A Suggested Investor’s Checklist

Introduction

In financial matters, operating through a checklist is very useful. This is the best way to avoid pitfalls one is likely to commit in the heat of a moment. Most of the investment options will reach you through a smart marketing campaign and, apparently, will look quite attractive. Hence, it is important to have a checklist ready that should help you quickly see through such options for their validity and viability. The most important point, in this regard, is to have a skeptical mindset that should have a bias towards ruling out all the grey areas and seeing clearly whether a particular risk is worth taking or not. After having made the checklist, you must pre-commit to yourself that every investment decision has to pass through this checklist before you finally pull the trigger.

Before going to a concise investment checklist, I recommend that you read my blog post: Personal Finance – A Suggested Checklist.

I also presume that you have a fair idea about debt, equity, and real estate as investment options and you tend to prefer equity over real estate. For more clarity, please read the following posts:

Debt, Equity, and Real Estate: An Overview

How to Compare Equity and Real Estate as Investment Options?

A Suggested Investor’s Checklist

Here is a suggested investment checklist. You may either follow it, wholly or partially or have your own. However, I strongly recommend that you have one.

• The first thing to ensure in your investment journey is to pay off all your debts except the home loan, if any. There is no point in investing if you are under debt. It is going to be a zero-sum game that must be avoided.
• The second pre-condition for investing is to build an emergency cash reserve for unforeseen situations. If you don’t do this before starting to invest, you might be forced to liquidate some of your investments prematurely. You might even have to book some losses.
• After having done these two things, you are now “investment ready”.
• Increase your savings rate as your income grows. This way you will have more funds available for investing.
• The next step in the sequence is to clearly define your investment objectives in broad terms. Following is suggested in this regard:
  • To preserve the corpus/ principal at all costs.
  • To beat inflation.
  • To earn an adequate return consistently, on a long-term basis.
  • Adequate but consistent return on a long-term basis is far better than attempting a big return in a short term.
• Before starting to invest, you should have basic knowledge about how to read financial statements and how to draw relevant inferences from them.
• The minimum investment horizon should be 5 years. Any money that you may need before that should not be invested. It is better to keep it parked in a debt instrument.
• Diversification is a fundamental principle of investing. The suggested size of a particular investment is minimum 5% and maximum 10% of the total invested amount. The recommended size is small enough to prevent any big loss in case something undesirable happens and big enough to be meaningful if it does well.
• Minimum 50% of your investment should be in high dividend yield companies. However, with the remaining 50%, you may target some growth companies. With the increase in age, your risk appetite should gradually reduce and you should keep increasing your capital allocation to stable, high dividend-yield companies.
• You should not buy an investment in one go. It is better to buy in small chunks over a considerable length of time. Dollar-cost averaging (Systematic Investment Plan) without trying to time the market is the best strategy.
• Avoid following, unless according to all other parameters, you feel very strongly about a particular investment option:
  • Cyclical businesses.
  • B to B businesses.
  • Government-owned companies.
  • IPOs.
• Anything that is being aggressively marketed, take it with a pinch of salt.
• The company that you are considering for investment must have following attributes:
  • Should be financially very healthy.
  • The management should be capable and honest.
  • The account books should be absolutely clean.
  • Should own some very strong brands to enjoy the pricing power.
  • Should have a sufficiently long track record to prove the above qualities i.e. minimum 5-7 years and ideally 20 years and above.
• While analysing the financial statements, before making the final decision, carefully see the following numbers:
  • P/E ratio should not be very high. P/E ratios should be compared within the sector. A high P/E ratio means the stock is expensive. However, if the company is outstanding on all other criteria, a higher ratio should be acceptable.
  • Look for companies with steady earnings growth. If you can find a company that is posting minimum 5-10% earnings growth every year, at least for 5 years, you should buy such a company even at a premium.
  • Return on capital employed (ROCE) is an important parameter. The minimum cut-off should be 15%. Take the average of at least 5 years and target higher ROCE.
  • As already explained, try to invest in companies with a high dividend yield. Also, relate the dividend yield with the payout ratio. A higher yield for a less payout ratio is preferable.
  • See how the company is planning to utilize its retained earnings. A company that can smartly use its retained earnings is better.
  • An important consideration for investment in a company is its cash flow situation. There should be congruence in earnings and cash flow. The cash flow should be, more or less, equal to its earnings. A company with an irregular cash flow should be avoided.
  • Debt-laden companies should not be considered for investment as their survivability during challenging economic conditions is questionable.

Conclusion

I strongly recommend that, as an investor, you should maintain a checklist. This will help you avoid investment errors which can prove very costly. Following a checklist can improve your performance as an investor manifold.