well-thought-out process.
Like a museum curator, I have been collecting frameworks to display on my Twitter page without taking the time to use them for their intended use.
That changed this week when I ran (RILY 0.00%↑ ) through David Gardner's 25-Question Risk Assessment. If you want to see how they scored, you can click on the Tweet below, but it's not the score that I want to tell you about, it's what I learned from the process.
Here's what I realized:
My biggest weakness in stock picking is my understanding of financials. Over the last year, I have taken a course, watched YouTube tutorials, and read multiple books on the subject. Again, I was collecting this knowledge without putting it into practice.
As I began to run RILY 0.00 through the 25-question framework, I understood why I had put it off for so long. The 10Ks and SEC filings are challenging to navigate. Sometimes you find conflicting numbers, and the information is difficult to interpret, but as I sorted through the documents, I began to gain confidence.
While I am not confident in the thoroughness of my 25-point risk assessment of RILY 0.00 (I've got a lot to learn), the key to growth is continuing to run businesses through the frameworks I have collected.
The framework is a map. It tells you where to go and becomes second nature when used consistently. Instead of depending on the map, you rely on your experience and new knowledge. Using maps (frameworks) others have designed helps you decide what you want yours to look like.
This may seem obvious, but it was a big breakthrough for me. Moving forward, I intend to put the frameworks I've been studying to good use. I will learn to navigate through a 10K and SEC filings and share my learnings as I go.
If you find yourself in a similar place, I hope you find my journey encouraging. This week, a friend joined me in running a business through the 25-question risk assessment. You can see her analysis of Ford (F 0.00%↑ ) below.
Having someone else go through the process with me was helpful. Not only did it hold me accountable, but we were able to compare notes and learn from each other.
My hope for this newsletter is that it will develop into a community of like-minded investors that learn from each other and offer encouragement in what can sometimes feel like a lonely process.
This week I am inviting you to join me for another framework challenge. As you know, I'm a big fan of John Rotonti (Head of Analyst Training at The Motley Fool). I have highlighted some of my favorite articles from John in a previous edition of The Investors' Library. His Investing Checklist is one of the most thorough I have seen.
This week, I will run GXO 0.00%↑ through his checklist questions on the balance sheet (attached below). I'd love for you to pick a company and run it through the checklist. You can share your work with me on Twitter or in the comments below.
1. Does the business have a strong balance sheet, preferably with net cash?
◾Does the business have net cash or net debt? Large net cash positions can be a key source of optionality.
◾Are the company's debt and net debt levels increasing or decreasing?
◾How does the company use debt? Is it strategic (issuing long-term debt at today's record-low interest rates), is it out of necessity, or is management mortgaging the company's future to buy back stock and increase the dividend while underinvesting in growth and adaptability?
◾What is the cyclical nature and capital intensity of the industry? Is the business both cyclical and capital intensive (something that is often a bad combination)?
◾Does the company have a lot of operating leverage and financial debt leverage (a bad combination if sales start to fall)? Operating leverage works both ways: If sales fall, earnings fall faster, and the company's interest coverage ratios fall, making it more difficult to service its debt.
◾What is the company's cost of debt (the interest rate it pays to borrow money)? What are its maturities on its debt (repayment schedules)? And can the company withstand rising interest rates?
◾What percentage of the debt is fixed-rate versus a variable rate?
◾What amount of debt is corporate debt versus bank debt?
◾What are the size of pension obligations and operating leases?
◾What is the company's credit rating?
◾What are the company's financial health ratios including net debt to free cash flow, interest coverage, debt to equity, debt to total capital, net cash to total assets, net cash to market cap, and goodwill (intangibles) to total assets?
◾If we ever have another economic shutdown as we experienced in the first and second quarters of 2020 in response to the global coronavirus pandemic, how long can the company's cash on its balance sheet cover the company's total annual expenses on the income statement (assuming the company generates zero revenue)? This is the ultimate stress test.
Are you up for the challenge?
If so, let me know. Either way, I’ll see you back here next week to share what I learned.
Before I go, here are two podcasts I enjoyed last week.
Tim Ferris hosted Bill Gurley on the Tim Ferris Show. Bill shares several investing lessons and some entertaining stories. It’s worth a listen.
Daryl Morey was on Invest Like the Best this week and did not disappoint. Morey is great at helping investors think outside the box.
Love the breakthrough! Isn't it interesting how we collect frameworks as if curating these alone is enough to help. But one framework thoroughly applied beats dozens of frameworks never put to use. Really great stuff this week!
Jason, this is helpful to me. I am a business as mission and church planting guy living in Ghana. I love digging through data, but haven't jumped into investing. You are giving me some ways to think and have confidence that this is something I could do. I am not ready to do an analysis this week, but following you...yeah, I will jump in soon.
Thanks for the nudge!
I am glad I found you through Ship 30!