This is due to the fact that in the early stages of business development the plans are merely a blueprint for management and shareholders, or essentially a best guess. Problems have a higher risk of developing and the business may not be analyzed to the full understanding/extent as the sales, production, accounting, teamwork, marketing, R&D, etc. do not have a proven continuity. Skip the IPOs.
“There are enough spectacular opportunities among established companies that ordinary investors should make it a rule never to buy into a promotional enterprise, no matter how attractive the price may be.”
2) Don’t ignore a good stock just because it is traded “over-the-counter.”
The spread between the bid and ask represents additional frictional costs (for a broker to buy & sell at a profit, i.e. make a market.) but is rarely an issue referring to point 5. Liquidity and marketability are seldom a problem due to the increase in sales forces taking orders rather than brokering trades (essentially allowing a sale to be converted to cash without breaking the market). When catalysts occur or earnings are released volume also tends to show up. As one over-the-counter dealer expressed it:
“We have one market on the buy side. On the selling side we have two. We have retail and a wholesale market, depending partly on the amount of selling and services that is involved.”
3) Don’t buy a stock just because you like the “tone” of the annual report.
I can attest to this bias and that I have come to be aware of it. When reading reports I tend to stick to the 10-Ks and 10-Qs for initial fact collection but may compare management goals from previous years' annual reports with the success and execution of the goals they aimed for. I bought my very first company presumably because of the influence of the annual report — only the fourth or fifth I had ever read. The company was also cheap on fundamentals based on the book, "The Intelligent Investor." The company was Heroux Devtek (HRX.TO) and I was lucky enough to obtain a 25% profit a few months later instead of what may have happened losing a portion of my investment. The lesson learned was to be aware of the bias and do what you can to avoid it. Needless to say the company ended up gaining 100% after dividends and share appreciation.
4) Don’t assume that the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price.
I am still very much at conflict with this point and have a hard time grasping assumed or forecasted growth rates at high price multiple levels. Understanding my limitations, I have attempted to learn more about the internal drivers of growth and how those rates may affect future cash flows and common stock price. Essentially if a P/E multiple is, let's say, 25x to 30x, but the earnings are doubling on a five-year basis and continue to do so, the multiple will be justified and more likely than not still trading at a large premium to the market — if not the same or a higher multiple five years later. On this basis future cash flow is not being discounted as the company shares will likely enjoy an increase of over 100% and may actually prove to be the biggest bargain. An example of this may be a fast grower like Wal-Mart historically trading at a premium to the market, through almost the entire life of the business.
5) Don’t quibble over eights and quarters.
A great personal example comes from John B. Sanfilippo (JBSS) in the winter/spring of 2012. JBSS was trading at roughly $10.50 to $11.00 range, but I wanted to buy at $10 or lower. I waited patiently to save my $200 dollars.
Since that time it has never came back under $12 and is now at $22 where it is still reasonably attractive at 11x earnings (missing $2,300 in gains). Another example of this mistake is with a friend of mine who lives a street over. I had told him I was buying Easyhome (Eh.to) after my original purchase of 100 shares at $7 had declined to $6.
My original thesis remained intact as it was below book value for an absurd reason while growing consistently and had explained this to him on numerous occasions. I bought another 400 shares and concentrated my holdings to almost 25% of my TFSA at a price average of $6.30 and a yield of about 6%. My friend wanted to get the company that day for $5.85 to 6.00 and had set a limit order for 500 shares. He did not get filled and in the presuming days and weeks the price began to gradually rise back to the $7 range where he still did not buy. The company has recently hit $14 and his attempt to save $150 had an opportunity cost of $4,000.
6) Don’t overstress diversification.
I have written about this previously here. Phillip Fisher goes on to divide companies into three categories: A, B and C. He gives them allocation percentages of 20%, 10% and 5%, respectively. The A group is of institutional quality, the B group being a moderately more risky business based on sales volumes (what you and I may call small and micro caps), and the C group is risky assets that will eventually end in a large gain or a complete loss. Individual businesses may provide diversification through product lines and services offered in varying industries or sectors.
The problem is that more often than not the majority of eggs end up in mediocre or unattractive baskets. To paraphrase Andrew Carnegie, “The way to become rich is to put all your eggs in one basket and then watch that basket.”
Industry diversification may be appropriate provided companies do not provide it internally already. Cyclical businesses should also be diversified to a certain degree to allow for general business trend fluctuation on an intermediate time frame. Great ideas are hard to find, as many of you may know by now, rather than having to choose between the great ideas.
7) Don’t be afraid of buying on a war scare.
The results are always the same: Stocks go down on war fears and confirmation and end up higher than original quotes pre-war, when the war fears or actual war subsides.
8) Don’t forget your Gilbert and Sullivan (Don’t be influenced by what doesn’t matter).
An undeserved amount of attention is given to previous years' earnings of a corporation for the investor wanting to buy now (guilty as charged). What matters is the earnings in the future years — not what has been earned. Fisher also touches on the influence price ranges may have in the investment process and to be aware of them and ignore them. To many investors this will be a paralyzing effect induced by the mere fact the price has already risen versus the stock must rise after such a large decline. This cannot be further from the truth, not all stocks rise. “The price at which the stock sold four years ago may have little or no real relationship to the price at which it sells at today.”
9) Do not fail to consider time as well as price in buying a true growth stock.
Literally, Fisher advises on buying based on a specified date as appose to a price. He advises this on occasion due to the basis of the growth that is present. An investor believes a company will be rising in the future, but may be afraid of a possible drop in price and is inclined to take advantage of it. Unfortunately there is absolutely no certainty he will buy anywhere near the bottom or the price will even drop and may be more inclined to buy 3 or 6 months from today's date based on a certain catalyst or to attempt to secure a low price relative to the future stock price. I believe Fisher views it more as a rational buying process much like a house, not worried about catching the over all lowest price that may be obtained but instead securing a permanent position at a specified time. There is also a period in December where a supply imbalance occurs as tax losses are booked and may provide an attractive "time" to buy companies you are already interested in at lower prices. Small caps are also known to be effected by the "January Effect."
10) Don’t follow the crowd.
"The woman who follows the crowd will usually go no further than the crowd. The woman who walks alone is likely to find herself in places no one has ever been.” – Albert Einstein
“Whenever you find yourself on the side of the majority it is time to pause and reflect.” – Mark Twain
There are many books and articles written on behavioral finance, crowd behavior and sentiment. I will not go into detail here. From a top-down prospective, unfavorable industries may be examined in further depth as well as any other “shunned” common listing by the financial community. I believe it takes many years of discipline to avoid crowd mentality or it is distilled in a certain set of people due to past experiences and knowledge.
Unfortunately I am just as susceptible to crowd behavior as any other investor. I personally stay away from the actively leading issues, Wall Street “darlings” and other high fliers everyone in the financial community is talking about. I try to examine companies within industries that have an unfavorable temporarily outlook due to some kind of present development. I have known since I started in this business that following a crowd will lead to crowded investments and average or worse results. This is simple math that no investor can refute.
About the author:I am working towards the CPA & CFA designations, and would love to manage an investment partnership in the future. I am a self taught investor through Warren Buffett, Charlie Munger, Ben Graham, Peter Lynch, Joel Greenblatt, David Einhorn, Seth Klarman, Howard Marks, Phillip Fisher and Thornton O'Glove. My focus is a bottoms up Value-GARP strategy with a mix of top down contrarianism.
"When you find yourself on the side of the majority, it is time to pause and reflect." - Mark Twain