Equity Portfolio Construction .. Checklist

ref: http://www.safalniveshak.com/wp-content/uploads/2014/12/Interview-with-Stable-Investor-PDF.pdf

Good equity investment should leave you with a lot of free time, which you can spend the way you like, instead of worrying about where the business is headed. Questions to ask every time you look at a business that can potentially become a part of your equity portfolio:

1. Is this business inside my circle of competence?
2. Is the business simple to understand and run? Complex businesses often face complexities difficult for its managers to get over.
3. Has the company grown its sales and EPS consistently over the past 8-10 years? Consistency is more important than speed of growth.
4. Will the company be around and profitably better in 10years? This suggests continuity in demand for the company’s products/services.
5. How well has the company done in retaining its earnings?
6. Does the company have a sustainable competitive moat? Pricing power, gross margins, lead over competitors, entry barriers for new players.
7. How good is the management given the hand it has been dealt? Capital allocation, return on equity, corporate governance, performance against competition.
8. Does the company require consistent capex and working capital expenditure to grow its business? Companies that have to spend continuously on such areas are like running on treadmills, which is not a good situation to have.
9. Does the company generate more cash than it consumes? Cash generators have a higher probability of surviving and prospering during bad economic situations.

DuPont Model's three key factors that determine the quality of a business - 

1. Generating profits (net profit margin)
2. Managing assets (asset turnover)
3. Finding an optimal amount of leverage (financial leverage).

ROE(Return on Equity) = (Profit margin)*(Asset turnover)*(Equity multiplier) = (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)= (Net Profit/Equity)

Note:

Profitability is measured by profit margin

Operating efficiency is measured by asset turnover

Financial leverage is measured by equity multiplier