"The first rule of fishing is 'fish where the fish are.'” -Charlie Munger (Trades, Portfolio)
If an investor wants to get better odds when looking for investment ideas, he should look where they are and where competition for them is scarcer.
Francisco Garcàa Paramés (Trades, Portfolio), in is recently published book, “Investing for the Long Term,” identifies several market characteristics where selection could be easier and opportunities could be better.
1. Family firms
According to the Credit Suisse CS Family 1000 Report, family-owned companies have outperformed non-family owned companies since 2006.
Source: Credit Suisse Research Institute
Family-owned businesses enjoy higher revenue growth and higher profit margins. They have more conservative balance sheets and invest more funds than non-family-owned companies. Those factors translate into higher stock performance for family-owned businesses.
2. Conglomerate or holding companies
These are companies that invest in a set of businesses with small or no relation to each other. They generally perform well against their comparable indexes and, as they normally trade at a discount to net asset value, they have that spread difference potential. Usually, when markets are in bullish mode, these stocks can trade at NAV.
3. Small companies
This is a very well-known factor of outperformance (check Fama & French three factor model). Small companies are less followed by analysts and by the market. Since they are more illiquid, they don’t tend to have many fans. These factors make this an interesting market for investment selection.
4. Preferred stocks
Some companies issue preferred shares. Preferred stocks have all the same rights as ordinary shares except for the right to vote. They could even have a higher dividend. But, especially in Europe and South Korea, preferred shares tend to trade a significant discount to ordinary shares. For a minority shareholder, the right to vote shouldn’t be so valuable and if the business in a good one with strong long-term prospects, this is an additional discount that investors can enjoy.
5. Spinoffs
In his classic value investing book, “You Can Be a Stock Market Genius,” Joel Greenblatt (Trades, Portfolio) said spinoffs generate considerable forced selling, therefore creating an investment opportunity.
When a company decides to spin off a smaller unit, shareholders receive shares of this new entity that they don’t know anything about. It’s too small and they want to sell to be rid of it. A new and more focused management team for the new company can also improve the business' metrics and provide better returns.
6. Free options
Sometimes, companies have assets with considerable hidden value whose progressive recognition can provide significant support for the parent stock over the long term. These assets could be a portfolio of real estate investments, a very promising unit still in their early days of development or a very strong brand whose value gets diluted within all the assets of the parent company. To release this hidden value, managers can decide to spin off the unit or sell part of the business.
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