My first ever stock pick was the well-known shoe company, Sketchers (SKX). I’ll admit, I didn’t know too much about the company or even how to invest at that point. I just knew that more and more celebrities I knew were endorsing the brand and my mom could help me out through her online account. Luckily, holding on to that stock yielded over 40% return. I had no basis for that investment decision, but it paid off. It was pure speculation. Today, as I’ve learned more through school and my own interests, my investment strategy has changed for the better. I discovered how complex investing in the stock market really is, despite it being so simple at the same time. It can hurt to think about how many metrics and ratios it’s important to monitor, how many things I should keep track of, especially given the rate at which news comes out. Perhaps most significantly, I figured out that even if I spent every minute of my day doing research and calculations, I wouldn’t be able to keep up with everything; not even close. That was an important realization because it spurred me to narrow down what I think is important, develop a systemized approach to making investment decisions, and outline how to go about getting the information I want. Below, you will find an overview of the strategy for my personal investing, how I use a model to do equity analysis, and more.
First, the overarching idea that governs how I go about investing is finding stocks that may be undervalued or are, at least, out of favour by the market relative to their competitors. You’ve probably heard of this idea from Warren Buffet or from the infamous novel, The Intelligent Investor by Benjamin Graham. While the book was written many years ago, you can’t deny the basis behind his ideas. The stock markets have listed prices for each public company but there are also intrinsic values for each stock that is independent of the price offered by the market. In a general sense, by being a value investor, you are looking for shares that have an intrinsic value that is below the market price, indicating the shares are undervalued. In this strategy, investors aren’t in it for short-term gains; they are in the stock for a long-term horizon, trying to keep their emotions out of it and ignoring what’s going on in the market (maybe not completely).
One of the main differences separating value investing from other strategies is understanding the difference between fundamental and technical analysis. A company’s fundamentals can be thought of as its basic operations, its profitability, its efficiency, how management runs the company, and any other information you can think of when you think of a business. If you look at how much cash a company generates from the amount of capital assets it has on hand, you can understand its profitability and efficiency. All other things equal, a company that generates more cash with fewer assets will be valued higher than its competitors. By looking at these factors, you stick to the fundamentals of a business. In comparison, someone that looks at the stock price and other technical indicators is said to be focusing on momentum investing. This, in general, has a much more short-term outlook as they are looking to ride out market movements. Compared to value investing, this a very speculative approach and there are discussions over whether this constitutes ‘investing’. However, this is a very popular method that does deliver returns to those who know how to use it.
A final note is that in current market conditions (April 2018), finding undervalued stocks can be quite difficult. It’s no secret that the global stock markets (in specific, the U.S. markets) have enjoyed great returns over the last decade or so, which has meant current market prices are very high (current Price-to-Earnings ratios) relative to historic levels. What does this mean? Finding value is almost near impossible. It makes investing in today’s conditions very risky, as a financial asset bubble may be about to burst. Investing today may mean very low returns for extremely high risk, a counterintuitive approach to many. In theory, I would think that momentum investing would be a better strategy during an economic expansion and value investing a better strategy just after a credit contraction or stock market crash. It’s very interesting to hear about the approaches professionals use and how they view market conditions.
Using a Model
As I wrote about in the article here, developing a model and template helped me come up with a more systemized approach to making investment decisions. When you look at a company as a possible investment opportunity, there is a lot of information out there. So much that without any frame of mind, I’d feel bombarded with information to sift through and interpret. By building myself a template, I am able to stick to what I find important with respect to a company’s business, strategy, and financial performance. It makes the entire process much more efficient to me and with my latest version, it allows for equity analysis in a peer group. Furthermore, it keeps me accountable. By performing the analysis through the model, I am able to look back on my decision after some time to remind myself WHY I made a decision. It’s like keeping a library of my decisions. This model was what I created for myself. However, a model can really look like anything and use any type of information. It can use different inputs and have different outputs. The thing about doing analysis is you use the information that you find important. To someone else, the information you use may be completely irrelevant. In that respect, the analysis you do may be completely arbitrary. In my opinion, shouldn’t stress you out too much because all that matters is the narrative you have. No single narrative is completely right. By having a record of your analysis, you prove to yourself why you would make that investment and that’s the most important part.
I now have a basis on which I make my decisions (value) and a method of performing analysis, but how do I get the information I need to make my decisions? I recognize that there are so many resources online. This includes, but is not limited to, news articles, annual reports (10K), quarterly reports (10Q), analyst reports, blogs, and other online resources. Analyst reports can be very beneficial to look through. Building a model was my decision to help create that systemized approach and keep myself accountable. However, there are many, many professional analyst reports done on companies available online that go through thorough investigation. It’s their job to analyze companies and determine whether there is an investment opportunity there, ranking stocks as a buy, sell, or hold.
As I said in the introduction, there is so much information out there. News comes out by the second and conditions are always changing. Economic data like unemployment, exports, imports, inflation, interest rates, housing, commodity supplies, and currencies, among many more things, are always changing. Companies constantly make decisions to react to the market. It can scare anyone. In addition, there are so many companies out there (not just in North America), it’s hard to know where to even start. One thing I quickly learned is that institutional investors are required by the Securities Exchange Commission (SEC) to publicize their securities holdings every quarter in a 13-F filing, available from Edgar.com (for U.S. companies). Form 13F’s must be filed within 45 days of the end of the calendar quarter. For example, if you want to know what stocks Warren Buffet has under his portfolio in Berkshire Hathaway, you can find out from these filings. By using the publicized holdings list, you can narrow down a list of securities to do your own analysis on, rather than pick from the thousands and thousands of public companies out there. It’s a great starting point for any retail investor.
After you have a list of companies that might make for good investments, you’d want to do your own homework on them. This would include reading through their quarterly and annual reports where the company would reveal their performance over the past time period, discuss their future plans and strategies, and display their financial statements. News articles are a great resource for stuff currently circling the company. Where else will you find out about the current CEO leaving the company, for example? There are also many online blogs or subscription-based online resources that have reveal the information they gather on companies. There’s no shortage of resources available. You just need to find the ones you like in terms of relevance, simplicity, timeliness and effectiveness.
What I’ve written about here are just a few basic ideas on my personal investment strategy. Sticking to finding value gives me a basis of picking stocks and making investments, rather than using technical indicators to ride market movements. Using a model keeps myself accountable and creates a systemized approach. Finding certain types of resources and information that I find the most useful makes me feel less bombarded and helps avoid information overload. There are smaller principles that I employ such as dollar-cost averaging, diversification methods, and specific requirements that must be met by the company. This is just the general idea behind my process. If you have any questions, want to learn more about this, or have any ideas, please comment! Thanks.