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Is this exceptional? The checklist

The same five structural tests every piece in the Exceptional Company Series runs — turned into what to actually look at on a filing, not just what the test is called.

Download the checklist (PDF) →
One page. Print it, or keep it beside the filing.

Before the five tests

Classify it first
Fast grower, steady compounder, cyclical, turnaround, or asset play. The same five tests do not mean the same thing across types — a cyclical's worst drawdown is supposed to look worse than a steady compounder's.
Say what it does, in one sentence
If you cannot, you do not know it well enough to hold it through a fall. Not what the industry does — what this company actually earns money doing.
Name the moat's mechanism
Switching cost, network effect, scale, brand, regulation. “It's a great business” is not a moat. Saying how is.

The five tests

1

Compounding

— is growth real, and repeatable?
  • 10+ years of earnings history, not two or three good ones
  • The CAGR over the whole period, not just the trailing twelve months
  • The % of periods with earnings up — not just the average growth rate
  • The worst drawdown in earnings (not the share price) — how bad did the single worst year actually get?
2

Earnings quality

— cash-backed, or engineered?
  • Does free cash flow track reported earnings, or quietly diverge from them?
  • The margin trend — expanding, stable, or eroding under the surface?
  • How much of “earnings” is the operating business, versus one-offs — buybacks, tax credits, asset sales?
3

Balance sheet

— could it survive a bad decade?
  • Net debt to equity — low, or net cash?
  • Interest coverage — how many times over can operating income pay the interest?
  • Would a real recession break it, or just slow it down?
4

Capital allocation

— is the cash deployed sensibly?
  • Where does free cash actually go — reinvestment, dividends, buybacks, debt paydown?
  • Track record on acquisitions — value-additive, or empire-building?
  • Are buybacks made below or above what the business is actually worth?
5

Per-share value

— does the compounding reach the shareholder?
  • Is the share count shrinking (buybacks) or growing (dilution)?
  • Does EPS growth match net income growth, or is a shrinking share count doing the work alone?

After the five tests

What would have to go wrong
Name the bear case before you are in the position, not after. If you cannot state the strongest argument against it, you have not finished the work.
Exceptional does not mean cheap
“Is this a good business” and “is this a good price” are two separate questions, answered two separate ways. This checklist only answers the first one — why that distinction costs real money to ignore.

A business can clear every test on this page and still be the wrong price. That is not a flaw in the checklist — it is a checklist for one question, answered honestly, which is worth more than a checklist that quietly answers two and only tells you about one of them.

General explanation of a method, not personal advice, and not a recommendation to buy or sell anything. Terms used here are defined in Key terms.