“A fool and his money are soon parted”
Holds true in investing too, how not to be such a fool is a very important part of investing.
Forensic analysis, channel checks, corporate governance evaluation, corporate structure & analysis of related parties are some facets that one needs to focus on to minimize the possibility of someone playing you for a fool. There is nothing more infuriating or frustrating than to be taken for a ride, especially as a minority equity investor who has no say in most things about the underlying business.
It is qualitative, back breaking work that is not sexy. Yet, this is what gives you the conviction to bet big when you see undervaluation. Without doing this leg work, you will at most make some money when you see an interesting story, you are unlikely to create wealth.
When you do the work, you also have the comfort that the story is unlikely to sink your capital. Unless you have lost 80%+ of your principal in an investment, you will not understand the importance of this aspect.
Frameworks and checklists work very well in doing qualitative due diligence on a business. They ensure that you cover all bases and consider the perspectives that are worth considering. This does not ensure you make good returns from an investment, but it does minimize the possibility of losing a chunk of your principal on any investment over the medium term.
Rule 1: Never lose money
Rule 2: Never forget rule 1
This is a quote attributed to Buffett himself. By now you should get the drift of how important this is.As is always the case, the focus of any publication here is on tangible takeaways that can improve the odds of investing outcomes. What follows next is a broad summary of what I do to minimize the possibility of me being a fool, what works for me should work for you too.
Always understand the industry well first, benchmark all the players before getting into the specifics of a particular business. Most businesses would be clustered around the average for that industry on unit economics, outliers always demand a deeper look before taking their numbers at face value.
Base rates exist for a reason, the outside view should be the starting point.
Once again, this is not a comprehensive exercise by itself. My corporate governance checklist has more line items than those listed above. I also triangulate the insights from credit rating reports and see if the story adds up before coming to any conclusions.
Governance checks call for the investor to think like a detective, any possible loose end has to be investigated thoroughly before coming to any conclusions. This is not the domain of black and white thinking; it is a qualitative domain where one can never be certain of the situation. Investors with some amount of worldly experience and wisdom are likely to do better than a 25-year-old Ivy league graduate.
None of this can rule out accounting errors/frauds totally but it does reduce the possibility of you getting caught in a story that had some obvious red flags to begin with.
Do whatever it takes to not be a fool in investing.
Do the work, don’t just go around quoting Buffett to impress people.
Saying is not the same as doing.
Anyone can read a book and quote from it.