Finding Hidden Gems in the Stock Market

The first step to building a successful stock portfolio is knowing where to look. Stock investing opportunities hide in plain sight. Learning where to start looking and what to spot is key.

Warren Buffett and other investors have been successfully picking stocks for over 80 years. By learning what to look for and where opportunities typically are, you will save yourself countless hours of work.

Unfortunately, most individual investors look in all the wrong places and chase the tail of opportunity, but never find it.

Knowing where to dig for “investing” gold will save time, effort, and money

The reasons why most people don’t make progress is:

Reason #1: Believe no-one can pick stocks consistently

This mindset can hold them back from exploring the world of investing.

Reason #2: Don’t know how or where to start

It's like having a treasure map but not knowing how to read it.

Reason #3: Short term focus

Some investors focus too much on short-term gains, missing out on the long-term benefits of strategic investing.

Reason #4: Follow the crowd

Following the crowd might feel safe, but it often leads to missing out on unique opportunities that others overlook.

Reason #5: Thinking it’s too hard

Investing can seem daunting, but breaking it down into simple steps can make it more accessible for everyone.

The good news is there are timeless principles and strategies that can be used to consistently pick stocks. This is exactly what we are going to cover.

Belief: The stock market is “mostly” efficient with pockets of inefficiency

A common thread I found in successful investors is they have the same belief - that the market is “mostly” efficient. Most academics and Wall Street analysts believe the market is completely efficient. Rendering stock picking a pointless activity.

Warren Buffett has a 19.8% return over 58 years, Seth Klarman’s 20% over 41 years and Howard Marks 18.8% over 31 years, says otherwise. Survey says - it isn’t pointless, it’s highly profitable.

These guys use a different strategy than most Wall Street firms - and they get vastly superior performance. I know who I’m going to learn from.

“I should limit my efforts to relatively inefficient markets where hard work and skill would pay off best” - Howard Marks

“If you spend your energies looking for and analyzing situations not closely followed by other informed investors, your chance of finding bargains greatly increases. The trick is locating those opportunities.” - Joel Greenblatt

Principles: The timeless hitlist to look for

Why do you need to know the principles? Well, if you ever find an opportunity that doesn’t fit the mold of the tactics you are using, go back to first principles. Exactly what we have here - the principles for investing opportunities.

Let’s start with the two core principles.

“Many attractive investment opportunities result from market inefficiencies, that is, areas of the security markets in which information is not fully disseminated or in which supply and demand are temporarily out of balance.” Seth Klarman

• Information not widely known
• Supply and demand imbalance (of the stock)

Each of these two points can have many different reasons why they occur. The most useful list I have found is from Howard Marks which translates these two points into something we can look for:

• Little known and not fully understood;
• Fundamentally questionable on the surface;
• Controversial, unseemly or scary;
• Deemed inappropriate for “respectable” portfolios;
• Unappreciated, unpopular and unloved;
• Trailing a record of poor returns; and
• Recently the subject of disinvestment, not accumulation.

There is also two more that I think make the cut:

• Demand from insiders
• Demand from trusted Investors

Here’s why. Marks has focused his points on why supply would be excess - effectively reducing the stock price. There are two sides of supply and demand. We want to see the “right” people investing.

“In their search for complete information on businesses, investors often overlook one very important clue. In most instances no one understands a business and its prospects better than the management. Therefore investors should be encouraged when corporate insiders invest their own money alongside that of shareholders by purchasing stock in the open market. It is often said on Wall Street that there are many reasons why an insider might sell a stock (need for cash to pay taxes, expenses, etc.), but there is only one reason for buying.” - Seth Klarman

These are the timeless touchstones for finding an investment opportunity. They also give you a checklist of what you should be looking for.

How to?

Let’s get tactical. What does this look like in practice?

Well, when Warren Buffett started in the 50’s, he grabbed a list of stocks (the whole universe of stocks) and started at A and worked to Z. Well this ain’t my day job Jack, I don’t have that sort of time for research. Yep, don’t worry because there are plenty of easier ways for us individual investors.

Most of the successful investors use a combination of targeted research from a list of stocks, and keeping an eye out for opportunities. Just remember as we go through these next points:

“You don't need special formulas or mathematical models to help you choose the really big winners. Logic, common sense, and a little experience are all that's required.” - Joel Greenblatt

Here's Where to Find Them:

Hiding Spot 1: Look into small companies (small cap stocks)

They may be overlooked, but they often have huge growth potential.

Small companies are not followed by investment firms and analysts, meaning less experience is required to find opportunities.?

Sometimes they can grow faster than big ones, leading to excellent investment returns.

Hiding Spot 2: Explore companies using the EV/EBITDA screen

It sounds complex, but it helps you find stocks that might be undervalued.

Some investors skip this step because it seems complicated.

Taking the time to understand it. You might discover hidden gems that others miss.

Hiding Spot 3: Pay attention to insider buying

When people within a company are buying its stock, it's a good sign.

Insider buying shows that people who know the company best believe in its future.

Imagine you find a company where the CEO is buying more shares. It often means good things are on the horizon.

Hiding Spot 4: Look into 13F filings

These documents reveal what big investors are doing with their money.

Big investors often have valuable insights. You can learn from their moves and make informed decisions.?

Remember, because they are investing large sums of money, small companies are off their radar.?

Hiding Spot 5: Explore the Net Net screen

This strategy involves finding stocks trading below their net asset value.

Net Net stocks can be hidden gems, offering a chance to buy a company for less than its true value.

Imagine finding a stock where the market values the company lower than the actual worth. By investing, you could potentially see significant returns.?

Fun fact: This is how Warren Buffett started investing in the 50’s and was referred to as “cigar butt” investing.?

Hiding Spot 6: Spinoffs and Partial Spinoffs

When a company splits, it can create opportunities.

Many investors miss out on spinoffs because they don't understand the potential behind these corporate actions.

Consider a company spinning off a part of its business. The new company might be undervalued initially, providing a chance for smart investors to benefit.

Hiding Spot 7: Newly Restructured or Post-Bankruptcy Businesses

These companies often get a fresh start, creating opportunities for investors.

Exploring these opportunities is like finding a company that faced challenges but is now ready for a comeback.

By considering these hiding spots, you're not just investing; you're strategically seeking opportunities that others might miss. Putting you in the best starting position, reducing your time and effort looking for investments.

Cheers,

Jack

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