The Little Book of Investing Like the Pros

Chapter TwoStep II: Identifying the Best Ideas Now you have a list of ideas, what's next?

The initial idea generation process outlined in Step I is designed to produce a short list of stocks for further consideration. This “short list,” however, may include several dozen or more potential ideas. So, how do you analyze all these opportunities in an orderly fashion?

Pros turn to an organized process to help sift through potential investments early on and assess whether they merit further consideration. In this chapter, we provide a framework and accompanying template to help you accomplish this. Our framework centers on investment thesis, business model, management, risks & considerations, and financials & valuation.

When filtering ideas, pros tend to apply certain criteria or “bright lines,” typically informed by past winners and losers. They may be based on financial parameters related to size, growth, profitability, leverage, or valuation—e.g., companies with a market cap above $1 billion, earnings growth above 10% annually, or leverage below 3x. Others may focus on specific sectors, such as consumer, industrials, or telecom, or situations, such as M&A, spin-offs, or turnarounds. You will develop your own rules of engagement over time. But, remember that successful investing requires continuous learning and adaptability. Bright lines can always be revisited.

When reviewing your initial list, certain ideas may jump off the page as potential core investments. In most cases, however, ...