Just like many value investors look at the 52 week low list for long value plays, some people, including myself, look at the 52 week high list for short plays. You can access this list on Bloomberg or various other financial sites on the web (do a Google search). Earlier in the week, I saw that Darden Restaurants ($DRI) had ticked off a high.

For those that do not know, $DRI owns and operates a number of restaurant chains - very well known chains such as The Capital Grill, Olive Garden, Longhorn Steakhouse, etc. I was surprised to see such a stock on the 52 week high list - why? Because in this recession, I would assume people eat out significantly less. So why not investigate and see what we can find?

The first thing that I do when researching a stock, whether it be long or short, is read the last three annual reports. Why three? That's what my boss told me on my first day on the job, and I just haven't experimented enough to see if one, three, five, or ten is the right number.

One caveat. I will go back quite a few years and read the shareholder letter. I want to see if the shareholder letter actually matches up with how the company performs in future years. Also I want a realistic shareholder letter. I.E. If I read a shareholder letter from 2018 where the author is all bulled up on the economy, I generally laugh and move the idea to the short pile. And in some situations, if a business is very cyclical, I will go back to the annual reports of the last down cycle to see what was happening.

What else am I looking at when reading the annual reports? Not only do I want to see how the business is performing, I also want to see how management is using their capital. Were they buying back stock at the highs? Were they levering up for acquisitions in the same year? How has capex trended with sales and what is the return on that capital employed? Does CFO match trends in net income. What are the accounting assumptions?

Pension assumptions are the most overlooked information in an annual report. While $DRI's pension plan is fairly small relative to the size of the enterprise, $DRI is assuming a 9% expected return on plan assets. Definitely aggressive in the context of real world returns.

Other things I look at: I read the notes voraciously. I want to get an insight that other people may have glossed over. Remember, investing is a zero sum game. For every winner, there is a loser. I like to win.

I then read the last three proxy statements.

Why do I read the proxy statement? Well for a few reasons. I like to see the make up of the board (and how they are paid), I want to see management holdings of stock, I like to see the proposals shareholders are voting for and how management responds, and a few others. The two most important things to look at when reading a proxy is: 1) How is management compensated and 2) What related party transactions have been taking place

In regards to #1, you want a management team that is compensated for things like return on capital, not sales. Why? Because a management team can pump up sales by spending capital on low return projects. All this will be under the report from the compensation committee. While it may be counter intuitive, I like to see management being compensated with restricted and common stock, yet I generally dislike when compensation is linked to stock performance. This just gives management an incentive to cheat and lie to boost their stock price. I want a management team to think like owners. I also want to see that compensation for a certain year was in line with what the business actually did...i.e. I do not want to see lots of bonuses paid out for a terrible year.

In regards to #2, it is fairly self explanatory. The less insider / related party transactions the better. $DRI has none which is a gold star in my book.

After reading the last three annual reports and proxies, I should be fairly comfortable about what the business does, its drivers, how they make money, where the capital is being spent and at what targeted return, etc. From here I will read as many conference calls and corporate presentations I can stand. You can find the conference calls on Seeking Alpha, or if you are an institutional investor on Bloomberg or Street Events. Good investor relations departments put all their historical presentations on the website, easy to find for investors. That reminds me, I will also spend quite a bit of time reviewing the corporate website, trying to get a better understand of the business. Lots of jewels to be mined there.

Why do I read the presentations and conference calls? Well first of all, I want to figure out the shared expectations of the market and the concerns of the market. Generally, an investor relations department will tailor their presentations to analysts questions and concerns. I.E. If a company is getting a lot of questions on its liquidity in private conversations with analysts and buy side professionals, the investor relations department will stick a slide in saying how great liquidity is. Always happens. On the conference call, follow the Q/A section and see what people are asking about and concerned about. You make money in the market by having different expectations about the future than the general consensus.

After reading the annual report, proxies, conference calls, and presentations you should have a pretty good understanding of the business, the market's perception of the business etc. You now need to do your comp work. And I do not mean build a comp sheet.

Where do you get your comps? A lot of the good ones are in the proxy. I then go in and add my own (and maybe take out a few I do not find appropriate).

You get the picture. You want to get insights into the business in which you are examining and insights into the strengths / problems the market is focusing on to exploit diversions between reality and opinion. I am telling you, less than 5% of sell side professionals do this. Why? Maybe they are too busy building excel models or maybe they believe Investor Relations' job is to blow smoke up every one's ass. I don't know. If you are smart about it, you can get good information.

So now you know a fair deal about the business, the industry, what is going on in the real world. From here it depends on the company being analyzed. You want some real on the ground, scuttlebutt research. For $DRI, I may call 10-15 different restaurants and chat up the hostess or manager and get some information about what is going on in the stores. How has business been? What's new to the menu? What are customers liking? Etc. For other businesses, I may call direct competitors or maybe even suppliers to get the same sort of information.

At this point, you should have a pretty solid opinion of what is going on in the business. At this point, I will throw together a few excel spreadsheets. The first will be a model (with some historical included) that will have three or four drivers. At this point, with all your due diligence, you should know the drivers. If not, go back and call the competitors and figure it out. You want to compare your thoughts on the drivers with the market assumptions. So you have your model, with your drivers, and then you compare it to the market's assumptions and drivers.

Unfortunately, that is not the only step. How much of this is already priced in? Maybe everyone know the analysts are wrong and that is priced in with low multiples. So now I want to compare the multiple to those direct competitors on a current basis, but also on a historical basis. What is the lowest a restaurant similar to Darden has ever traded for? What is the highest multiple ever traded? What is $DRI's highest EV/EBIT multiple ever (on a normalized basis)? What is the lowest cash flow multiple it has ever traded for? Etc.

If you find a stock where your expectations are significantly lower than the market, and the stock is trading at a relatively high multiple to its competitors and its historical range, well that is just a beautiful thing.