How Do You Look for Stocks?

The pros and cons of different stock discovery methods

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Mar 08, 2016
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If you need a list of stock-finding techniques, here is one I have compiled, organized from my least favorite to favorite.

Recommendations from the mainstream financial media

I define the mainstream financial media as organizations like CNBC, Bloomberg, Barrons, Fortune, etc. I don’t like this method for a couple of reasons.

  • First, if a recommendation is broadcast from a popular avenue, then everyone knows about the stock idea. When Jim Cramer says to buy whatever, then many retail investors follow his advice; as the stock price goes up, it becomes less attractive.
  • Second, the reasoning on recommendations from the mainstream press tends to be extremely shallow and ill considered. I write more extensively about my distrust of mainstream media in another post here.

Despite my misgivings, one shouldn’t dismiss this method entirely as there will be guests worth listening to from time to time.

Screeners, 52-week low, 52-week high stocks

Using a screener involves searching for stocks that meet certain criteria like low PE ratios, high growth rates, low debt ratios, etc. I lumped these three methods together because you could argue that looking at 52-week low and high stocks is derived from using a screener. There’s nothing wrong with this method. I notice that, when I use screeners depending on the criteria, the same stocks routinely appear for at least a quarter because it takes time for new results to be reported and for business conditions to change.

For example if you looked at 52-week low stocks last year, many names from the oil and gas industry appeared because of falling commodity prices. This year, when you look at the 52-week high list, the same oil and gas companies from last year’s 52-week low list are appearing as they rebound from very depressed prices.

I have a number of issues with screeners.

  • First, screeners take time to generate new ideas. As I mentioned, it takes time for companies to report new financial results so on a daily basis the list from screeners might remain stagnant for awhile.
  • Second, investors tend to use the same criteria. Popular filters include strong balance sheets, high returns on invested capital and consistent cash flows. The result is that many people find the same companies.
  • Third, I find absorbing information in this manner is not the most efficient method. When you use a screener, it spits out a list, and you research those companies one by one. I then start reading articles, SEC filings and earnings calls. The list of companies can be from different industries. For whatever reason, this process sometimes makes it difficult to get into a flow. What typically happens is that most ideas get rejected, and it can be discouraging. Furthermore, when studying companies one by one, I don’t necessarily get the big picture. I prefer to get an overview of an industry and then study companies one by one.

Ideas from investment professionals

You can follow the ideas of gurus like Warren Buffett (Trades, Portfolio) but again, depending on how widely followed a guru is, the ideas can become popular and as the stock prices rise they become less attractive. Sometimes investment professionals will share their ideas very publicly because they want to influence the stock price. Examples include Herbalife (HLF, Financial) and Valeant (VRX, Financial) where Bill Ackman (Trades, Portfolio) and Andrew Left published their findings. These research papers usually provide good industry background.

One must keep in mind that authors who have an established position may not present fair and balanced views. Often someone on the other side of the trade will publish a retort so it’s up to the reader to seek different viewpoints. Reading presentations from others is the starting point. Investors should always follow up and perform their own due diligence.

Ideas from bloggers

There can be a difference between the incentives of individual bloggers and the mainstream publications. Sometimes mainstream publications are downright shameless in their quest to earn advertising dollars by using misleading headlines.

Since many bloggers aren’t well known, there’s a greater incentive to produce a quality product so it attracts more readers. In addition, bloggers may write about less-followed companies. It takes time to weed out good writers from bad ones.

I prefer reading industry experts who improve my business acumen. I have learned a great deal from bloggers who cover the fracking industry. These bloggers have enlightened me on industry dynamics, exposed me to new sources of information and shared detailed information to which I didn’t have access. It’s important to keep in mind that a writer may be knowledgeable about one subject area but not another.

The comments sections on blogs can be even more helpful than the original articles. Many readers will add helpful information and start a dialogue. Sometimes these conversations are civil. Other times disagreements can escalate to the point where adults insult each other like participants in a presidential debate. A commenter may write an unpopular view and get attacked by multiple people on the other side of the trade. Ultimately one side will be wrong. As a result, readers can witness raw emotion, get insight into the psychological aspect of investing and see mistakes unfold in real time. Readers can observe how some people refuse to accept new developments and bend logic every which way to justify their original views rather than admit to being wrong.

My new favorite method

Earlier this year I invested in a broadband company that serves rural communities. I researched this company by reading customer satisfaction reviews in its top markets. Some of my Google searches led me to articles in the business sections of local newspapers. Over time, I developed the habit of steadily reading the local business sections from different digital newspapers around the country. I’ve found this to be a highly enjoyable exercise, and it’s become my favorite way to generate stock ideas. Here are some examples of news topics that you’ll find in a local paper and how they might generate ideas:

  • New regulations  When new regulations mandated pilots to undergo more training and take longer rest breaks, that affected the supply of pilots and has greatly disrupted the operations of certain regional airlines.
  • Mergers, acquisitions and IPOs of lesser known companies  A number of the mergers I’ve read about are in the community banking sector which has exposed me to companies I might not have found through a screener.
  • Small corporate layoffs  A Fortune 500 company shedding 50 jobs may not make national headlines, but it may be newsworthy to a small community. Small layoffs may give insight to underlying weakness in the employer’s business operations.
  • Bankruptcies of smaller companies  This might give insight to trends in a particular industry or region.
  • Local startups  I learned about a company that organizes painting lessons at local pubs. Who knows? One day, it could become the next Buffalo Wild Wings (BWLD, Financial).
  • Local real estate projects  A current theme emerges which is that many cities are struggling with affordable housing. In the great financial crisis, workers in the housing sector faced disproportionately higher levels of unemployment. What’s surprising now is that some builders are facing shortages of construction workers.
  • General local news I was surprised to see that The Oklahoman newspaper has a section dedicated to earthquakes. Oklahoma has become a hotbed for earthquakes and even its governor admits that a connection between fracking and the increase in earthquakes exists. I’ve seen these headlines before in national publications, but it didn’t sink in. Seeing that a regional newspaper has a whole section dedicated to the topic made me realize how concerned the local citizens are.

In each of the examples above, an opportunity or an obstacle is appearing that means there will be winners and losers. The idea is to stay consistent in reading local news headlines and to compound knowledge. Hopefully, I will be able to recognize patterns and uncover the winners and losers. I have only been consistently using this stock-finding method for the last several weeks. So far all of my ideas have ended up in the junk pile or on a watchlist, but I’m less frustrated when I hit a dead end. That’s because companies feel more tangible using the local news story method.

Let’s say that I find an equipment manufacturer from the 52-week low list. I tend to forget about many of those companies if I go straight to the SEC filings. That’s because SEC filings are dry, and the information is hard to retain. However, if my first exposure to the equipment manufacturer comes from reading a news article about how that company created new jobs in a small town in Idaho, then I’m more likely to remember that company. When a company feels more tangible, it makes reading the SEC filings more pleasant. The downside of this method is that it is extremely time consuming.

Parting thoughts

Good ideas are really hard to find. That’s why I use all of the methods listed above to varying degrees. Personal preference will dictate with which method each investor is most comfortable. Warren Buffett (Trades, Portfolio) said he would settle for one good idea a year. I haven’t found this year’s idea yet, but at least I found a new way to search for stocks that I find to be rewarding. I would be interested in how other people generate investment ideas and why it works for them. Feel free to share in the comments below.