5 filters on value investments

1. Good Management.
Without a good management, no matter how compelling the valuation is, it is not investor's money. Bad management has many ways to destroy shareholder value, bad acquisitions, bad stock buy-backs, bad expansion strategy..., just to name a few. That said, a mediocre management is acceptable, if all the other aspects are very compelling. However, bad management is never acceptable not matter what, at least not for an "investment".

Good management means honest/integrity and competent. Among these two, honest/integrity is more important. An incompetent management might make a lot of mistakes and no smart decisions, but still it won't destroy too much value.

2. Safety.
This is considering the worst scenarios, or whether there is a significant chance for bankruptcy. Apparently, companies in cyclic sectors, with low profit margin or operating margin, with high debt ratio, rely on single supplier or customer have low safety and uncertainty. Low safety doesn't mean the risk-reward ratio is always bad, but it may not fall into the "investment" category. In that case, it becomes a speculation.

3. Valuation.
This means the stock is relatively cheap comparing to its growth, earning, asset and cash flow.

4. Durable competitive advantages.
Over long term, it is the durable competitive advantage that could maintain consistent high profit margin and above average growth. This is not a must-have though, if the valuation is more focused on current cash flow or asset, and the current earning is not subject major changes if other competitors enter the field.

5. Within circle of competence.
This is what Buffett emphasized in most of his talks. Without deep understanding of the industry, it is hard to really gain any advantage on information. And most retail investors don't have deep understanding of the industry, unless this is the field he/she worked on for many years. So a work-around could be getting some confirmation from some trustable gurus, plus a fair amount of understanding on the field. The effectiveness of this approach still needs to be tested though. This is probably the hardest part for normal investors.

Other non-mandatory filters include Catalyst and Growth. Having a catalyst will improve the efficiency of capital usage. And having good growth potential will increase the upside potential since the fair value varies a lot when the growth rate shifts a little bit. This part is especially important if the intention is to hold stock for many years without selling (like Buffett).

5 filters in the checklist seem to be a lot to remember, but underneath, there really is just one thing: "certainty". I use these filters to achieve high "certainty". That is what Buffett calls "never lose money", what Graham calls "investment, not speculation", and what James Rogers calls "do absolutely nothing unless there is something really worth doing"