Someone who reads my blog sent me this email:
"How do you screen for micro caps? What criteria do you use and what screening service do you use?"
I don’t really screen for stocks.
I’ve used these four screeners before:
1. Morningstar
2. StockScreen123
3. Sharelockholmes
4. FT.com
They’re fine.
But that’s not how I find most the stocks I buy.
Generally — and I say this all the time and no one ever believes me — you want to just go through stocks by starting with the As and going through the Zs. Think of it like dating. I’m sure you have some idea what you’re looking for. And you might be right in broad strokes. But you’re going to find something that surprises you — in a good way — if you just keep looking. It’s not that the screeners aren’t any good. It’s just that we’re not very good at knowing what we’re looking for until we find it.
So start with the As.
Look for obvious stuff that stands out. Stocks selling for less than net cash, net-nets, stocks with 10 straight years of profits, etc. Don't worry about close calls. They aren't worth your time. Look for stocks in simple businesses where the last 10 years of EBIT times one minus the country's corporate tax rate leaves you with a low, low P/E ratio. You want something like 6. Something that's going to give you 15% returns or better a year even if the business does more things wrong than right in the next few years.
These stocks are out there. Don't focus on the upside. Don't worry about a thesis. Don’t worry about envisioning exactly how you’re going to make your money in those stocks. Just focus on value. Focus on getting a bargain.
Think of it as a treasure hunt.
All you're doing is finding merchandise you know the rough value of.
Something that's profitable year after year is usually going to trade at closer to 10 times pre-tax earnings than three times pre-tax earnings. Ignore the stuff trading at 10 times pre-tax earnings. Focus on the stuff trading at three. Those are the needles. The 10 times EBIT stocks are the haystack.
Look at lots of stocks.
Don't waste time on stuff you can't grasp the economics of immediately. Unless you know a lot about banks, insurers, tech companies, capital goods companies, etc. because you've studied those things in the past or worked in those industries — just blow right past those stocks.
The key is putting yourself in the customer’s shoes. No one makes a profit unless their customer lets them. Competition comes later. Bargaining comes first.
The central question is why a company’s customers are trading away more cash for a product than was put into that product.
The answer determines how much profit the folks who make that product can earn. It also sets the battleground. On what terms will companies compete for these customers?
They can only compete against each other on the terms the customer sets.
The terms are whatever the customer places extraordinary value on.
If a food company uses quality ingredients and a customer pays up for that — that’s ordinary value. It’s meaningless. The product can be sold for more than a competing product. But it won’t make any more profit for the company.
Investors don’t care about that stuff. Investors only care about extraordinary value.
Take See’s Candies. Yes. They use quality ingredients. No. That’s not where the extraordinary value comes from.
See’s could use the same ingredients in New Jersey that they use in California. You can always move ingredients. You can’t always move reputation.
That’s why See’s makes big profits in California and next to nothing in New Jersey.
The ordinary value is in the chocolate. The extraordinary value is in the customer’s mind.
Don’t believe me?
Right now — it’s Easter Sunday as I write this — I’m looking at a chocolate bunny wrapped in gold foil. On the back, are the words:
“Made in Germany.”
It’s more profitable to ship a chocolate bunny across the Atlantic than to ship a brand name across the Mississippi.
That’s the kind of economics investors need to focus on. We all spend too much time worrying about interest rates. And too little time worrying about customer captivity. One of those things will fluctuate. The other doesn’t have to.
I don’t want you to think it’s just about brands.
It’s not. Most good businesses go unseen. And most good businesses are unsexy.
Take Bunzl.
It’s a UK stock. Half the business is in the United States and Canada. So, the company is hardly foreign to Americans.
Bloomberg says:
“Bunzl plc is a distribution group supplying a range of non-food consumable products for customers to operate their businesses but which they do not actually sell. The company partners with both suppliers and customers in providing outsourcing solutions and service oriented distribution. Bunzl's main customer markets include grocery, foodservice, cleaning and safety.”
While the company itself says:
“We provide a one-stop shop distribution and outsourcing service supplying a broad range of internationally sourced non-food products to a variety of market sectors.”
Basically, Bunzl inconspicuously takes care of things that are necessary but tangential parts of their customer’s business.
It’s a completely unsexy, very low visibility business. A true hidden champion. You’ve probably used the company’s products without noticing.
The next time you’re in your grocery store’s bakery section, taking out a pair of tongs, picking up a roll, and dropping it in one of those small plastic bags – check the name on the bottom of the bag. It might very well say “Bunzl.”
My point is that Bunzl is a good business. And it has nothing to do with a brand name. And even without a brand name — it’s still a business you can understand very easily if you just take the time to put yourself in the customer’s shoes. You can see why Bunzl’s customers are willing to pay Bunzl more for the service it provides than it costs Bunzl to provide that service. Basically, going with Bunzl means you get to focus on other things. The service the company provides is worth more than the sum of its parts. That’s why there’s a potential for profit in there.
Even though Bunzl isn’t a brand name business — the value is still in the customer’s head. It’s still about making a promise the customer is willing to pay up for.
Most investors can’t understand most businesses.
But there are some businesses anybody can understand.
Focus on those.
Even in the case of my Japanese investments, they aren't especially complicated businesses. Sadly, they aren’t especially good businesses either. Beggars can’t be choosers. If you look hard enough for stocks selling for less than cash — you’ll find them. Just don’t expect them to be good businesses. But that doesn’t mean you can afford to have no standards when it comes to such cheap stocks.
Even the mediocre Japanese net-nets I bought are in boring industries that I've seen before in other countries. I knew when I found them that those industries tend not to be places where folks are at risk of running repeated losses. They don’t have brutal economics where you need to keep running a tech race, or you have perpetual price deflation, or where big beats niche.
Those are the obvious risks that should run through your mind. Since the value in most stocks comes from future cash flows, you need to be able to quickly get comfortable with the idea that the long-term profitability of the business you’re buying is much higher than the price you are paying.
So here are the six questions you want to ask about every stock:
1. Is it crazy cheap?
2. Has it been profitable for a long, long time?
3. Does it do the same thing year after year?
4. Are folks who use the service happy to leave some cash crumbs on the table?
5. Is the value the company provides intangible?
6. Will existing customers stay even if a competitor lowers its price?
Those questions are ordered in the way you normally run through them. Any "no" answer is potentially lethal. But it's so hard to get a yes answer to question #6, that often that won't kill the idea.
The answers to questions #1, #2, and #3 always need to be "yes," "yes," "yes." If they aren’t — you’re speculating. That doesn’t mean you’re wrong or you’ll lose money. It just means you’re guessing about the future.
It's possible to answer questions #4, #5 and #6 "no," "no," "no" and still buy the stock if it is selling for less than net cash, net current assets, etc. However, as a rule, if the answer to question #4 is "no," then the answer to question #5 should be "yes" and vice versa.
The reason for this is that question #4 is a margin question and question #5 is an asset turnover question. If it takes a lot of assets to make a small amount of sales you're going to need very fat margins or you're going to have a business that is always worth less than book value.
The two easiest ways to think about any stock are in terms of assets and sales.
Are you paying a lot or a little for the company’s assets or sales? And does the company squeeze a lot or a little cash out of its assets or sales? Those two questions will steer you right when looking at non-financial stocks.
If all you did in your entire investment career was find stocks that are clearly selling for less than their tangible book value and yet are clearly worth more than their tangible book value, you'd do very well.
The same is true of sales. If you can find a stock selling at a below-average price-to-sales ratio that you know will squeeze more cents of cash from each dollar of sales than the typical business — you’ve found yourself a bargain.
Regardless of the ratio you use — if you're completely satisfied you're getting an above average business at a below average price — you’ll do fine.
If you aren't satisfied about one of those things or the other, you're in a dangerous gray zone. I've invested in that gray zone at times — I’m doing it right now in Japanese net-nets.
Is this the part where I tell you to do as I say, not as I do?
Kind of.
Sometimes the stock market is an expensive place, and obvious bargains are hard to find. Now is one of those times.
And sometimes even mediocre businesses can get to such low prices that it’s obvious you are paying less than they are worth. That’s my bet in Japan.
In the case of Japan, I bought profitable companies selling for less than two thirds of the cash on their balance sheets. That’s clearly a gray zone investment. The businesses are not better than average. But, the price paid is so, so far below average that I feel it’s worth venturing into that investment gray zone — a place Ben Graham spent much of his career — as long as you buy them as a group.
It’s a slippery slope.
My advice is just to look at as many stocks as possible with a complete focus on finding the stocks you personally feel most certain are above average businesses selling at below average prices.
You need a margin of safety.
So, it should be a clearly much above average business selling at a clearly much below average price.
You can't always find that. But, if that's all you invested in, you'd leapfrog 99% of investors with that one idea.
If you stick to that idea, it's just grunt work. You just go through every stock you can find and you buy that one in one thousand opportunity.
There are lots of ways of doing that. In the past, I've recommended you pick a specific country to start with. You can pick a specific industry.
You can also screen for stocks. But very few of my best ideas have come from stock screens. It’s just too hard to know what you’re looking for before you find it.
Morningstar has a screener that lets you screen by state. If you want to become a better investor, there's no better way to start than by making a list of all the stocks headquartered in your home state that have a market cap under $100 million. Become an expert on those stocks. You'll probably be the world's sole expert on that group. The knowledge will come in handy — not just now, but also in a year or five when prices change.
Stock prices change a lot faster than companies. I can't tell you how many times I've bought a stock I originally looked at years ago. Some of those have been my best investments.
There are a lot of ways to find stocks. The finding isn’t the hard part. The ability to recognize a bargain when you see it is the hard part. And the ability to avoid calling something a bargain that isn’t a bargain is the hardest part.
Investors are always eager to do more than we should.
Follow Geoff at Gannon On Investing
"How do you screen for micro caps? What criteria do you use and what screening service do you use?"
I don’t really screen for stocks.
I’ve used these four screeners before:
1. Morningstar
2. StockScreen123
3. Sharelockholmes
4. FT.com
They’re fine.
But that’s not how I find most the stocks I buy.
Generally — and I say this all the time and no one ever believes me — you want to just go through stocks by starting with the As and going through the Zs. Think of it like dating. I’m sure you have some idea what you’re looking for. And you might be right in broad strokes. But you’re going to find something that surprises you — in a good way — if you just keep looking. It’s not that the screeners aren’t any good. It’s just that we’re not very good at knowing what we’re looking for until we find it.
So start with the As.
Look for obvious stuff that stands out. Stocks selling for less than net cash, net-nets, stocks with 10 straight years of profits, etc. Don't worry about close calls. They aren't worth your time. Look for stocks in simple businesses where the last 10 years of EBIT times one minus the country's corporate tax rate leaves you with a low, low P/E ratio. You want something like 6. Something that's going to give you 15% returns or better a year even if the business does more things wrong than right in the next few years.
These stocks are out there. Don't focus on the upside. Don't worry about a thesis. Don’t worry about envisioning exactly how you’re going to make your money in those stocks. Just focus on value. Focus on getting a bargain.
Think of it as a treasure hunt.
All you're doing is finding merchandise you know the rough value of.
Something that's profitable year after year is usually going to trade at closer to 10 times pre-tax earnings than three times pre-tax earnings. Ignore the stuff trading at 10 times pre-tax earnings. Focus on the stuff trading at three. Those are the needles. The 10 times EBIT stocks are the haystack.
Look at lots of stocks.
Don't waste time on stuff you can't grasp the economics of immediately. Unless you know a lot about banks, insurers, tech companies, capital goods companies, etc. because you've studied those things in the past or worked in those industries — just blow right past those stocks.
The key is putting yourself in the customer’s shoes. No one makes a profit unless their customer lets them. Competition comes later. Bargaining comes first.
The central question is why a company’s customers are trading away more cash for a product than was put into that product.
The answer determines how much profit the folks who make that product can earn. It also sets the battleground. On what terms will companies compete for these customers?
They can only compete against each other on the terms the customer sets.
The terms are whatever the customer places extraordinary value on.
If a food company uses quality ingredients and a customer pays up for that — that’s ordinary value. It’s meaningless. The product can be sold for more than a competing product. But it won’t make any more profit for the company.
Investors don’t care about that stuff. Investors only care about extraordinary value.
Take See’s Candies. Yes. They use quality ingredients. No. That’s not where the extraordinary value comes from.
See’s could use the same ingredients in New Jersey that they use in California. You can always move ingredients. You can’t always move reputation.
That’s why See’s makes big profits in California and next to nothing in New Jersey.
The ordinary value is in the chocolate. The extraordinary value is in the customer’s mind.
Don’t believe me?
Right now — it’s Easter Sunday as I write this — I’m looking at a chocolate bunny wrapped in gold foil. On the back, are the words:
“Made in Germany.”
It’s more profitable to ship a chocolate bunny across the Atlantic than to ship a brand name across the Mississippi.
That’s the kind of economics investors need to focus on. We all spend too much time worrying about interest rates. And too little time worrying about customer captivity. One of those things will fluctuate. The other doesn’t have to.
I don’t want you to think it’s just about brands.
It’s not. Most good businesses go unseen. And most good businesses are unsexy.
Take Bunzl.
It’s a UK stock. Half the business is in the United States and Canada. So, the company is hardly foreign to Americans.
Bloomberg says:
“Bunzl plc is a distribution group supplying a range of non-food consumable products for customers to operate their businesses but which they do not actually sell. The company partners with both suppliers and customers in providing outsourcing solutions and service oriented distribution. Bunzl's main customer markets include grocery, foodservice, cleaning and safety.”
While the company itself says:
“We provide a one-stop shop distribution and outsourcing service supplying a broad range of internationally sourced non-food products to a variety of market sectors.”
Basically, Bunzl inconspicuously takes care of things that are necessary but tangential parts of their customer’s business.
It’s a completely unsexy, very low visibility business. A true hidden champion. You’ve probably used the company’s products without noticing.
The next time you’re in your grocery store’s bakery section, taking out a pair of tongs, picking up a roll, and dropping it in one of those small plastic bags – check the name on the bottom of the bag. It might very well say “Bunzl.”
My point is that Bunzl is a good business. And it has nothing to do with a brand name. And even without a brand name — it’s still a business you can understand very easily if you just take the time to put yourself in the customer’s shoes. You can see why Bunzl’s customers are willing to pay Bunzl more for the service it provides than it costs Bunzl to provide that service. Basically, going with Bunzl means you get to focus on other things. The service the company provides is worth more than the sum of its parts. That’s why there’s a potential for profit in there.
Even though Bunzl isn’t a brand name business — the value is still in the customer’s head. It’s still about making a promise the customer is willing to pay up for.
Most investors can’t understand most businesses.
But there are some businesses anybody can understand.
Focus on those.
Even in the case of my Japanese investments, they aren't especially complicated businesses. Sadly, they aren’t especially good businesses either. Beggars can’t be choosers. If you look hard enough for stocks selling for less than cash — you’ll find them. Just don’t expect them to be good businesses. But that doesn’t mean you can afford to have no standards when it comes to such cheap stocks.
Even the mediocre Japanese net-nets I bought are in boring industries that I've seen before in other countries. I knew when I found them that those industries tend not to be places where folks are at risk of running repeated losses. They don’t have brutal economics where you need to keep running a tech race, or you have perpetual price deflation, or where big beats niche.
Those are the obvious risks that should run through your mind. Since the value in most stocks comes from future cash flows, you need to be able to quickly get comfortable with the idea that the long-term profitability of the business you’re buying is much higher than the price you are paying.
So here are the six questions you want to ask about every stock:
1. Is it crazy cheap?
2. Has it been profitable for a long, long time?
3. Does it do the same thing year after year?
4. Are folks who use the service happy to leave some cash crumbs on the table?
5. Is the value the company provides intangible?
6. Will existing customers stay even if a competitor lowers its price?
Those questions are ordered in the way you normally run through them. Any "no" answer is potentially lethal. But it's so hard to get a yes answer to question #6, that often that won't kill the idea.
The answers to questions #1, #2, and #3 always need to be "yes," "yes," "yes." If they aren’t — you’re speculating. That doesn’t mean you’re wrong or you’ll lose money. It just means you’re guessing about the future.
It's possible to answer questions #4, #5 and #6 "no," "no," "no" and still buy the stock if it is selling for less than net cash, net current assets, etc. However, as a rule, if the answer to question #4 is "no," then the answer to question #5 should be "yes" and vice versa.
The reason for this is that question #4 is a margin question and question #5 is an asset turnover question. If it takes a lot of assets to make a small amount of sales you're going to need very fat margins or you're going to have a business that is always worth less than book value.
The two easiest ways to think about any stock are in terms of assets and sales.
Are you paying a lot or a little for the company’s assets or sales? And does the company squeeze a lot or a little cash out of its assets or sales? Those two questions will steer you right when looking at non-financial stocks.
If all you did in your entire investment career was find stocks that are clearly selling for less than their tangible book value and yet are clearly worth more than their tangible book value, you'd do very well.
The same is true of sales. If you can find a stock selling at a below-average price-to-sales ratio that you know will squeeze more cents of cash from each dollar of sales than the typical business — you’ve found yourself a bargain.
Regardless of the ratio you use — if you're completely satisfied you're getting an above average business at a below average price — you’ll do fine.
If you aren't satisfied about one of those things or the other, you're in a dangerous gray zone. I've invested in that gray zone at times — I’m doing it right now in Japanese net-nets.
Is this the part where I tell you to do as I say, not as I do?
Kind of.
Sometimes the stock market is an expensive place, and obvious bargains are hard to find. Now is one of those times.
And sometimes even mediocre businesses can get to such low prices that it’s obvious you are paying less than they are worth. That’s my bet in Japan.
In the case of Japan, I bought profitable companies selling for less than two thirds of the cash on their balance sheets. That’s clearly a gray zone investment. The businesses are not better than average. But, the price paid is so, so far below average that I feel it’s worth venturing into that investment gray zone — a place Ben Graham spent much of his career — as long as you buy them as a group.
It’s a slippery slope.
My advice is just to look at as many stocks as possible with a complete focus on finding the stocks you personally feel most certain are above average businesses selling at below average prices.
You need a margin of safety.
So, it should be a clearly much above average business selling at a clearly much below average price.
You can't always find that. But, if that's all you invested in, you'd leapfrog 99% of investors with that one idea.
If you stick to that idea, it's just grunt work. You just go through every stock you can find and you buy that one in one thousand opportunity.
There are lots of ways of doing that. In the past, I've recommended you pick a specific country to start with. You can pick a specific industry.
You can also screen for stocks. But very few of my best ideas have come from stock screens. It’s just too hard to know what you’re looking for before you find it.
Morningstar has a screener that lets you screen by state. If you want to become a better investor, there's no better way to start than by making a list of all the stocks headquartered in your home state that have a market cap under $100 million. Become an expert on those stocks. You'll probably be the world's sole expert on that group. The knowledge will come in handy — not just now, but also in a year or five when prices change.
Stock prices change a lot faster than companies. I can't tell you how many times I've bought a stock I originally looked at years ago. Some of those have been my best investments.
There are a lot of ways to find stocks. The finding isn’t the hard part. The ability to recognize a bargain when you see it is the hard part. And the ability to avoid calling something a bargain that isn’t a bargain is the hardest part.
Investors are always eager to do more than we should.
Follow Geoff at Gannon On Investing
