*Courtesy of Andrew Schneck of thestreport.com
Typically, when I find a company I’m interested in, I spend somewhere between 20-50 hours reading everything. I go back 10 years, get a sense on all sorts of company news, investor conferences, financials, how the business has changed, even go through the whole website. At the end of it all, I look into the numbers from a valuation standpoint. This qualitative research puts the numbers in good context, allows me to know what I’m playing with in my idea of valuation, and it’s at that point when I make an investment decision. Price is everything, and many of my ideas are shot down once I have a better context for the financials.
I was trying to be a detective, find any misspelled words on page 98 of the notes to financial statements, and basically getting a David Einhorn-like presentation on St. Joe (139 slides) with every company I read all about. Rather than repeat this lengthy exercise many times and be stuck on a few names, I’d like to get good exposure to more businesses and just understand the basic story, economics, and where they’re likely headed. Last year, now that I try to put a number to it, I think I likely went extremely in-depth on about 15-20 companies, and went extremely broad (value line 5 minute overview) on about 3,000. This dichotomy isn’t healthy- while I got a very good understanding of offshore drilling, dry bulk shipping, for-profit colleges, tax returns, and teen retailing for 2010, I missed all sorts of other areas.
Peter Lynch recommends spending a few hours on each business- get its story, understand its financials, read about competitors, the usual stuff. But unless you’re absolutely certain you’re making it 20% of your portfolio, it’s not really necessary to do this heavy lifting all the time. You also end up with cluttered thinking- something I try to stay away from. If you can understand something in 2 hours, why spend 30 on it? My Reading Int’l article got (much needed) criticism for missing a large portion of their real estate holdings. You know why I screwed it up? I spent 30 hours reading everything, when at the end of the day, it’s all just two businesses supporting each other in different ways. I tried to compile lists of how it had changed in the past (everything from number of screens to historical real estate valuations on their books), management’s compensation, etc. These are helpful to have when you’re making a massive bet, but when you’re trying to understand a business’ story, it’s not helpful at all. I’ve had times where I spent 30+ hours reading everything, only to get to valuation with cluttered thinking and become frustrated. At that point I never buy. It should be a screaming buy, otherwise I’ll just hold cash. With H&R Block, it was a screaming buy, I just didn’t recognize it because I spent 40 hours in one weekend and had muddled thinking. Never again.
One other thing I picked up from Lynch’s book- categorize your investments. Before, I’d simply look for earning power at a certain earning’s yield. This is a nice strategy, but there are others work well when buying businesses. Here are his six categories that I’m shamelessly copying:
- Slow Growers- slightly negative, flat, or growing a few % each year
- “Stalwarts”- large cap company, growing 5-10% per year
- Fast Growers- 10+% growth/year, preferably 20+%
- Cyclicals- ups & downs
- Turnarounds- hopefully going to come back with a bang
- Asset Plays- sitting on something worth more than stock price
Rather than cherry-pick my intensive research projects, hoping to find undervalued companies by earning power, I’m not discriminating on what I research. Each business has a story and some are overlooked by the Street. In organizing them, I can really focus on what matters. If it’s a cyclical, I know I’m less focused on reported income and more on the inventory or how the industry is shifting. If I’m looking at a fast grower, I better know the growth story will continue if it’s trading at a high price to earnings. You can only sell so many cows to people in Farmville (yes, Zynga, I’m calling you out).