On Finding Investment Opportunities
The investing strategy of The Deliberate Investor is rooted in the principles of value investing. I first seek out companies that are trading well below peer valuations for Price to Earnings, Price to Book, and Price to Earnings Growth. My methods for finding such companies are diverse: screens are useful, but often don’t catch some of the best potential investments; more frequently, I explore investing forums and community sites to see what companies other investors are researching – Why do the work that other investors have already done? Bottom line: I believe that good ideas can come from a multitude of sources and that often the best ideas come from the places that you would least expect. (Author note: Some of Warren Buffett’s best stock picks in his early investing career were found in Pink Sheets Magazine – an investment publication that provided information about unlisted companies.)
Having found a slew of potential investments, I undertake a more thorough examination of a company’s financial situation. This examination includes a rigorous study of the firm’s SEC statements, with special emphasis paid to the company’s working capital position, operating cash flows, and earnings and revenue growth. It also includes a consideration of insider ownership and institutional ownership.
Typically, I will invest in companies that boast a high current ratio, strong and consistent operating cash flows, and earnings and revenue growth above 20%. I do make exceptions, however. Perhaps a company’s current ratio is noticeably low due to a large capacity expansion project that is funded out of strong operating cash flows or maybe a company’s operating cash flow is has been consistently negative because of an inventory and accounts receivable build-up that is supporting regular 50% earnings and revenue growth. Flexibility in one’s strategy is necessary in order to take advantage of such promising opportunities.
On Buying & Selling a Company:
My decision to purchase a company’s shares is primarily motivated by fundamental analysis; however, I do loosely employ technical analysis to help inform a purchase decision. For instance, I tend to avoid buying a stock if it has recently appreciated significantly or is near its 52-week highs. Conversely, I am more enthusiastic in my purchase decision if the stock has recently declined substantially or is near its lows.
In every instance in which I invest in a company, my initial intention is to hold the shares for at least a year. This being said, there are a number of catalysts which could force an earlier sale of the stock. For instance, material news might surface that undermines my original investment thesis. I may also choose to reduce a position if it has appreciated considerably relative to the rest of my investments in order to increase a position that has become a far better value.
Bottom line: I will hold a company’s shares as long as my value-focused investment thesis continues to be applicable. If it is not, I will pack up my show and move elsewhere.
On Trading & Market Timing:
I’ve yet to meet anyone who knows the future or who can consistently make accurate short or medium-term market predictions over a long time period. This isn’t to say that such an individual does not exist (in fact, if any of you reading this have met such a person, please contact me), just that no one has yet convinced me that anyone is capable of the equivalent of stock divination.
Given my experience, I am inclined to believe in the philosophy of investors like John Bogle who hold that the best way to beat the market’s inevitable ups and downs is to ignore them.
On Fear and Exuberance:
Both catalysts exist and play a decisive role in market movements. An investor needs only to carefully observe his own conduct to confirm this fact. Many are the times that I have gone to bed feeling positively giddy about my stock picks, only to awake the following morning feeling like I have made the worst of all possible decisions. Most often these swings in investing fervor are prompted by an apparently unprompted portfolio rally or decline – or it may just have been something I ate…seriously.
Many people let these spontaneous sensations – whether willfully or inadvertently – guide their investing decisions. For my part, I force myself to cast these feelings aside. It isn’t easy and on more occasions than I would like to admit, I have traded based upon passion rather than reason.
Ultimately, I think that to be successful in the market, one must heed the words of Rudyard Kipling: to “…meet with Triumph and Disaster and treat those two imposters just the same.”
On Holding a Company’s Stock:
Over my admittedly short investing career, I have derived the following observation about human beings and their ability to simply sit still: Waiting is an easy concept to imagine, but is frequently an impossible act to perform.
I think that every human being – myself certainly included – thinks that they have more control over their lives than they actually do. One way that we maintain this façade of control manifests itself in the act of investing. When prices change – up or down – many people feel compelled to act.
However, many studies have suggested that this is often the wrong thing to do. Ultimately, we are told, most active traders do not beat the market. Instead, they build up higher commission costs and pay ordinary tax rates on their gains. They also tend to go bald earlier.
The advocates of Modern Portfolio Theory would have us all believe that risk is nothing more than volatility – the gyrations in a stock’s price that more often mimic the swings in man’s mood than fundamental changes in a company’s operations or operating environment. I view risk differently: as the likelihood that a permanent loss of intrinsic value will occur.
My perspective on risk has tremendous implications for the act of diversification. You can’t avoid the likelihood of permanently losing capital simply by adding more stocks to your portfolio. Rather, the only may to mitigate this genuine risk is through careful research.
By only investing in companies that I believe are highly undervalued, I (hopefully) receive a high margin of safety on my investments, thus limiting the potential for permanent loss of intrinsic value. I will not diversify, purely for the sake of diversification. If this means increased volatility, so be it – I have enough hair on the top of my head so that I can stand to tear out quite a bit of it before it becomes noticeable.
On Eating a Good Meal Before Doing Research or Making a Trade: