Challenge To You and How I Do Research
The first thing I recommend after reading this book is to find a company you find interesting for some reason, read its annual, quarterly, and proxy reports, and value and evaluate the company. THE ONLY WAY you are going to improve as a value investor is if you constantly practice techniques and valuations, work on your thought and investment process, and work on your patience, temperament, and confidence as you get better.
When I say constantly practice I do not mean just doing the same thing over and over like most people do, is very easy, and is sometimes even fun. When I say practice I mean deliberate practice where you constantly push yourself to learn new things and constantly look for ways to improve by going back over your previous articles and reports to see where you may have made some errors. This kind of practice is not easy, generally isn’t fun, and takes a lot more time. If you truly want to become an excellent value investor though you must practice deliberately and not just keep doing the same things over and over. For some examples of deliberate practice search my blog or Google with the words Deliberate Practice.
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The way I do research has probably been the area that has changed and evolved the most since starting to invest. I used to put together very detailed stock screeners on places like finviz.com looking for companies that had good-looking ratios and that was about it. I looked for things like a high current ratio, high margins, growing revenues, high insider ownership, etc and ended up wasting a lot of time sifting through poor companies because I didn’t have a defined and repeatable way of searching for companies.
Now I follow a very regimented research strategy that has paid off by saving me a lot of time and has helped me find better companies faster. Instead of doing my full research on a company that had good-looking ratios, I now follow a three-step process that discards a lot of companies off the bat and saves a lot of time. Before we get into the details of what I do, I want to tell you that this is just what works for me and it may not work for you. You need to find whatever works best for you but I wanted to share how I do research because I get the question relatively often.
The first thing I do now is put together a very basic stock screen with only a few criteria instead of the 10+ individual criteria I used to use each time. All of this is based on finviz.com. I use very basic search criteria in the screens now like recent positive insider buys, if it has a P/B below 2, and it has a market cap below $300 million. Sometimes using more sometimes less, but generally this is the criteria I now use to start with.
I also consider the amount of shares that insiders own, if any analysts are covering the company, if a company has had recent bad or good news, if the company is under strategic review, and a lot of other criteria as well but those are a lot more subjective to my preferences than anything. Recent insider buys are always something I like to see because insiders know more about the company than anyone and if they are buying it usually means they expect the company to do well over time or they think the company is undervalued. Make sure that the insider buys are actually buys in the open market and not just the awarding of options or shares by the company. You can do this by looking at the company’s form 4 releases which can usually be found on the company’s site or on Morningstar.com. In all honesty I would love to see a company that has P/B below 1 but I use 2 as my cut off. I used to use a P/B of 1 and below as the cut off but that left very few companies to look through. Now that I am more confident I concentrate almost exclusively on small and nano cap companies because a lot of investors and analysts do not look at these smaller companies. This is different from large caps where sometimes dozens or hundreds of entities are following a company. If you are interested in special situations you can use sites like stockspinoffs.com as well. I also find investment ideas from other value investing blogs, insidermonkey.com, Seeking Alpha, GuruFocus, etc.
With the above criteria from the stock screen I usually end up with a list of between 50-350 companies to look into. After that I discard Chinese companies because of my previous horrible experience with Chinese small caps. I also discard financials except insurance companies, pharmaceuticals, and mining/natural resource companies because I do not understand how to value or analyze those companies. After discarding those companies I end up with a list of between 30-150 companies usually.
When I get to this point I go one by one using Morningstar.com or yahoo finance to look at things like insider ownership, what the company does for business, how healthy the company’s balance sheet is, its profitability, any positive or negative news, or if I find a company to be interesting for some reason, to determine which companies I am going to do further research on. Using my personal criteria for what I look for in an investment (Again, this is something you will have to figure out for yourself) I narrow that list of usually as many as 150 companies down to fewer than 5 that I start minimal research on.
For each of the as many as 5 companies remaining I download each company’s most recent annual, quarterly, and proxy report, read through those reports and take notes on them.
At this point I will discard more companies, sometimes all of them if I find enough things about the companies that bother me. Things like related party transactions, decreasing profitability, excessive management pay, expensive law suits, expiring patents, debt filled balance sheets, etc. If I discard all the companies at this point I then adjust the stock screener and start the research all the way over from the beginning going through several hundred companies again. I also may look for things like spin offs, companies that are experiencing good or bad news, or a company that I find interesting for some reason.
If I find a company or companies that I still like after reading the most recent financial reports of a company I then value the company or companies and analyze its float to see if they are undervalued and if they could potentially have a moat. At this point I usually end up discarding all the companies because they are not undervalued enough or their margins are not good enough for me to invest in. I will then adjust my search criteria again and start looking through potentially hundreds of companies to find more to research.
If I do find a company that is undervalued or supremely interesting still, this is where I end up doing my full amount of research and analysis and generally end up writing an article.
At this point I download an annual report for at least each of the past five years (10+ years if they go back that far) and read every one of those annual reports and take a lot of notes to see if a company has had problems in the past, how they went through the previous recession to get an idea of how they may react in another worst case scenario, how they came out of those problems and got better, and how the company’s operations have evolved over time. I take notes about margins, debt, cash levels, profitability, revenue, float, total obligations and commitments, how a company’s operations have changed over time, and how these things have changed over the years. I also research the company’s competitors, usually reading at least a few of their annual reports, taking notes on their margins, debt, cash levels, profitability, revenue, float, etc to compare the companies together over a long time period to see how they stack up against each other and to see who is at least on a relative basis the most undervalued. While doing research on competitors keep in mind that these can also turn into potential investments if they end up having better margins, better profitability, and are more undervalued than the company you are analyzing as well. I read proxy reports to see what executive and management pay is, if there are any red flags, who owns 5%+ of the company, and to find out if management is exceptional. I also search Google to see if there have been any new developments within the company since their last annual or quarterly report came out to see if there are any new things that need to be factored into the analysis. Those are the main things I look for but I also look at some other things I consider to be more minor but can potentially have major relevance as well like industry trends, if the overall market is over or undervalued, how the company may do over the long-term, etc. At this point I usually end up writing an article because by this point I have put in well over 100 hours discarding companies, researching, valuing, and analyzing the company that I did find that was interesting or undervalued and its competitors.
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Even after all of this work I still may not end up buying into a company. You need to keep an open mind and let the numbers and your analysis take you where they may and not be boxed into wanting to buy into a company just because you put a lot of hours into researching said company. When I get to this point I still end up buying into just over half of the companies I do full research on because they ended up not being as good of an investment as I thought they would be.
If you think value investing is easy and not time-consuming you are very wrong. By the time I write an article about a company, I have discarded a few hundred companies, and spent a hundred hours plus discarding companies, researching, analyzing, valuing, and comparing a company or companies to their competitors, still to only have a little better than a 50% chance of buying into a company.
This seems insane, and it probably is to some degree, but if you want to truly be an excellent value investor you need to research as many companies as possible. Around the world there are tens of thousands of companies that you can research and you can only find investments that fit your particular criteria if you put in the work to find them. This obviously takes a lot of personal drive, will, and passion. Value investing is probably something you cannot get excellent at if you do not have passion for it and actually like digging into companies. Reading companies annual reports fascinates and relaxes me and is treated like a kind of treasure hunt. Most people, including most professional investors, find it boring and just are investing because it is good way to make money. If you do not have the drive, will, and passion to do hundreds of hours of work, while still only having a little better than a 50% chance of finding a company to buy into, this is probably not a very good way to spend your time and you should probably let someone like me who loves doing this manage your investments so that you can free up your time to do things you like and want to do.
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