To that end, I’ve started something new on my blog (for those who don’t know – I write a blog with Quan Hoang called “Gannon and Hoang on Investing,” there will be a link at the bottom of this article). Each day, I’m posting a “daily idea.” It’s not a stock pick. It includes zero comments from me. It’s just a name you can practice on. It’s not chosen at random. These names will reward appraisal practice more than picking stocks at random.
The first two names were:
· Greggs (GRG)
· Tandy Leather Factory (TLF)
Pick either stock. Or do them both. Try to give a one page appraisal of what the company’s stock is worth – and whether there is a margin of safety. You can email me your one page appraisal (there will be a link at the bottom of the article). Or not. Either way, it’s good practice.
The important thing is that you do practice. That you do the work yourself. And you do it your own way.
This will cause you to face practical problems. What is Greggs’ return on capital? Should I capitalize the leases? If I do capitalize the leases, does this change the value of the stock, my margin of safety, my upside potential in the stock, just my downside risk – which is it?
You have to decide for yourself. Do you focus on ROE? Or on return on capital? How do you capitalize the leases?
You’ll find yourself checking how other people treat leases. You’ll find yourself scanning other 10-Ks, annual reports, etc., for hints on how companies treat this problem.
You’ll also find yourself getting into theory. For example, it’s fine to answer what the return on capital of the business is – but are you buying the business? You’re not their landlord. You’re valuing the equity. How do you do that? Do you value it relative to peers, what it would be worth in a takeover, or some discounted cash flow (I strongly recommend no on this one) approach? In that case, do you value it on a leveraged (equity only) or unleveraged (enterprise value) approach?
We could talk about these things in theory. It is better to face them head on in practice. If you analyze a retailer, a restaurant, a bank, a real estate company, etc., you’ll start to really ask yourself these questions. Why do people do a return on capital calculation for retailers who lease their property but focus on return on equity for a bank? Isn’t a bank using its customers' deposits? Why are those safer than leases? And is safety what determines how we treat the use of other people’s money? What about trade credit?
You probably know that analysts net out working liabilities against working assets to get net working capital. But why do they do this?
We can talk all day about this. But it won’t be as informative as you dealing with a company with a lot of working capital, a company with negative working capital, and a company with a normal amount of working capital. Seeing the spectrum of actual experience in the wild will teach you the most about how to deal with issues like that.
So, the first thing you need to do is find something to practice on. I already gave you two names: Greggs and Tandy Leather. And for some time – I’m not sure how long – I promise to post a new name you can practice on at my blog each day. It’s a rare investor who flies through multiple valuations in one day. So, if you just check my blog each day, you should have a steady flow of companies to practice on. And, if you send me your appraisal (and keep it to something that would fit on one page), I’ll reply to your email with the questions I’d follow up with.
Regardless of whether you are working with someone else – emailing them your work for follow up questions to point you in the right direction – or working blind, you’re going to need to actually work. And you’re going to need to focus.
You may have a job that requires intense focus. Most people don’t. Most people have jobs that require a fair amount of multitasking. Don’t do that when you tackle investing. Take one task. And take it seriously.
I suggest starting with a 10-K of a company you are interested in. Make sure you have a notepad, pen, highlighterand calculator before you sit down. If you forget any of these, you will risk breaking focus or being lazy. For example, if you don’t have a calculator, you’ll skip over doing math that would be helpful. If the company mentions its number of locations and total operating profit – and you have a calculator – you’ll breakdown the per location profit, sales, etc., right then and scribble it in the margin. You’ll only do this if you come prepared. Otherwise, you’ll be lazy and not do the work. If the calculator is in the other room – you won’t get up and get it. You’ll figure this calculation isn’t really important.
So, come prepared. Always have all the tools you need in front of you. Otherwise, you’ll have to break focus.
What do I mean by focus?
If you can roughly keep track of time while doing an activity, you are definitely not focused. For example, if I am in bed and not yet asleep – I can very easily guess it’s been about 10 minutes. A quick glance at the clock confirms this. I may be off by three minutes on either end. But it won’t have been 33 minutes if I thought it was 13 minutes.
If you have any sense of time while working on the 10-K, doing your research, etc., you’re working but you’re not focused. You’re underperforming the level of efficient work you could be getting done. And it’ll show.
At first, some people will have trouble achieving the kind of focus that means you have no idea how long you’ve been doing the activity. In fact, when you’re really focused you’ll measure how long you’ve been working by knowing the pace you normally work at.
If I’m 1,000 words into this article, I know roughly what that means in time, because I know how fast I write. Without knowing I’m 1,000 words into the article – I only know this because I have word count constantly updating on my screen in Word – I’d have no idea how long I’d been writing. That’s what focus feels like.
Your goal should be to work on one task and achieve that level of focus. You won’t the first few times you do this. So just scribble down the time you start reading the 10-K right now. Then, when you’re finished with all the reading and note taking and everything at a nice, normal pace – write down the time you put down the 10-K.
Was it less than 90 minutes?
If it was, that’s a manageable chunk for you. Anyone can focus for up to 90 minutes. So, in the future, you can always rest assured that sitting down to work on a 10-K is a fine single activity for you.
A task that takes you five hours is not appropriate to focus on. Don’t try to focus for five hours. You’d need to break that task down into smaller chunks and tackle them at different times. It’s possible to binge work for five hours. People do this in their day jobs all the time.
But it doesn’t lead to the kind of results we want in investing. The bar for investing insights – for the analysis you’ll be doing here – is a lot higher than for a normal hour of office work. For one thing, you’re going to be spending less time investing than on your day job. And yet it’ll still be important to your financial future. If you really think about the time investment on this areas of your life versus what you’re risking here – it’ll scare you. You need to perform well. The bar here is more at the level of an athletic competition than daily office work.
It’s high. So, you need to come to your practice each day like it’s a competition. I’m not going to tell you how long a task should take you. That’s unimportant. I just want to make sure you are fully focused throughout the task. So, don’t bite off more than you can intently chew.
Never attempt more than 90 minutes of focus. You may succeed. But you won’t come back to it tomorrow. I want daily practice out of you. I want you to sit down – it can be for 30 minutes of intense focus – and really practice valuation work each day. I don’t want you to do two hours every other Tuesday. That’s no good.
Monitor your behavior. Break down your process into individual tasks that you can focus on. For example, do you go out looking for ideas?
For now, eliminate that step. I’m putting one idea a day up on my blog. Just take that one. I saved you time. This is just for practice purposes. And your practice time – at first – is better spent doing active work on an idea than passively trawling for ideas.
Do you like to put things in a spreadsheet? Many investors do. I do. I use a standard form. Break that into a task. Data entry requires a low amount of focus. It can also – once you have a system for checking EDGAR, have a blank worksheet you reuse in Excel, etc., be done very fast.
We already talked about reading the 10-K. That can be a long process. I also read the 14A and 10-Q and S-1 (if available). This is what I do with every stock I seriously consider. Picking up each report is a habit for me. It doesn’t have to be for you. Maybe you just want to do the 10-K for now. I think that’s a good choice.
One you’ve read the 10-K what else will you need to do every time to practice?
You have to value the company. Unless you are writing down an actual per share stock price, you aren’t getting the most out of this practice. You’re working. But you aren’t learning like you could be.
We want to maximize the amount of learning you accomplish versus the amount of time you spend working.
So get in the habit of always doing a one page appraisal of the stock.
For me, such an appraisal has to meet these requirements:
· Fits on one page
· Calculates an exact per share appraisal (example: $67.05 a share)
· Calculates an exact margin of safety (example: 28%)
· Makes explicit, logical statements
· Provides evidence in support of statements
· Shows the actual arithmetic
It’s possible you can find an approach that will teach you as much – or more – and doesn’t follow all those steps.
I’m not suggesting anything elaborate. Evidence for me is simply an appeal to actual experience. It’s citing a real-life observation. Not using theory. So, Company B trades at 0.7x sales and Company B is comparable to what I’m analyzing is evidence.
Logical statements can be very simple. I opened my appraisal of John Wiley by saying “John Wiley has 3 businesses: 1) Journals 2) Textbooks 3) Books.” I then proceeded to value each. The logic here is clear. I am saying the value of John Wiley is the sum of the value of its assets. The company’s assets are its three business segments. I then value each segment.
This is practice. It is not what I would put in an article. It may not even be persuasive. Often, stories are more persuasive. Even portfolio managers seem to like hearing stories. I don’t like including stories in my appraisals, etc. – really in anything I work on for myself, because I am suspicious of the power of stories. They have a special hold over humans. If you want to sell someone a lie, you create a story to justify it.
So, for me, stories are not part of the practice process. Likewise, I try to keep moral judgments to a minimum. I find that the most common examples of sloppy thinking in investing come from four sources:
1. Not doing the work
2. Lack of focus while doing the work
3. Seduced by a story
4. Blinded by moral judgments
So my advice on practicing investing is to focus on valuation work (what I call appraisal). Try to practice every single day. It’s better to practice for 30 minutes seven days a week than 60 minutes for five days a week – because five soon becomes dour and then three, but seven stays seven.
Rule No. 1 of practice is: Do it everyday.
Rule No. 2 of practice is: When you work, you focus.
The last two pieces of advice are to be aware of your innate human weaknesses. You are overly interested in stories and morality. Put them aside when you enter your practice zone.
And don’t binge. That’s advice for later. It won’t be an issue at first. But once you really enjoy practicing you’ll want to do it for three hours at a time. Bad idea. Do it for 90 minutes at a time two or three times a day. Don’t work yourself up into a manic state. If you do that, you’ll find you won’t come back to it tomorrow. Instead, you’ll start doing all your investment reading in great big gulps once a week, once a month, etc.
That’s no one way to practice. You want to stay in constant contact with investing. You want to make doing the actual work completely routine.
You do that by making sure you completely focus on the right task every day. It doesn’t have to be for long. And it can be literally one task. You can accomplish just reading a 10-K today. Or just doing a one page appraisal today.
If you do it with total focus and you do it everyday – you’ll get good at this.
Talk to Geoff
Read Geoff’s Other Articles
Follow Geoff at Gannon and Hoang on Investing