What are the investment criteria?

There are four primary questions that have to be answered affirmatively before I can be interested in an investment.

First, is the business within my circle of competence?

As a patient long-term investor looking to compound capital, I am interested in industries where I can contemplate how they may look ten years down the road. In other words, I am only interested in investments that I find to be relatively stable. By this measure, businesses in Bitcoin or Biotech industries will tend not to fit my personal criteria. Fortunately, there are a number of sectors like Consumer Staples, Financial Services, or Technology that do fall within my circle of competence. We only need a handful of businesses, carefully selected, and patiently held, to create wealth.

Second, is this a good business?

In evaluating if it is a good business, I ask:

• Does the business have a long-term sustainable competitive advantage?

• Does the business generate a high return on capital employed, in cash?

• Is the business self-funding or does it rely upon external financing?

• Does the business have opportunities to redeploy such capital back into the operation?

Third, is the business run by honest, competent and talented management team?

In evaluating the quality of the management team, I look at the history of capital deployment and the efficacy of such, compensation and incentive programs for the management team, and the management team’s ownership interest in the business.

I tend to use the quality of management test as a negative filter, i.e., discarding the company from further analysis if current management has made questionable capital allocation decisions, or the compensation and incentive payment structure is heavily skewed in favor of management team. Rarely would I assign a premium valuation to what I believe is the intrinsic value of the business to be, based on the quality of the management.

I find owner-operated entities to have honest, competent, and talented management teams with appropriate compensation programs, and skin-in-the-game. As such, I favor owner-operated entities.

Fourth, is the company trading at a reasonable valuation?

I follow the simple tenet that the value of a business is the present value of all future streams of cash. I estimate what the free cash flow of the business is and is likely to be in the future. I decide to invest only when free cash flow per share as a percentage of the company’s share price (free cash flow yield) is demonstrably high relative to long-term risk-free rate.

Due to the nature of the capital structure of certain financial services companies like banks and insurance companies, I tend to value those based on book value or franchise value.

Since the exercise of valuation involves many assumptions, my primary objective is to be approximately correct and not precisely wrong.