Someone emailed me this question:
“One thing that’s been bothering me lately is if I’m spending enough time researching my stocks. Would you mind sharing with me how many hours you spend researching something before you buy it?”
This is a tough question to answer. The truthful answer is that I know very quickly – a lot more quickly than you’d think – whether I might buy a stock. Usually I can tell within a matter of minutes (often five minutes or less) and definitely I can tell within an hour of research whether this stock idea should go to the front of the idea queue and be the thing I focus on or whether it’s more of a typical idea that might be good but isn’t instantly appealing.
Now I like to be inactive when it comes to buying and selling stocks. For example, I try to limit myself to just one new stock per year. That rule keeps me from flitting from stock to stock whenever I get an idea I like. Having said that, I will admit that when it comes to a stock I will eventually buy, I usually get more than 90% of the way to “yes” within the first 60 minutes. As I said, very often I’m 90% of the way to “yes” within the first five minutes. I know that’s not what you’re supposed to say. You’re supposed to say that you’ve carefully and objectively considered a stock idea without any preconceptions about whether it is or isn’t any good – and then you’ve appraised it as best you can and finally you’ve compared the current stock price to your appraisal price.
Then – and only then – does the impulse to buy come into play. In my experience, the decision process is nothing like that. I’m attracted to a good stock idea within the first five minutes, or I’m probably never going to be attracted to that idea. It really does work that way.
There are exceptions. The key here is the “frame” through which you are looking at the stock. That frame is going to be different for different people, and it’s even going to be different for the same person at different times. There are stocks I have looked at over and over again where my understanding of that business has evolved over time. It’s not usually an overnight thing. Sometimes it is. I read something John Huber (of Base Hit Investing) wrote about Apple (AAPL, Financial) recently and that got me thinking about the stock in a different way. It wasn’t the only thing that got me thinking differently about Apple, and I’m still pretty sure I’ll never buy Apple stock, but I can trace some changes in the way I “framed” the Apple problem to what Huber wrote.
Likewise, I pay attention to what Warren Buffett (Trades, Portfolio) does. When he bought railroads that got me to try to use “intellectual empathy” to put myself in Buffett’s way of framing the problem of whether or not to invest in railroads even if I didn’t see them that way. The same was true of Buffett’s investment in IBM (IBM, Financial). I’m never going to buy that stock, but I took some time to try to see IBM the way Buffett sees IBM.
Airlines are a more nuanced situation. I was interested in airlines – specifically Southwest Airlines (LUV, Financial) – long before Buffett bought stock in them. Airlines are something I might have pushed for putting in the idea pipeline when Quan and I were writing the Singular Diligence stock newsletter. About four years back, I got interested in finding businesses that I thought were fundamentally fine, but their earnings power had – for many years during the 2000s – been in some way disguised by high oil prices. I was sure oil prices would collapse at some point (though I had no idea when). I was often pushing businesses that used oil as fuel like Carnival (CCL, Financial) and Southwest Airlines.
When Buffett bought all the major airlines the same way he once bought into almost all the major railroads, that just got me more interested in stocks I was already considering as potentially interesting. A few days ago, I think I mentioned reading an excellent Bloomberg article about the chicken industry. The chicken industry is very cyclical, but it’s a very short cycle. It’s also still very fragmented. The three largest producers are Tyson (TSN, Financial), Pilgrims Pride (PPC, Financial) and Sanderson Farms (SAFM), but I'll bet the three of them together don’t account for more than 40% of the total pounds of chicken produced in the U.S. each year. The fourth-largest producer probably only has like 5% market share. You have 60% of the industry in the hands of competitors with 5% or less of the market. That’s not a great structure for rational behavior. There is a lot of temptation for companies that have 5% or less of the market – which, in the chicken industry is most of the overall production – to engage in behavior that they think will benefit them in the short term but will make the market worse for everyone in the long term.
On the other hand, the product economics of actually processing chickens is not bad. And chicken is a cheap protein in the U.S. that has been gaining share versus beef and pork for probably half a century. Much of the cost of chicken – like feed – is also part of the cost of competing meats. It’s a very durable business in the sense that people are going to want to eat meat, and chicken is going to be the cheapest meat. Long term, the industry is fine as a place to invest. However, it has these very short, very violent cycles that can be bad for the businesses in it.
On the other hand, you look at the record over the last 20 years at Sanderson Farms – I use 20 years because the company mentions in its 10-K that it changed corporate strategy in 1997 – and you see that it’s an excellent record. The average profitability has been solid. The return in the stock has probably been something like 13% per year over 20 years. Where previously I “framed” the problem of the chicken industry as purely this perfectly competitive industry in the long run, reading this article about the amount of information sharing between the companies in the industry led me to rethink the possibility that the industry could behave more rationally (and more like a cartel, implicit or explicit) rather than being this hopelessly cyclical industry.
Then when you look at the financial results of a company like Sanderson, you can see evidence of a very decent business there. Now, of course, there will be cycles and within the next couple years you can – and should – assume Sanderson will post an actual loss. For a long-term investor, that doesn’t matter though. What matters is whether the industry is going to be more like a perfectly competitive industry or more “rational” as the players in the industry would describe cooperative rather than competitive behavior. If the answer is that the industry is going to be more rational, then Sanderson would be an excellent long-term investment at today’s price.
At this point, I doubt I’ll buy Sanderson Farm, but I know I’d be “framing” the problem differently if it wasn’t for that Bloomberg article about the antitrust lawsuits now happening in the industry.
How can you make a decision so quickly? How can you know within five minutes or – let’s make this easier – one hour of first meeting a stock that it’s something that should jump right to the front of your idea line?
The three biggest positons in my portfolio are Frost (CFR, Financial), BWX Technologies (BWXT, Financial), and George Risk (RSKIA, Financial). Not all of them have been winners. I’ve owned George Risk since the summer of 2010. In that time, it’s probably underperformed the stock market and has certainly underperformed other stuff I could have bought instead, but all three of those decisions were made really quickly. I brought Frost to Quan’s attention – and he was very interested in the idea within an hour of hearing me talk about it. Quan brought Babcock (this was before the spinoff) to my attention. I wasn’t 100% sure we could understand the business, but I agreed that if we could understand it we’d definitely buy it.
Even though I wasn’t sure I could understand technical aspects of what the company did, I could tell right away that Babcock as a whole definitely wasn’t a bad business, and it definitely wasn’t expensive. That decision took less than an hour. In the case of George Risk, it was maybe a five-minute decision. It took me longer to learn a little about the business, but George Risk was a net-net. I read a blog post over at The Rational Walk about the stock. By the time I had finished that article, I was 90% of the way to “yes” with George Risk. I just needed to read the 10-K and learn a little about the business, the family, etc., to make sure there were no deal breakers that the article hadn’t considered.
By the way, the article I read actually wasn’t entirely pro-George Risk. The conclusion of the article was that the stock had no catalyst; it was cheap, but it was a “pass.” The no catalyst part is true. I still own the stock 6½ years later, and not that much has changed with it. As I said, I was probably 90% of the way to “yes” with Frost, BWX Technologies and George Risk within one hour of “meeting” the stocks. I would go on to do research for another week to a month with each of those stocks. In the case of something like Frost, I actually waited maybe six months to buy the stock, but that’s typical of me. I often decide to buy something or sell something and then I’m in no hurry to actually carry out the purchase or sale. I like to be as inactive as possible. As I said before, I try to limit myself to one stock purchase per calendar year. In the case of Frost, I was hesitating because I was deciding whether I would put about 20% of my portfolio into the stock or about 50% of the portfolio.
I decided on 20% of my portfolio. I’m not sure that was the right decision, but that’s what took me about six months to decide. Deciding how much of the stock to buy took six months. Deciding I was probably going to buy the stock happened within 60 minutes.
There’s often a period during which I am still researching a stock but even I have to admit that I’m at least 90% of the way to “yes.” Howden Joinery (HWDN, Financial) is the clear example now. I don’t own the stock, but I know that for a couple months now I’ve been 90% of the way to “yes.” I’ll probably buy Howden sometime soon, and I probably knew that within a few days – at most – of suggesting the stock as a newsletter idea that Quan and I should research.
We shut down the newsletter before doing an issue on Howden. If we had kept doing the newsletter, our next issue probably would have been Howden. It’s a good example of how I can be focused on one particular stock I like better than all other options right now and yet not actually buy the stock yet. In fact, that’s the whole point of my one new stock per year rule. It’s to make me take a long time between being 90% of the way to yes and actually buying a stock. I don’t want to do too much buying and selling, but that hasn’t stopped me from recognizing the stocks I love as opposed to the stocks I might like within the first 60 minutes or so of learning about them.
My answer is that there’s no harm in doing a ton of research and waiting a long time before buying. However, if you’re an experienced investor, you’re going to be instantly attracted to the best ideas you have within the first hour of hearing about them. That’s just how it happens. Good ideas are simple. They’re obvious. You know them when you see them. It happens really fast. That doesn’t sound prudent and full of the kind of due diligence we’re told we’re supposed to practice, but it’s the truth. A great investment is usually something you fall in love with the day you first find it. It doesn’t take months. You know pretty much right away.
Disclosures: Long Frost, BWX Technologies and George Risk.
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