The Little Book of Investing Like the Pros

Chapter ThreeStep III: Business & Financial Due Diligence Time to take a deeper dive on your best ideas

It's now time to perform detailed business and financial due diligence. Many of the diligence items outlined below were researched at a high level in Step II. You gained initial ­comfort to justify additional work. Now, you are set to take a much deeper dive.

For business diligence, you are trying to figure out the quality of the company's operating model. Is it a ­sustainable business with a strong moat? Alternatively, has it been struggling but you see a path to redemption? Much of this analysis is qualitative, requiring sound judgment and insight. Experience and familiarity with specific business models and sectors is particularly helpful. We will help you develop the skills to quickly dissect a business.

For financial diligence, you must examine the company's core financial statements to determine where it has been and where it is going. A large portion of this analysis is making observations about key financial items and seeking defensible answers. Why are sales going up or down? Why are margins expanding or contracting? Getting answers to the “why's” is critical.

Your overall diligence should go beyond simply identifying companies with high-quality fundamentals. Embrace the flexibility and creativity needed to unearth less obvious opportunities, including underperformers with potential for substantial improvement. The latter requires high conviction gained through deep ...