Due-Diligence Checklist
A checklist to reference while performing due diligence on a company.

Sector/Industry

  • The Product
    • What is the sector primarily selling?
    • How is the sector sub-classified based on product segments? (for example, FMCG can be categorized into home care, personal care, food products, etc)
    • What is the market size for the product?
    • Is the product prone to disruption from an alternate solution?
  • Brief History / Key Events
    • What are some key events that have had material impact on the industry?
    • What are the domestic policies that affect the sector; what forthcoming policies are expected; how will they affect the sector?
  • Value Chain
    • What are the key raw materials & machinery/equipment required to build the product?
    • Where does the sector largely source these raw materials & machinery/equipment from?
    • What are some geographical advantages that preferred production destinations enjoy?
    • What kind of labour force/workers are required for conducting the production process?
    • What are steps involved in the core production process?
    • What is the preferred strategies for marketing, distribution, delivery & installation of the product?
    • How capital intensive is the production, marketing, distribution, delivery & installation of the product?
  • Market Overview
    • How mature is the sector domestically? Is the sector expecting a turnaround from the current trend?
    • How is the product's market share split between organized & unorganized players? Which way is the market leaning now?
    • How is the product's market share split between domestic & international players? Which way is the market leaning now?
    • Who are the key players that set the trend for the sector? (in terms of pricing power, product innovation, market practices)
    • Who are the emerging players that could have material impact on the trend for the sector?
    • What barrier to entry does the sector enjoy?
  • Industry Benchmarks / Key metrics
    • Industry's preferred benchmark for capacity
    • Industry's preferred benchmark for utilization
    • Industry's preferred benchmark for consumption

Business

  • Brief History/Key Events
    • When was the company founded?
    • What are some key events that have had an impact on the core operations of the company?
    • What are some key events that have had material impact on the stock price?
  • Value Proposition
    • What is the company primarily selling?
    • What product segment is the company catering to?
    • Where does the product fit in the market? Is there something that differentiates the product against competitors?
    • What is the addressable market size for the product?
    • What is the product's market share, mind share, or position in the market?
  • Business Model
    • A brief overview of the business model of the company.
    • What are the growth avenues for the company?
    • How does the company market its product?
    • What is the capital allocation policy of the company?
    • What is the earnings retention policy of the company?
    • What is the dividend distribution & buyback policy of the company for earnings not retained?

Financials & Ratios

  • Profit & Loss Statement
    • What does the revenue & profit breakup look like between different businesses of the company?
    • What does the revenue & profit breakup look like in terms of the geographies the company sells to?
    • What has been the revenue growth for the past 3, 5 & 10 years?
    • What has been the EBIT (earnings before financial costs & taxes) growth for the past 3, 5 & 10 years?
    • What has been the net earnings **growth for the past 3, 5 & 10 years?
    • Is the revenue of the company overly concentrated within a few clients?
  • Balanced Sheet Statement
    • Is the balance sheet clean/strong?
    • How does equity dilution look like in the past few years for the company?
    • How much cash, or equivalents does the company hold currently?
    • What's been the major capital expenditures that the company has done in the past few years?
    • How does regular capital expenditure look like for the company?
    • What is the quantum of debt obligations for the company?
    • Is there inventory building up for the company?
    • Does the company face issues with collecting cash — Is there receivables building up for the company?
  • Cash Flow Statement
    • Are cash flows from operations comparable to net earnings?
      • If CFO > Earnings, cash is not translating to earnings in the P&L statement
      • If CFO < Earnings, there may be early revenue recognition without realizing/collecting it
    • How much cash is being left after tending to operational expenses and capex (free cash flows)
    • Are there any anomalies/red flags in the cash flows of the company?
  • Profitability Ratios
    • What has been the trend for operating margins for the past few years?
    • What has been the trend for net profit margins for the past few years?
    • What has been the trend for return on capital (roic/roce) for the past few years?
  • Capital Ratios
    • Is the company over-leveraged? (in terms of debt to equity etc)
    • What is the latest cost of equity, cost of debt, & thus weighted average cost of capital for the company?
    • Is the company able to service its debt obligations? (in terms of interest coverage ratio, quick ratio etc)
  • Efficiency/Operational Ratios
    • How much time does it take for the company to convert its investments into cash? (in terms of cash conversion cycle)
    • How much time does it take for the company to convert its inventory into sales? (in terms of inventory days/inventory turnover)
  • Industry Benchmarks
    • How does the company stack up against peers in terms of industry benchmarks (like capacity utilization, average revenue per user, revenue per room, gross merchandise value etc)

Management

  • Overview of promoters & management
    • Are the managers of the company competent enough to run it?
    • Is the management style overly conservative or aggressive?
    • Have the actions of the promoters or managers been in the interest of minority/retail shareholders?
    • Have the promoters or managers been transparent & integrous in actions that impact the operations or valuations of the company?
    • Is there a proper succession plan in place for key positions of the company?
    • Is the management of the company being remunerated more than they should be?
    • Do the promoters or managers of the company communicate well with the shareholders (hold conference calls, conduct interviews, answer to investor relation emails, etc)?
  • Shareholding Pattern
    • What has been the trend for promoter shareholding in the recent past?
    • How does the distribution look between retail and institutional shareholding?
    • Is there enough free float? Are the shares of the company liquid?
    • Is the quantum of shares pledged a concern?
  • Red Flags
    • Is there any pending litigation against the promoters or managers that can materially impact the stock?
    • Is there any pending litigation against the company that can materially impact the stock?
    • Are there too many/suspicious related party transactions taking place?
    • Is the structure of the company too complex (in terms of subsidiaries, holding companies etc)?
    • Are there any red flags in the auditor notes?

Valuation

  • Multiples
    • What multiples have been used to evaluate the valuation of the company, if any?
    • How do the multiples compare versus peers in the same sector?
    • Is there a significant discount for risks that the multiples of the company suffer from? Why?
    • Is there a significant premium for moats that the multiples of the company enjoy? Why? Does the moat show up in financial statements?
    • Has there been a significant rerating of multiples for the company? Why?
  • Valuation Models
    • Have you used any valuation models (such as Discounted Cash Flow or Discounted Dividend or Sum of parts) to evaluate the company?
    • If a valuation model has been used, what is the approximate intrinsic value of the stock as per the model? What discount does the stock price enjoy with intrinsic value in context?
  • Valuation Philosophy
    • Would you characterize buying of the stock as value investing, or growth investing?
    • Is there adequate margin of safety in an investment in the stock? What constitutes it?

Investment Thesis

  • Consideration of investment
    • What is your primary thesis for investing in the business?
    • What is the expected duration for which the company is being bought?
    • What are the quantitative factors that could invalidate this investment thesis?
    • What are the risks or threats that could cause invalidations to this investment thesis?
    • What would conclude your investment in the company if everything goes according to the thesis? What is the exit plan?
    • Is your investment thesis in consensus with other participants of investing forums such as r/IndiaInvestments Subreddit/discord or ValuePickr? Does this classify as a contrarian bet?
    • Is your investment thesis based on a corporate action or a key event that would have material impact on the stock price? Does it therefore qualify as a workout investment?
  • Should this transaction be avoided?
    • Where does the primary thesis for this investment come from? Was it peddled on a news channel/social media post or did it come into your radar as a consequence of independent research?
    • Is the investment being done due to Fear of missing out on positive price action momentum?
    • Can the investment qualify as a case of Catching a falling knife?
    • If you're exiting an investment because it has fallen significantly/sharply, is it because something has changed fundamentally about the business or its future earning potential?
    • How does the stock fit into the overall portfolio? How much do you own of that sector/country already?
  • Staying on track
    • Does the latest Quarterly earnings report validate or invalidate your investment thesis?
    • Does the latest Annual report provide you any material information that could validate or invalidate your investment thesis?
    • Does the latest Investors call or management interview provide you any material information that could validate or invalidate your investment thesis?
Last modified 3mo ago