In an interview with Warren Buffett (Trades, Portfolio) in 1993, Adam Smith, author of "Supermoney," asked how the small investor can find good investment ideas.
Warren Buffett (Trades, Portfolio):Â I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities, and that bank of knowledge will do him or her terrific good over time.
Adam Smith:Ă‚ But there are 27,000 public companies.
Warren Buffett (Trades, Portfolio):Ă‚ Well, start with the As.Ă‚
It’s all well and good to talk about how and when to buy a stock, but if we don’t know how to find them what's the point?
About 90% of the investment books I’ve read don’t deal with the search process very much (as in at all) so for a self-taught person such as myself it is hard trying to find ways to find the bargains that everyone always talks about.
“Fish where the fish are.” – Bruce Greenwald
That quote pretty much sums up my investment thought process: Fish where the fish are and don’t overpay for the bait. In other words, look at places that over the long term outperform the marke. For example, net-nets, or spin-offs. Then it's just a matter of picking the best fish out of the bunch.
Where Are the Fish?Ă‚
Net-nets, spin-offs, mergers, dividend payers and the Magic Formula stock screen are all ponds that you can fish in for big returns.
How to Find These Ponds?Ă‚
Net-nets:Â Net-nets are an endangered species. More than any other pond it’s getting harder and harder to find suitable net-nets here in America, although if you can find a group that is selling for two-thirds below NCAV Â my suggestion is to scoop them up.
Old School Value has two screens that you can use to find net-nets. One screen is based on NCAV, the other on NNWC. NNWC is an even more conservative version of NCAV. Basically, NNWC is base line, and NNWC is liquidation. I suggest using the NNWC screen. If a company is trading below NNWC, it is more likely that it is trading at 75% NCAV. (I will also consider companies trading 50% below NCAV if insider ownership is higher than 25%.) The list is updated every five minutes.
Spin-offs: Spin-offs are my favorite pond to fish in. Most of the time the market simply doesn’t know exactly how to (or won't)Â value the spin-off, making for some potentially sweet gains! You just have to know how to tell an elephant from a mouse.
There are two ways I search for spin-offs: The first way is to swing over to a great site, Stock Spinoffs. This site is great because it tracks a lot of the spin-off news that most simply don’t worry about. It's pretty much my CNN for spin-offs. I love this site.
The other way I search spin-offs, (I consider this to be more like true fishing) is to go to the Edgar site Stock Spin-Off List and just ”start with the A’s.” It’s not the most efficient way to go, but it gets the job done. Also it allows you to see the company-taken steps actually to spin off the division.
Mergers and acquisitions: A lot of people, including myself, think that investing in mergers is a high-risk endeavor.Ă‚ Joel Greenblatt (Trades, Portfolio) had this to say in regards to mergers and acquisitions:
"It aint over till it’s over – too many things have to go right too often.”
He goes on to say:
“However, you should be able to make a reasonable return – that’s because despite everything that can go wrong, most deals close."
Risk arbitrage is a dangerous game, if you don’t know how to play. Contrary to belief, most risk arbitrage plays happen after the deal has been announced.  I won't dig into how to take actual advantage of risk arbitrage as this is about search strategies. However, I will link to my risk arbitrage worksheet.
Now to find these meager announcements one simply has to read the paper, or at least part of the paper, specifically the mergers and acquisitions section of the New York Times. And of course, I have a link for you:Ă‚ Deal Book Mergers & Acquisitions. It's simple: Read, research, do your due diligence, repeat.
Magic Formula: This is probably the simplest of my invest strategies. Joel Greenblatt (Trades, Portfolio), invented a formula that outperforms over the long term (over 20 years). He outlined it in his book, “The Little Book That Still Beats the Market.” To summarize, the book outlines a screen that employs: Earnings Yield = EBIT / Enterprise Value and Return on Capital = EBIT / (Net Fixed Assets + Working Capital), to give a list of high performing, undervalued companies. Nothing could be more simple. Go to the website, Magic Formula Investing, enter your info, (don’t worry, it's free, and they never send emails or spam) and use the screen and pick the stocks you want to own.
If you are feeling “picky” you can use this screen as a starting point to dig deeper into stocks. Doing this fits into our thought process: "Fish where the fish are, and find the best fish in the pond.”
Any questions?
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