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The Bear Case
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After you've assessed growth, profitability, and financial health, your next task is to look at the bear case for the stock you're analyzing. Start by listing all of the potential negatives, from the most obvious to the least likely. What could go wrong with your investment thesis? Why might someone prefer to be a seller of the stock than a buyer? Constructing a convincing bear case is especially important for those who like to buy high-quality companies that have hit temporary speed bumps, because what looks like a speed bump may very well be a roadblock on closer inspection.

Equally important, your bear case will be a great reference point even if you do decide to buy the stock. You'll know in advance "what signs of trouble to watch for, which will help you make better decisions when bad news comes down the pike in the future. Having already investigated the negatives, you'll have the confidence to hang on to the stock during a temporary rough patch as well as the savvy to know when the rough patch might really be a serious turn for the worse.

I'll admit to a painful example from my own history that shows the importance of developing a bear case before buying a stock. In the mid-1990s, I purchased some shares of a small firm called Ballantyne of Omaha, which "was one of the world's largest manufacturer of motion picture projectors (for movie theaters) in the world at the time. (The big ones in movie theaters not the ones your teacher used in elementary school.) The firm was growing at a decent clip, had few competitors, and management seemed to have their heads on straight. The stock was selling for what I thought "was a pretty reasonable price, as well.

Unfortunately, the movie theater industry—Ballantyne's main customer— was in the midst of a huge debt-fueled building boom at the time. Remember all of those 10- and 2O-screen suburban theaters that got thrown up during the 1990s? That's what was pumping up Ballantyne's sales, and the expansion wasn't sustainable. Many of the big theater chains had liquidity crunches, and a few even went belly up. Needless to say, this did not do wonders for movie- projector demand, and Ballantyne's financial results (and stock price) went Into a fast slide.

The lesson? I should have constructed a convincing bear case for Ballan- tyne before I bought it. If I'd looked deeper into the financial health of Ballantyne's customers, I might have asked myself what would happen if the multiplex boom slowed down. I didn't and, as a result, I made a poor investment that could have been avoided.

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