Idea generation is passive.
Investment ideas are scarce and hard to come by at times. People constantly ask me about companies they work for (Bell) or businesses they purchase a lot of product from (P&G or Coca-Cola), and what I think about the prospects/valuation. When it is not the blue chips in the limelight it certainly is the Netflix’s,Tesla's, 3-D printing, and other companies I would classify as speculative. It is not that I am a Grinch, but I do not like giving out investment ideas. Rather, I attempt to give lessons. As Maimonides said, “Give a man a fish, feed him for a day; teach a man to fish and feed him for a lifetime.”
So how do you find ideas? Do you mindlessly follow others? Did someone else give you a recommendation to buy or sell? Did you see it on CNBC or another business television network? If you answered yes to any of the above questions, you may want to revamp the idea generation step of your investment process.
Recommendations or following others may be lucrative, provided you do your research and form a personal thesis/valuation. Doing your own research is very important, so when the investment falls in value you have strong conviction to hold or preferably buy more.
I read a lot. About 70% of my ideas come from newspapers, books, newsletters, fund commentary, 13-Fs, or articles. The remaining 30% would be split equally between fundamental screening methods and looking at producers of products. When I complete valuation screens the variables usually change slightly, although I do have a microcap and small-cap focus. I look for companies with high gross margins, 10-year revenue growth, modest debt to equity, plausible ROIC and operating margins over 10%. Finally, I usually screen for P/S ratios less than 1.0 and P/Es fewer than 15 to 17. The problem with screens is that they are based on present accounting metrics and a company may have reported terrible (or great) numbers in the most recent year, leaving them excluded from the screening methodology. Sometimes I will be very specific with the criteria and other times very loose and vague, retrieving many more results.
Product analysis is always an exciting experience filled with channel checks and interviews with employees, managers (if they will talk) and customers. I start with friends and family, asking where their discretionary spending is going currently and what businesses they believe they spend the most money on. I ask questions regarding new products I have heard of or any that they may have heard of. I ask about brands and which are their favorites (name the top five that come to mind).
When a new product, service, retailer, restaurant, etc., is found, I also like to know the employee’s perspective of the culture and how products are selling. I will look for people employed by the company on the Internet and send an email. If a location is close by I will drop into place un-announced asking questions to random employees. Usually a manager will approach me at some point and I will introduce myself as a shareholder (even if I am not), attempting to peel any information I can from them. The most recent products or services I have done informal research on in the recent years include Netflix, Soda Stream, Green Mountain Coffee, Buffalo Wild Wing, La Senza (my girlfriend did it for me), Apple, Take-Two Interactive Software, Michael Kors, Coach, Fossil, and others go unnamed. (Usually after an idea is generated it will make its way through this process.)
What is your approach to product analysis and collecting grass root opinions?
Finally, back to where the bulk of the ideas come from: reading. Reading annual reports has proven to be the most useful, followed by newspapers, books and 13-F filings. I attempt to read 200 to 300 pages a day of something related to business or investing, whether it is Fortune magazine, The Wall Street Journal, a recently received Amazon order, newsletters, case studies, fund commentary, annual reports, or old books off the shelf. I am trying to absorb as much as I can.
A lot of investment and business books give great examples of enduring companies with large durable moats that are attractive when priced right. Warren Buffett has mentioned on several occasions he has bought businesses based on simply reading about them briefly and examining public financial statements, although he did also have the following to say:
“You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.”
Again, investment idea generation is passive in nature.
Once an idea has been generated it is time to check the balance sheet and crack open the annual reports and other recent filings that are of interest. This is one of my favorite parts of the investment process: You have started your journey through the forest, but it is thick, dark and overwhelming. As we analyze the annual report and read competitors' reports, more profound ideas may jump out through reference in the reports. I have recently started reading annual reports in hard copy with a red pen or highlighter to more efficiently “tag” where my time needs to be spent. My red pen or highlighter is my flashlight in the dark, thick forest. It is a great idea to have scrap paper to write down ideas, thoughts that come to mind, quick calculations or warning signs you may see within the filings.
Some of my favorite reading resources are:
- · The Wall Street Journal
- · Shareholder Letters
- · The Globe and Mail
- · The Guardian
- · Fortune Magazine
- · Canadian Business Magazine
- · Forbes
- · 13-F Filings
- · Gurufocus
- · Morningstar
- · Value Investor Insight
- · Hoovers
- · Valueline
- · Value Engine
- · Value Walk
- · Graham and Doddsville (Columbia)
- · Barron’s
- · Trade Journals
- · Industry Reports
- · Amazon (For book orders)
One of the students asked what he could do now to prepare for an investing career. Buffett thought for a few seconds and then reached for the stack of reports, trade publications and other papers he had brought with him.
“Read 500 pages like this every day,” said Buffett, or words to that effect. “That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.”
About the author:
"When you find yourself on the side of the majority, it is time to pause and reflect." - Mark Twain