Bill Ackman is one of the most successful stock investors of recent times.

He has made some pretty good stock market bets – among others, in the American fast-food chain Chipotle Mexican Grill, which more than quadrupled in value in the few years since he invested in them.

But he has also previously had some years where everything went wrong, such as when he shorted Herbalife.

He lost money, the investors fled, but he turned things around and became successful again. 

The tough years made him analyze what went wrong and return to the old way of investing.

Bill Ackman Rediscovered His Own Checklist

He says he and his team went astray and had to return to classic value investing. In the beginning, he followed a checklist to find good companies – with great success. 

Then he veered from the path, and the problems began to pile up.

“I went back to the core principle that had driven our success for the first 12 years. I had a member engrave them on a stone tablet, not unlike Moses’ 10 commandments,” he said in an interview with Bloomberg.

Today, he and his team go through the checklist for analyzing companies prior to each investment. 

I don’t know about you, but I’d love to get my hands on that checklist. 

Don’t worry, that’s exactly what I’m going to reveal in this blog post. 

1. The Company Must Be Simple and Predictable

It must be a single business with a single structure, operating in an industry you understand and selling a product you understand.

We want to be able to predict the future of the company. 

That means that a lot of sectors will be out of your reach. It’s difficult – for example – to predict the future for a biotech company without a product on the market.

It can also be difficult to predict the future for companies whose turnover or profit fluctuates a lot. 

2. The Company Must Have a Positive Free Cash Flow

You don’t want to invest in companies where money is pouring out the bottom. 

Bill Ackman looks at free cash flow. 

It is a key figure that is usually stated in the accounts. In case it’s not, you can calculate it yourself. You find operating cash flow and deduct maintenance capex from the cash flow statement. 

Why is it important? As Bill Ackman says:

“If we can’t predict the cash flows, we don’t know what it’s worth.”

3. They Have to Be Dominant

Bill Ackman loves companies that have a dominant position within their market: companies such as the hotel chain Hilton, the coffee chain Starbucks, the streaming service Netflix and the fast-food chain Chipotle Mexican Grill.

Why? Because it’s a sign that they have some kind of competitive advantage. 

4. They Must Have High Barriers to Entry 

Barriers to entry mean that it’s difficult for competitors to enter their business, typically because it’s costly to start business at the same level. 

It’s always important that the company you invest in has some kind of competitive advantage that protects them so other companies can’t easily steal their clients. 

Competitive advantages may be that they have a secret ingredient (e.g., Coca-Cola) or a patent. These advantages may also be that they have a direct monopoly (bridges, railways), economies of scale (Amazon, Walmart), a strong brand (Coca-Cola), costs – either in price or time – if you want to switch to another company (banks), or network benefits (Facebook, Microsoft).

5. High Return on Capital

The company must be good at making money on the capital invested in the company.

Here you can look up a key figure such as ROIC (return on invested capital).

6. Limited Exposure to Extrinsic Risks

This could be the threat that the legislators will step in and make restrictions in the area.

An extrinsic threat is something coming from outside and something out of the management’s control.

Like when the EU zooms in on Big Tech and you sense that some crackdown might be in the cards. 

7. Strong Balance Sheet

He only wants to invest in companies that do not require access to outside capital to survive.

In other words, this means that they must have low debt compared to the money they make.

A rule of thumb is that they must be able to pay off their long-term debt with the free cash flow in three years.

8. Good Management and Governance 

The company must be run by management that you trust.

This applies not only to top management, but also to the board of directors.

One way to evaluate them is to go back historically and read their letters to shareholders that you find with each annual report. 

What have they promised in the past, and have they kept it up?

9. A Gap Between Price and Value 

Sometimes it happens that the share price falls to a level below what the company is actually worth.

This is something you can calculate. It may sound big and difficult – but it is not.

I explain how you can do it yourself in my e-book Free Yourself, which you can download below.

In my free e-book Free Yourself, you can learn a lot more about the style of investing that we call value investing. You can download it here. 

To learn more about my style of investing, you can download my e-book Free Yourself here.