The other day I was attending a party in the neighborhood. As I introduced myself and presented my plans for money management under a structured vehicle of investment partnership, one of the guests posed me a question: Sachin, so what is your edge?

It is a fundamental question and one that I have given significant thought to. In one of my future posts, I will delve into a detailed response to this question– very much in the spirit of the article, I wrote a few weeks back on Why Now?

However, I feel the “edge” question is a good primer to getting into the topic of today– a qualitative checklist for investment.

Bill Miller, the famed investor who ran the Legg Mason fund and beat S&P 500 index for 15 consecutive years, once quipped that there are three distinct advantages to consider when evaluating the likelihood of investment success– informational, analytical, and behavioral.

As a private money manager, running operations from a one-room office at home, the biggest advantage I can speak of is behavioral, and therefore, having a checklist to run through to internalize my behavioral edge for a given investment thesis is essential.

Let me begin by the following quote from one of the investor letters of Jeff Bezos circa 2005 that highlights the importance of non-quantifiable metrics for investing:

“As our shareholders know, we have made a decision to continuously and significantly lower prices for customers year after year as our efficiency and scale make it possible. This is an example of a very important decision that cannot be made in a math-based way. In fact, when we lower prices, we go against the math that we can do, which always says that the smart move is to raise prices. We have significant data related to price elasticity. With fair accuracy, we can predict that a price reduction of a certain percentage will result in an increase in units sold of [sic] a certain percentage. With rare exceptions, the volume increase in the short term is never enough to pay for the price decrease. However, our quantitative understanding of elasticity is short-term. We can estimate what a price reduction will do this week and this quarter. But we cannot numerically estimate the effect that consistently lowering prices will have on our business over five years or ten years. Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com. We have made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and – we believe – important and valuable in the long term.”

This is an amazing write-up and foresight by Jeff on how he ran Amazon. No wonder Amazon is successful as it is today.

I have highlighted a few sentences above that tie-very well with my thinking on the importance of behavioral edge and qualitative analysis of an investment thesis.

For starters lets look at, “…This is an example of a very important decision that cannot be made in a math-based way.”

Investing for the most part is a numbers game and given the advances in modern computing technology, anything quantifiable will be quantified and analyzed to death. However, there are certain things in the game of investing that simply cannot be analyzed within the framework of mathematics and computing. In the example, above, logic and math dictate that Amazon should have increased prices to maximize revenue and that there is a clear-cut mathematical relationship through pricing elasticity to determine the outcome in the short term.

However, that is not the game to be played. The game to be played is long-term and therein lies the behavioral edge! Bezos is precinct when he says, “…we cannot numerically estimate the effect that consistently lowering prices will have on our business over five years or ten years”

The ability to develop a variant perspective, “… relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow,”  that diverges from consensus and cannot be encapsulated in any form of mathematical representation, and the courage to act accordingly when the opportunity presents itself, offers a unique edge to investors who are patient, are willing to expend brain cells and countless hours to really understand the business.

So how does one go about developing a variant perspective on any business being analyzed? I do not know! My guess is, the insights can come in part, through constantly pouring over literature on varying topics and in the process constantly evolving one’s mental model of the world!

That being said, below is a checklist of questions that I want to answer, and hopefully, by going through this exercise for each company that I evaluate for investments,  I can begin to form opinions on investing thesis, either outright reject or in an ideal world, develop an insight that merits the badge of variant perspective!

It is important to note that none of the answers to the questions posed below are quantitative, rather they are designed to force me to determine whether I can really understand the business and the folks that are running the business, before ever looking at the numbers!

• What does the company do?
• Do I trust / like the management and can I come up with a reason as to why?
• Is the company within my circle of competence? and if not, am I convinced through management writings and track-record to invest time into expanding my circle of competence?
• What is the company’s competitive advantage/moat?
• Will this company be around in 20 years?
• What should I be wary of with this company?
• What do I like about this company?
• Does this company give me international exposure?
• If the stock market closed tomorrow for the next five years, would I still buy this company?
• Is the company operating in a growing market place and if not, do I see an avenue for the firm to grow into these markets?
• Are insiders buying or selling shares?
• Are super investors buying or selling shares?

By running through the above checklist, I should have a reasonably clear idea on whether I should dig into the numbers and therein will be another checklist to run through– a topic for my next blog post!