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What's Your Investing Routine?
Posted by: Geoff Gannon (IP Logged)
Date: November 19, 2012 10:19AM
My investing routine is mostly just reading. I read blogs, SEC reports, earnings call transcripts, analyst reports, interviews and articles.
Someone who reads my articles sent me this [url=mailto:firstname.lastname@example.org]email[/url]:
I would like to ask you more a lifestyle rather than accounting kind of question, since these are harder to find by reading or researching:
What does a day in the life look like to you? How much do you read, at what rate? What tools do you use to discern information? How do you manage time?
A day in the life looks pretty simple. I have a stock in my mind. There is always one stock on my mind first thing in the morning. Lately, it has been Western Union (WU). Right now, I don’t need to be reminded which stock is on my mind. Because that stock is on my mind in a big way.
But I have a white board. Something you use markers to write on. And in the bottom left corner there is always a list of ticker symbols.
Right now, those symbols are: “WOOF, AEY, FCN, CEC, MATW, OMC, DST, ENR, WM.” These are reminders. They are not stocks I am looking at now. Since I’m looking at Western Union now. But they are stocks I want to remember.
Those names all came from a screen I run. They are the stocks from that screen that I am already familiar with. So if Western Union turns out to be a dead end – I will move on to something on that list.
Actually, that’s not true. Something else – something more interesting – might come up first. Every day I read blogs. I subscribe to about a hundred blogs now. Many are inactive. Some post regularly. And some post very frequently.
Among the blogs that post very frequently are a couple where I read every post. Those are blogs like Oddball Stocks – which just wrote about a $3 million market cap Israeli DSL chipset company – and Market Folly. Market Folly writes about hedge fund managers. There is also a paid subscription newsletter for that one. I don’t subscribe to many newsletters. Market Folly’s is a good one for getting a list of research candidates.
I run some screens all the time. I created the screens myself. I don’t run any screens written by others. I use StockScreen123 and Morningstar to run screens. Morningstar lets you screen for 10-year data. That’s key. Every screen I run depends on long-term consistency. I don’t screen for one-year results.
So what do I screen for?
My two favorite screens are simple. I run one at StockScreen123. It looks – something – like this:
Market Cap/EBITDA< 8
EPS > 0
Rank by Number of Straight Years of Positive EPS
Over time, the top 10 results from this screen will crush most mutual funds. The important thing is that it gets good results – over the long run – through good and bad markets. It gets acceptable results. It isn’t about outperforming the S&P 500. It’s about performing even when the S&P 500 isn’t.
The idea with this screen – like all screens I run – is to get me a list of stocks to research. Here are the top 10 stocks from this screen right now:
Superior Uniform (SGC)
Archer Daniels Midland (ADM)
H&R Block (HRB)
Weis Markets (WMK)
Bristol Myers (BMY)
What’s the point of this screen?
These are stocks that are cheap enough. And they are businesses that had been profitable enough. That doesn’t mean they will be profitable in the future. It doesn’t mean their return on capital is high enough for them to create value with their retained earnings. This is not a screen that answers all those questions. It’s a screen that gives you leads.
Those are good leads. Most stock ideas fall short in two ways. The stock is not cheap enough. And there is not a long enough history of profits. This list clears both those hurdles. And that’s a good start.
Now is a good time to stop. And talk about how my investing style shapes my investing routine. My style is to find good enough businesses at low enough prices. I do not want great businesses at high – but not too high – prices. I am not a Phil Fisher investor. And I am not a Ben Graham investor. I do not want bad businesses – but not too bad businesses – at low prices.
I want a good business at a good price. It should be an above average business. And it should sell for a below average price. If most public companies earn 12% on capital and trade at 8 times EBITDA – the stock I buy should earn 14% on capital and trade at 7 times EBITDA.
You get the idea. I want double protection. I want two separate defenses that have to fail to destroy my principal.
This is different from how a lot of investors work. It is how I work. But it may not be the best way to work. I doubt it is optimal in any sense – other than the one sense that matters. It is the optimal strategy for me – personally – to carry out. It is the right fit of task and team. There is such a thing as the right job for the right person. And the right person for the right job. The idea of a right job – regardless of who performs it – is nonsense.
My focus is above average businesses at below average prices. I don’t focus on micro caps alone – remember, I owned Omnicom (OMC). I don’t focus on specific industries. I focus on what I think are above-average businesses selling for below-average prices.
With one more condition. It needs to be a business I understand better than most. So I want an easy (for me) to understand, above-average business selling for a below-average price.
That is what all these screens are for. They are for turning up names for me to read about. And judge on those three grounds: understanding, quality, cheapness.
At a glance, I can guess which stocks will interest me most. For example, there is a restaurant stock on this list. That one probably won’t interest me. I’m a bad judge of restaurants. Walgreens makes most of its money on prescription drugs. And Bristol Myers is a drug company. Those two are outside my circle of competence. Drugs are not in my comfort zone.
One of the stocks – Weis Markets – is a grocer. I’m comfortable investing in grocery stores. There are a lot of public grocery stores. It’s easy to read all their 10-Ks and compare. Groceries are a business I can understand. I owned Village Supermarket (VLGEA) for many years. And I worked in a grocery store as a teen. So groceries are a business I can understand.
And I’ve looked at H&R Block in the past. I remember what they did in the housing boom – dumb things – and why I passed on the stock back then. So I wouldn’t be starting from square one there.
I kept things simple for this article. I only listed the first 10 stocks on this screen. I would actually look at anything in the top 100.
One advantage of a list like this is how many companies are in the same industries. And how few names drop off the list. So you’ll see the same grocers, restaurants, etc., year after year.
My Morningstar screen is similar. It’s an operating margin screen. It’s just a list of stocks that have had an operating margin higher than 10% in each of the last 10 years. It’s a list of stocks that have – or had – strong competitive positions. Here are 10 names from the list:
NII Holdings (NIHD)
ITT Educational (ESI)
CEC Entertainment (CEC)
FTI Consulting (FCN)
You’ll remember two of the names from this list – CEC and FCN – were on my whiteboard. So, obviously, those are stocks I think I might be able to understand. The other stocks on this list are mostly outside my comfort zone. Further down this same screen we have Matthews, Omnicom, DST, etc. Which are also on my whiteboard. Because they are also businesses I can understand.
In between, there are a lot of oil companies, some healthcare, some education, etc. All things I can’t understand. All things not on my whiteboard.
The list is ordered by price to sales. These are companies with operating margins that are always above 10%. And yet they have price to sales ratios below 1. That’s important. If their operating margins were sometimes below 10% – then maybe a price to sales below 1 would be justified. But one of these things has to give. Either the companies have to make less than 10% on sales in the future. Or their shares have to trade for more than a price to sales of 1.
As you can see, I like to keep things simple. Using a price to sales ratio of 1 as a cut off is simple. Using a 10% operating margin is simple. But using the two together – and requiring a 10% operating margin in 10 straight years – gives you a good list.
It gives you a list of stocks where investors think the future will be worse than the past. If you can find one stock on that list where the future will be as good as the past – you’ll make money.
This brings us to earnings yield. I tend to think in terms of a price to some item like sales. And then a business’ return on that item. So, I pick a stock like CEC Entertainment (CEC) – this is Chuck E. Cheese – and ask myself how many cents per dollar of sales can they make in profit. And will sales be as high in the future as in the past? And how much am I paying per dollar of sales?
Those are the only questions I need to ask. And that is what all the reading I do is focused on answering.
There is actually one last question, which is how much capital it takes to run the business.
The number I care about above all else is owner earnings versus purchase price. If I pay $40 for a stock, I want that stock to have $4 in owner earnings. And 10 years down the road, I still want it to have $4 in owner earnings – or more.
If it is a business that doesn’t need much capital to grow, the math will be kind to me. A lot of investors worry about growth. I don’t. I worry about what I just laid out.
Let’s imagine a stock that has $4 in owner earnings today. I pay $40 for that stock. I hold it for 10 years. At the end of 10 years, the stock has $5 in owner earnings. That’s a growth rate of 2% a year. Most investors will say that’s a bad investment.
We don’t know enough to know that. If the business needed no extra capital to grow 2% a year – and paid earnings out each year – it worked out fine for me. I had my original $40 investment completely returned over the 10 years. And the stock price is now probably anywhere from $50 to $100 a share (10 to 20 times owner earnings).
Under that scenario – there’s a very high chance I made at least 10% a year in that stock.
So the key things I look for in a stock are making sure owner earnings is high enough compared to the stock price (I like a 10% yield) and making sure owner earnings are permanent enough (I like a 10% perpetual annuity).
Owner earnings is the amount of free cash flow a business would generate if it stopped growing. A business that is shrinking often has less owner earnings than its statement of cash flows suggests. A business that is growing often has more owner earnings than its statements of cash flows suggests.
There are exceptions to this rule. Right now, I’m looking at Western Union. This is a business that doesn’t need capital growth to create sales growth. The only investment in growth is signing bonuses for new agents.
This brings me to what happens when I find a stock I’m interested in. After the screens have been run – or the blogs posts read – and something catches my eye, what do I do with that idea?
I read about it. I get the SEC reports starting with the first 10-K on EDGAR. I read both the 10-Ks for the company I’m interested in (Western Union) and for the competitor I’m not interested in (MoneyGram).
I don’t read especially fast. I read about 500 words a minute. I read SEC reports on paper – not on a screen. I read slower on a screen than on paper. I highlight and take notes when I read a 10-K. The whole thing can take a couple hours. Sometimes less. But never more than that.
I also read the 10-Q, 14A (proxy statement) and all the past earnings call transcripts. These are only available for large companies that do earnings calls.
SEC reports are the biggest part of my reading. Blog posts also make up a good chunk. Analyst reports are a small part of my reading. They are useless for stock recommendations. But sometimes have good historical graphs, market share data, etc.
If you tallied up the actual amount of time I spend reading – you’ll find I actually spend more time reading competitor 10-Ks than anything else. For example, if I’m looking at a grocery store chain or a railroad – I may have six other “peer” 10-Ks to read. Other companies have no public peer. Western Union has one: MoneyGram. So I will spend almost half my time reading about MoneyGram.
Am I really that fixated on competition? It’s more than that. It isn’t just trying to know what the competition will do. It’s learning more about the company – and industry – you are interested in by seeing it from another angle. Studying similar companies gives me more angles on the company I’m interested in. It doesn’t lock me into one fixed view.
[url=mailto:email@example.com]Talk to Geoff about his investing routine[/url].
Read Geoff’s Other Articles
Stocks Discussed: WU, OMC, VLGEA, CEC,
What s Your Investing Routine
Posted by: Josh Zachariah (IP Logged)
Date: November 20, 2012 12:32AM
Great article Geoff, please share with us your thoughts on Western Union.
Stocks Discussed: WU, OMC, VLGEA, CEC,
What s Your Investing Routine
Posted by: ry.zamora (IP Logged)
Date: November 23, 2012 11:26AM
Great article. Hehe, after reading this whole thing, I'm almost tempted to ask you if you are also balancing a social life with all the reading and analyzing you're doing. XD
Anyway, why would you use a quantitative screener in the first place? Isn't it better to source your ideas from, well, the very blogs and newsletters you read? They're already prescreened for you and all you need to do is run them through your "model" as to ascertain their applicability for YOUR particular philosophy and other strategic constraints.
After all, it doesn't matter how you source your ideas. Grab it from Gurufocus. Grab it from Seeking Alpha. From the Fool. From StockTwits. From Market Folly. From quarterly newsletters by eminent managers. Whoever.
None of that matters. What really matters in the end, concerning the respect you get from YOUR peers in the community as well as YOUR investment performance, is how you justify your investment actions. The source of inspiration must be a mere citation for your investment thesis. Nothing more.
IIRC, there was a specific account in the Snowball where the unknown Buffett was defending his thesis against his peers. Despite having done his own research, the very first thing that came out of his mouth was: "Because Graham invested in it." This left a bad impression that lasted for years and it got in the way later on, and Warby was given the statement, "Think for yourself!"
That event serves to exemplify my point. The value investing community may be large with respect to what it was sixty years ago, but because of human nature and intrinsic conflicts of interent in the investment industry our philosophy is not mainstream and never will. So we might as well chuck the online screener and mine the world for ideas by using other people and staying current on the global macroeconomy. I've come across several value investor interviews on Gurufocus, Graham & Doddsville, and other VI newletters to realize they don't even bother using screeners, and this tells me my thought processes are moving along the right track.
Stocks Discussed: WU, OMC, VLGEA, CEC,