Last week McGrath, an integrated residential real estate services company (that we don’t own) saw a 31% decline in its share price after the company downgraded estimates for future earnings. In this piece, we are going to look at the mechanisms we use to filter out companies that have a higher probability of future issues to reduce heartache. This exercise is based on the concept that removing a few “losers” from the long-only portfolio is more consistently beneficial to a portfolio’s performance than focusing on picking the next Aconex. In developing the model, we reviewed corporate failures in Australia over the last decade looking for contributing factors which lead to the disaster. Across the corporate graveyard, it became evident that many companies exhibited similar characteristics that contributed to their demise. The key factors we watch are: 1) financial leverage; 2) rate of expansion; 3) corporate governance; 4) regulatory risk; and 5) technological & operating risk. Read more in the attached letter.