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How to Learn Everything You Need to Know About a Stock
Posted by: Geoff Gannon (IP Logged)
Date: January 15, 2013 10:36PM
You don’t need to know everything about a business before you invest. But you do need to know enough to understand a few key factors: price, product economics, competitive position and permanence. The best way to understand those factors is to ask the right questions.
Someone sent me this [url=mailto:firstname.lastname@example.org]email[/url]:
But how does one analyze any stock if one has to know the inside and outside factors especially when one is only an investor and really does not know the ins and outs of the business but only knows the info of the 10-ks,14As or S-1 when available?
How would we know that it is the agents of the Western Union Co. that are a big factor in purchasing this stock?
How would we know Carnival Cruise keeps its costs down compared to the other cruise lines?
In my opinion we can only know that info if we know everything about the businesses and that is impossible for the average investor.
As you mentioned in your article, even Warren Buffet did make mistakes and if he did and it looks like he did it a lot, the average investor who knows no executives that are passing info on what the company plans to do almost has no chance to make the right decisions on investments.
What do you think about that and how can we get info like that?
You need to go beyond a formulaic approach. You need to use common sense. Questions are the key to analyzing a stock. You need to keep asking questions. And it is often best to actually ask those questions in writing.
Whenever you read a 10-K, 10-Q, 14A, S-1, earnings call transcript, etc., you want to have a notebook, a pen, and a calculator. Jot down questions whenever they come up. Don’t try to standardize your approach. Instead ask questions that would be relevant to someone buying the entire company.
Basically, imagine you were acquiring the whole company. What questions would you have? What due diligence would you do?
You don’t have to limit yourself to the SEC reports. In fact, you shouldn’t. There is no limit to the research you can do. No limit to the sources you can use. And, honestly, talking to a company executive would not be my first choice. Even if you had complete access to the CEO – I’m not sure that’s what would be most helpful in analyzing the stock.
In fact, I’ve invested in many micro caps. In some cases, I know I could have talked to management. I didn’t. I know plenty of people who do. I’ve never believed it would help me much. And I’ve always believed it would bias me.
I prefer looking at past behavior. I’ve seen plenty of company presentations about the future. With few exceptions, I ignore them. When I say I think a company will buy back stock, do dumb acquisitions, etc., it is almost always simply because that’s what they’ve done over the last 10 to 15 years.
The only exception to this rule is when management has already achieved long-term goals in terms of capital allocation, economic value added, etc., and then sets out another five-year plan. If a company like Ball (BLL) laid out future plans – I would listen. But that’s rare.
So we know how I don’t do research. I don’t talk to management. And I usually don’t even listen to management. At least not about the future. So what do I do?
I read the SEC reports for the company and for its competitors. I also read earnings call transcripts. And I love to look at company presentations. Old ones. Reading what a company said it was going to do in 2000 or 2005 now that it’s 2013 can tell you a lot.
I spend a lot more time with historical financials than most people. EDGAR now goes back about 15 years. So you can put together your own 15 year long Value Line-style sheets for any company just by entering EDGAR data from old 10-Ks into Excel. I always do this. And I like to do it both for the company I’m looking at and for competitors.
That worksheet will raise a lot of questions. And what you need more than anything when researching a stock is a good list of questions.
For some very well-known companies there will be books to read. In the last year, I looked at both DreamWorks (DWA) and Carnival (CCL).
So I read "The Men Who Would Be King," "Disney War," "Selling the Sea," "Devils on the Deep Blue Sea," etc. I also read books less directly connected with those companies themselves where I knew some parallels were present. For example, I read a couple books on Pixar. And a biography of Walt Disney. That was all background for analyzing DreamWorks.
That might sound like a lot of work. But it’s really not. I’m sure you read plenty of books each year. Replace some of your reading with books that will help you analyze some specific investments you’re looking at.
The key is to focus. Most people flit around. Once you have a possible investment in your sights – block out everything else. Don’t spend half a day thinking about Carnival or DreamWorks. Spend a whole month focused on just one stock.
Once you get into the mindset of a dedicated analyst, reporter, investigator – whatever analogy you want to use – it will become second nature. You will have a trail of common sense questions to follow. And they will take you to new and different sources.
Sticking with the DreamWorks and Carnival examples, there were plenty of conference call transcripts to read. And a few recorded calls to listen to. For those two companies the CEO is an owner/operator who goes on the conference calls himself. So they are particularly valuable.
For DreamWorks, there were also probably half a dozen good interviews with Jeffrey Katenberg online that I had to watch. Everything from Charlie Rose to industry events.
I also watched a couple DreamWorks movies in theaters. And I ordered all the past DreamWorks movies. I rented the DVDs instead of streaming the movies so I could also listen to the commentaries.
That’s all just background. And none of it is hard to do. It’s not exactly unpleasant reading books and watching movies. It’s true that for the interviews – and just about everything else – you’re taking notes. But no one is judging you on your notes. They just have to be clear to you.
It’s important to understand you don’t need to know everything. I did a lot of research on DreamWorks’ products. I talked to some parents and kids – since I’m neither – who see DreamWorks movies in theaters. I went to theaters so I could see the actual audiences.
That’s not necessary with most products. I can’t judge a lot of products. I use Windows 8. And Windows 8 is obviously important to Microsoft’s financial future. But if I was going to invest in Microsoft (MSFT) – I wouldn’t put any special stock in my impression of Windows 8. I have no reason to believe my view of a tech product is better than what analysts, etc., are saying. I’m not a good guide to what the public wants. And certainly not what large corporations want.
DreamWorks was different because the reception of their movies by the public is the key to investing in that business. Movie ticket prices are fixed. They aren’t set by DreamWorks. The distribution of the movie – done through a major distributor – is well understood. I know roughly how many screens DreamWorks can get on. I know the kind of marketing budget they have.
The key question is how many people will show up in each theater. For most companies, you worry about price and volume. Not with movies. With movies you just need to worry about volume.
If I was analyzing another studio, I wouldn’t have gone to see any of their movies. The only reason to see DreamWorks movies was because they are repeatable. All DreamWorks movies are big CG animated family movies. They try to build franchises out of them. There is an element of repeatability here. They are doing the same thing over and over. I needed to study that thing.
When analyzing any investment you want to focus on the things that are: constant, consequential and calculable.
The kind of movies DreamWorks makes is constant. Public reception is consequential. As we saw when Rise of the Guardians flopped. Is public reception calculable?
There are some numbers you can play around with. And I did. I looked at how big the CG animated market has been each year since Toy Story. How much of the overall box office does it claim? How much of that market segment does DreamWorks get? How much do new entrants, smaller movies, lower quality movies, etc., matter?
I was able to answer some of these questions. For example, it’s obvious the top CG animated movies tend to account for a huge part of the business regardless of how many CG animated movies come out. There is probably some built-in audience for any Pixar release and – to a lesser extent – any DreamWorks release.
However, the possibility for total failure when you move away from these two companies was much higher.
All of this information was easy to gather using websites like Box Office Mojo, the-numbers, etc.
Once you have an industry you are interested in – follow it. For example, I read Variety. Entertainment companies can make good investments. I can understand some of them. It’s a fine place to fish for good stocks. They aren’t always cheap. And in most years I know I won’t find any entertainment stock worth buying. But it won’t hurt to have the background knowledge that reading Variety every day provides.
I highlight anything that interests me and then I go look up those companies. Or I look into the economics of that kind of venture.
You never know when this will come in handy. For example, DreamWorks was originally just a movie company. It has si