A reading checklist
The reading checklist
Seven questions to ask before you buy - most of the time, they help you say a fast, confident no.
You are in a hurry. Fine. This is the shortest honest path through a company. It is built to help you REJECT quickly - because the money is made mostly by the ideas you skip, not the ones you chase. Work top to bottom. The moment an answer is a clear no, stop: you are done, and you just saved yourself. If an idea survives all seven, you have not found a 'buy' - you have found something worth the slow, full read. Every line links to the deeper reading. This is a method, never a tip, and never advice.
- 1Circle of competence
Can you explain, in two plain sentences, how this company turns effort into cash?
If you cannot say what it sells, who pays, and why they keep paying, you are not investing - you are guessing on someone else's story. Knowing what you own is the whole game.
Warning signs
- You reach for the company's own slogan or a news headline to explain it.
- The business 'does many things' and you can't name the one that makes the money.
- You'd struggle to explain it to a school student.
When to stopReject if you can't explain it simply. Not your circle - not your problem to solve.
- 2The cash test
Does the reported profit actually show up as cash?
Profit is an opinion; cash is a fact. A company can look profitable for years while no real money comes in. The gap between the two is where most accounting trouble hides.
Warning signs
- Profit rises but operating cash flow stays flat or negative.
- Receivables (money owed by customers) or inventory grow much faster than sales.
- 'Exceptional' or 'one-time' items appear almost every year.
- Profit depends on revaluing assets or 'other income', not the core business.
When to stopReject if profit never turns into cash. Good businesses eventually get paid.
- 3Whose side is management on?
Do the owners treat outside shareholders as partners - or as a wallet?
You are buying a minority stake. If the promoter and management do not respect small holders, the best business in the world can still leave you with nothing. In India this is the single most decisive check.
Warning signs
- Promoter shares are heavily pledged (borrowed against).
- Lots of related-party transactions - money flowing to entities the promoter also owns.
- Promoter holding quietly falling, or dilution that hurts small holders.
- A history of broken promises, or of treating the listed company as a personal ATM.
When to stopReject on a pattern of minority-unfriendly behaviour. One warning is a question; a pattern is an answer.
- 4Start from the base rate
Most companies do NOT compound for a decade. What makes this the rare one?
The story in front of you always sounds special. The odds say it usually isn't. Begin by assuming the company is ordinary, and make it earn its way out of that assumption with evidence - not with a good narrative.
Warning signs
- Your case rests on the future ('it will dominate'), not the record ('it already does X').
- You're comparing it to the one legendary winner, not to the hundred that faded.
- The whole thesis is a story you find exciting.
When to stopReject if the only thing carrying the idea is a story. Excitement is not evidence.
- 5Invert - what kills it?
Name the three things that would destroy this business. Is any of them already happening?
Don't ask why it will win; ask how it dies. Most bad outcomes are visible in advance if you look for them on purpose. If a killer is already in motion, no amount of upside makes up for it.
Warning signs
- A bigger, cheaper competitor can copy the product in a year or two.
- One customer, one supplier, one regulation, or one raw material can sink it.
- The moat you imagined is just 'they got there first'.
When to stopReject if a business-killer is already underway. You don't need to be a hero here.
- 6What is the price already assuming?
What growth is the price ALREADY baking in - and can the business beat that, not just meet it?
A wonderful company at the wrong price is a bad investment. The price you pay already contains a forecast; you only make money if reality turns out better than that forecast. 'Good company' and 'good buy' are different questions.
Warning signs
- The price only makes sense if near-perfect growth continues for many years.
- Everyone already agrees it's great - so the greatness is in the price.
- You're paying up for growth that may be destroying value, not creating it.
When to stopReject when the price already assumes the happy ending. No margin of safety, no trade.
- 7Size it so a mistake can't ruin you
If this read is wrong - and some will be - can you survive it comfortably?
Selection is only half the job. Even a great read fails sometimes. The size of the bet, not the brilliance of the idea, decides whether one mistake is a lesson or a disaster. Survive first; compounding needs you to still be in the game.
Warning signs
- The position is so big that being wrong would hurt badly.
- You're borrowing, or betting money you may need soon.
- You already have enough, and are risking it to chase more.
When to stopIf you can't size it so a loss is survivable, the answer is smaller - or no.
If most ideas end in the reject pile, the checklist is working.
That is the point, not a failure. A good reader says no far more often than yes. If you don't have the time or interest to do the slow, full read on the few that survive, the honest default for most people is a low-cost index fund - you own the whole haystack and skip the guessing. Nothing here tells you what to buy. It is a way of reading, so that when you do decide, you decide for reasons you can defend.
Browse every idea in the principles library, or read how the great investors actually did it in the investor studies.