- Warren Buffett, 2013 Berkshire Hathaway Annual MeetingBen Graham taught us that it is crucial to make Mr. Market our servant, not our master.
Buffett once said if he taught a business school program on investing, he would have just two classes: How to Value a Business, and How to Think About Market Prices.
Build a Database of BusinessesI was discussing my search process with a client recently and I mentioned I have built up a database of over a hundred stocks that I watch. I use Google spreadsheets to track these. I don’t look at the list every day. I don’t necessarily need to look at it every week, although I like checking it periodically. It’s a list of businesses that I’ve researched, or in the process of learning about. They are stocks I know something about.
The reason I build lists like this is so that when the Mr. Market gives me an opportunity with a general market decline, I can take a look at the list to see what the new valuations of these businesses are. I can cherry pick the very cheapest ideas from this list.
This is not a novel idea… I’ve heard many other investors that have such lists. But I thought I’d comment briefly on how I put them together.
Quality ScreensI’ve mentioned before that I use screens. Many investors use screens to find cheap stocks (low P/B, low P/E, net-nets, etc…). I check these screens once in a while, but it’s hard to get excited about a dirt cheap stock that you know nothing about, so while I look at these lists, they are just a starting point.
But I wanted to talk about quality screens. I’ve mentioned before how dangerous it is to rely solely on quality to make investment decisions. It is tempting to overpay for a great business. So you have to always keep Ben Graham in mind when looking at great businesses. Let the market serve you, and let the game come to you (i.e. make sure you’re buying these businesses cheap). It’s true that Buffett pays up for great businesses, and sometimes that can make sense in hindsight, but ensuring that you’re paying a cheap price for this quality merchandise gives you a significant margin of safety should your judgment regarding the quality of the business be off.
With that forewarning said, I’ll briefly mention a few screens I like to look at once in a while for good ideas.
I have a “cannibal” screen (Charlie Munger’s term for buybacks) that looks for companies that have been steadily and significantly reducing their share count over the last 10 years. This is one of my favorite screens to glance at. I have developed a separate google spreadsheet specifically for these companies.
Value Line Great Businesses:
This isn’t a screen, but a technique I’ve used to find quality businesses. I’ve mentioned before I use Value Line. I page through the lists each week looking for abnormally good businesses, and I track ones that appear to be of higher than average quality. Basically, I try to find the best 100 or so businesses among the 3500 stocks. I slowly have been building this list. It evolves slowly over time.
I got this idea from something I read regarding one of Buffett’s early contacts. I can’t remember who, but I think it might have been someone that worked for Buffett in the early 1960’s (one of just a few that Buffett employed). It was someone Buffett was close to… might have been someone that knew Buffett, but ran his own ideas—could have been Stan Perlmeter or maybe Bill Ruane. But in any event, I thought it was a good idea, so I page through Value Line always trying to identify the cream of the crop (in addition to really cheap stocks).
10-Year Free Cash Flow Producers:
Geoff Gannon gave me the idea to look at stocks that have produced 10 years of positive free cash flow, so I set up a non-financial screen for this on Morningstar. Munger once said he likes businesses that "drown in cash", that could write you a check at the end of the year (vs. having to reinvest all the earnings back into the business). This list will uncover some of these businesses. Only about 14% of the universe meets this 10-year FCF hurdle last time I checked.
Stock Price Compounders:
This one is somewhat unique, and not usually mentioned in the context of value investing. It's kind of the opposite of checking new low lists. Gannon also gave me this idea a while back, although I think he uses it for a different purpose. He mentioned looking for ideas from a list of stocks that have grown 10% a year for the last 10-15 years.
This is not a typical value investor’s screen, but it certainly would uncover the next M&T Bank (a boring bank stock that has compounded at roughly 20% per year for the past 30 years or so). I glance here occasionally to identify compounders that might be priced attractively.
The idea here is that this type of list might uncover management teams (think "Outsider" type CEO's that have effectively created shareholder value over long periods of time).
Net Worth Compounders:
Perhaps my favorite is the screen that lists all the companies that have compounded their book value at 10% or more for each of the last 10 years. This is a great way to find quality businesses. One of the simplest ways to identify businesses that are creating shareholder value are ones that are steadily growing their net worth over time. Long term compounders show up on this list such as Berkshire, Markel, and M&T Bank. But other less known stocks that have just as much "value creation" potential also show up. It's an interesting list to look at.
To Sum It UpHere are the lists I like to look at periodically for ideas on great businesses.
- Use Value Line to identify the Top 100 or so businesses
- Buybacks (Stocks that have reduced their share count by 30%+ over the last 10 years)
- 10 Years FCF (Non-financials with 10 consecutive years of positive free cash flow)
- Stock Price (Stocks that have compounded at 10%+ annually for the last 10 years)
- Book Value (My favorite quality screen: Stocks that have compounded their book value at 10%+ for last 10 years)
The concept of this exercise comes from Chapter 8 of the Intelligent Investor: The Investor and Market Fluctuations. More specifically, as Graham said it:
"The investor's primary interest lies in acquiring suitable securities at suitable prices."
These lists will likely generate numerous "suitable securities". The key is to methodically build your database so you can identify intrinsic values and then wait for Mr. Market to offer you "suitable prices".