Checklists
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Getting Things Right With Checklists
How we use the timeless tool to reduce the rate of error in important decisions.
I t's a remarkable thing that one of society's most useful inventions is still the humble checklist. It's remarkable because humans generally are really terrible at following procedures. We get bored. A computer, on the other hand, is really good at following procedures. That is pretty much all a computer ever does. And their rate of error is much lower than humans.
In an increasingly complex world with specialization in every corner of society, we have gotten used to divide problems up into pieces. Therefore, we all pretty much agree that checklists are a very necessary tool in the world. Airliners would not be able to fill their seats if passengers thought they hadn't ticked every box before each flight. The same goes for construction - or surgery.
But the problem is: we all tend to think that checklists are important for other people to follow. We know that we don’t make mistakes – obviously, that goes without saying – but other people are infinitely stupid and so it is a really good idea that they are forced to make doubly sure.
We think we're mentally prepared to take the right action all the time. And we tend to rely on optimism when planning ahead and thinking through how - and how fast - future problems will be solved.
But that's a planning fallacy.
The reality is that all sorts of unknowns creep in and the goal sometimes escapes us for avoidable reasons. Errors in communication, disturbances, and inconsistencies in preparation are just a few examples that can be responsible for such fatalities as forgetting a simple, obvious detail.
Sometimes, processes simply become too long and complex, and expertise in any field is not enough to fight it. Even super-specialists make mistakes in their field. The remedy lies in the humblest and simplest of techniques: the checklist.
As Atul Gawande writes in The Checklist Manifesto:
Under conditions of complexity, not only are checklists a help, they are required for success.
Last Level in Decision Making
Here's why checklists are the last level in the Junto Decision Levels framework.
If you landed directly on this page, you can find our Decision Levels framework here.
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A checklist is not meant - nor is it at all necessary - for every situation. If that was the case, everything would quickly turn into bureaucratic nightmares.
No, checklists are for comprehensive tasks and hard problems.
At Junto, we don't like comprehensive tasks that are out of our circle of competence. There are way too many options and opportunities in the world to spend time on such things. And so, we try to focus on problems that are important and knowable. If both aren't the case, the problem simply doesn't reach the last level in our Decision Levels framework.
When I say important, I mean really important. Many things are knowable but not really important that we decide on all the time. But some things are really important. Managing capital is really important and so we use checklists for our investments. Putting written words out into the world is really important and so we use checklists for our writing.
When dealing with hard problems that we have the ability to solve, we want to focus on reducing the rate of error. And for that, checklists do a marvelous job.
But reducing error is just one aspect of solving problems and it might not always be the most optimal thing to do. We also need insights. And for that, we need creativity and aptitude.
Hence, it's important to recognize that while checklists are sometimes crucial, they do not deal with being creative. We need both.
If this fact is not recognized, writing checklists can easily become self-defeating. A checklist is not an instruction manual, and it isn't supposed to provide one with all of the steps necessary to do anything as an expert. In fact, a checklist should be crafted from the assumption that the person using it is an expert already. Checklists can't fly airplanes.
The idea is that as long as we've covered the error reduction part, we can focus on what lies on top of it.
Writing a Good Checklist
Why it's not easy to write, nor follow.
An improperly specified checklist is more a hindrance than a benefit. And like a poem, a checklist is not an easy thing to write well.
It must be comprehensive; leaving out the things that aren't necessary, but making sure to include what is.
It must not be too cumbersome, or it loses efficiency.
It must also not be authoritarian, or it loses its discipline.
It must turn people's brains on rather than off.
It must be efficient, to the point, and easy to use even in the most difficult situations.
A checklist like that is not a bit easy to write in one go.
And so, efforts should be made to test and refine it through constant iteration, trial, and error. Consequently, to be able to write a good checklist, one has to be able to admit to making mistakes through first-hand experience.
Furthermore, different situations require different checklists even within the same domain. For example, in investing, we use different criteria and weightings of those criteria for different companies. It's not a rigid process and we have to change it all the time.
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Conclusively, the ultimate purpose of a checklist is to ensure that one has done all that really must be done – that, if it hasn’t been done, then all hell will break loose.
On that cheery note, here are Junto's main (as in non-exhaustive) checklists for our two main important endeavors: stock investing and writing.
Checklist for Stock Investing
Different companies need different checklists. This is our main one.
Psychology
- Are you exercising great temperament or are you rushing into/out of things?
- Are you resisting historical price anchoring?
- Are you ignoring daily fluctuations and market folly?
- Is the investment your highest opportunity cost?
- Do you have a high degree of confidence in your own research?
- Are the odds heavily in your favor?
- Do you rely on independence of thought from first-hand sources or are you influenced by others in your investment thesis?
- How do your expectations differ from the consensus?
- Have you reconciled disconfirming evidence against your investment thesis?
Business Tenets
- Do you fully understand the business and is it within your circle of competence?
- Can you comfortably know how the industry/business will look in 10 years?
- Could a fool run the business?
- Does the company have a consistent operating history?
- Does the company have a durable competitive advantage?
- Does the business add or extract value from customers?
- Does the business include advantages or disadvantages of scale?
- Can current operations be maintained without excessive reinvestment?
- Can the capital be reinvested at attractive compound rates?
- Does the company have a worthwhile profit margin and is it doing enough to maintain and improve it?
- Has the company created at least one dollar of market value for every dollar retained?
- Are there other aspects of the business, somewhat peculiar to the industry involved, which might give you important clues as to how outstanding the company may be in relation to its competition?
Governance
- Does management display integrity, rationality, and talent which you trust?
- Is management candid with shareholders?
- Does management have a long-term orientation?
- Does management resist the institutional imperative?
- Has management resisted the temptation to grow quickly by merger, sacrificing profitability?
- Does the company have outstanding labor and personnel relations?
- Does the company have outstanding executive relations?
- Does the company have an above-average sales organization?
- Are the company's cost analysis and accounting procedures trustworthy?
- Is there anything unusual going on with the company's ownership or capital structure?
- Are insiders interested in their own stock?
- Is management compensation (size and type) in line with sensible performance targets?
Risk
- Could the moat be shrinking or evaporating?
- Does the company have a secure, sticky customer base?
- Has the company fared well during previous recessions?
- Is the balance sheet solid and "knowable"?
- Is the company likely to meet future obligations?
- How will the company perform if interest rates double or if credit access is cut off?
- Are there significant debt covenants?
- Is the company able to stay afloat if revenue starts to fall but costs stay the same?
- Does the company have limited regulatory risk?
- Is the company immune to or able to follow a fast-changing industry?
- Is the company immune to foreign low-cost providers?
- Is the company free to adjust prices to inflation?
- Is the company largely unaffected by commodity prices?
- Is the company operating in a fiercely competitive industry?
- Can the company control the actions of its dumbest competitor?
Valuation
- Does the price include a margin of safety to safeguard against a loss of principal?
- Are there temporary tailwinds enhancing free cash flow?
- Are revenues or cash flows sustainable or overstated/understated due to boom or bust conditions?
- Will the company's underlying value endure until shareholders can benefit from its realization?
- Are you overly reliant on growth expectations to justify value?
- Have you resisted a craving for false precision in your valuation?
Checklist for Writing
Ben Franklin said: "If you would not be forgotten, as soon as you're dead and rotten, either write things worth reading, or do things worth the writing."
Message
- Does the text communicate the ideas appropriately and effectively to the target reader?
- Do the ideas fit your relationship with the target reader?
- Are the ideas useful?
- Can the reader test the ideas in practice?
- Do your points support those ideas?
- Are the ideas presented coherently?
- Are the ideas connected through the text across sentences and paragraphs?
Communication
- Does the text quickly capture the reader's attention and illuminate the general idea?
- Have you presented a balanced view of the topic?
- Are you using emotionally charged language about the subject?
- Are you using vague or generalized language about the subject?
- Are your style and tone appropriate in terms of your standards?
- Are you writing at a level that’s appropriate for your audience in terms of vocabulary, sentence structure, and complexity?
- Are you using jargon that your audience might not understand or buzzwords that are overused or cliché?
- Are you adding information and evidence that seems unnecessary just to bolster your point?
- Are you omitting important facts?
Language
- Is there a range of vocabulary and grammatical structures and how accurately are they used?
- Do all of your subjects and verbs agree?
- Do all of your pronouns and subjects agree?
- Have you eliminated any instances of passive voice?
- Do you have run-on sentences or comma splices?
- Have you spell-checked all names, terms, and titles?
Organization
- Is the text interesting to read and easy to follow?
- Are your sentences too wordy?
- Are the transitions smooth?
- Are you using a combination of short and long sentences to avoid monotony and create a good cadence?
- Is the text visually engaging (i.e., is broken up into the right chunks, headlines, visuals, etc.)?
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I hope you enjoyed reading the process of our decision-making process at Junto Investments. If you didn't go through the levels consecutively, you can go back to the first page here.
If you've got any thoughts or tips to share regarding our process, please write to me at oliver@junto.investments.
To your lifelong success,
Oliver Sung
Research Analyst