Generating Idea's, Cold Beers and Big Questions
Over a lovely couple of pints of Milton Mango with a fellow member of the financial advisory industry, we were talking about investment philosophies and it really got me thinking about my personal philosophy towards investing in direct equities/building a portfolio.
They were surprised to learn that most of my clients are directly invested in Australian Shares (their approach was to use a mixture of Index Funds and Managed Funds, not my style but I won't judge) and that nearly all of my investment ideas are generated in house.
The first question I was asked after that was "how do you generate your ideas?"
The answer is that most ideas start with a few scanners (basic stuff like growth rates, P/E ratios, nothing to different to anyone else) and if something takes my eye I put the idea into a watchlist to have a further look into. But this is boring and often doesn't lead any where.
However, often my ideas are generated in more unusual ways. It might be an article, it might be a click bait title, it could be noticing that friends are drinking more seltzer and less beer, it could be noticing more people going vegan/vegetarian, social media trends.
Honestly, how the idea is formed means nothing. Maybe 90% of my initial ideas lead no where but it flows into questions, which flow into ideas and more questions. Like a brutal network effect I've written about previously.
Generally, these ideas will fall into the following categories:
There's more, but they aren't so fun to write about (i.e. boring, steady business, fairly priced etc) so for the sake of keeping this interesting pretend they don't exist.
Hated - This can be as simple as the sector is on the nose, fears of new competition, regulation, commodity prices, poor management etc. Often these businesses will be trading at a reasonably cheap price on the surface. For example, if you look over the Australian retail sector 5 years ago, it was disliked because "Amazon and Online Shopping" are going to destroy their business model, they will all go the way of Circuit City (a great tale btw) and that they are cheap because they are going to zero eventually.
Take Harvey Norman for example, 5 years ago the stock was trading at $3.60, today it's only grown to $4.05 but has also paid $1.595 in dividends over that time (with some tax credits too). The stock has fallen heavily this year over concerns of demand having been pulled forward in Covid, a likely recession in 2023, the effect of rates on sales etc. etc. I could make a million cases why the business is likely in for hard times.
Now this isn't a recommendation on the stock but the business is reasonably well run, manages inventory well, owns a mountain of hard assets and in my opinion will be a business that if it fails, will do so very a slow march into irrelevancy than a quick jump into bankruptcy. In fact, at current levels, the entire retail sector following it's significant falls from it's highs at the start of the year are starting to interest me and I will be looking into it further to consider if I can find a reasonable investment.
My thought process with these types of stocks is "how much further could things go wrong that the share price isn't compensating me for?" and "okay, if anything goes right (i.e. Amazon doesn't come and immediate dominate) how much upside is there?" A surprising amount of time I find the answer is "my downside is pretty much capped if the business doesn't go bankrupt and my upside is multiples of the downside".
Universally Loved - There's not much to say about these types of stocks. Everyone is talking about them, they are market darlings, almost everyone who wants to own them already owns them and almost certainly by this point the valuation is stretched. Often these are high quality and due to the real lack of incredibly high quality companies in Australia are trading at multiples far exceeding what they would trade in foreign markets.
One example (that isn't Afterpay for once) is Xero. Loved by users, loved by accountants and mostly loved by accountants. I'll openly admit I am full of admiration for this company but I've never been comfortable enough with the valuation to buy it. For the longest time the stock was priced for perfection. My thought process at looking at something like this is "at this price, how much needs to go right to get an acceptable return on my investment?". Often at the valuations we see on these types of names, for the stock price to fall we don't even need to see bad news. Good news that isn't great/excellent news can often be enough.
BTW, I would love to own XRO at some point (I really do think it's a great business) but alas I'm too cheap to buy it, even with it falling in excess of 50% from it's highs.
领英推荐
Interesting But Outside My Skillset - The title says it all. I have no idea about the likelihood of a new kidney cancer drug being approved, the chances of some tiny mining company finding a huge deposit in Peru, I don't have a degree in chemistry (although I did have a great track record of getting kicked out of year 11 chemistry), I'm not an expert in off balance risk In fact, what I know next to nothing about has filled several hundred libraries around the world. I'll just put these in the too hard basket and pretend they don't exist.
Misunderstood - Generally speaking these require a fair bit of research to truly understand and often require the market to wake up to what you are seeing in order to generate returns. However, businesses can be misunderstood to the upside and the downside.
I can think of one company that for years was priced as fair for a leading A.I., big data tech company but in fact was closer to labour hire with fancy titles.
Ignored - There can be a million reasons why companies are ignored by large parts of the market. Maybe they are just a boring business, maybe they haven't needed to raise money in years, maybe the sector is unsexy, maybe their is a dominating shareholder that won't sell. These always interest me. If you can find the needle in the haystack of a high quality but ignored business, almost always it is going to be cheap and the long term returns will be more than acceptable.
Cheap For A Reason - Similar to Hated but with one big difference, it has almost no chance of earning supernormal returns for investors. Blind Freddie could probably tell you why this is a bad investment. Basically, a value trap. The thing to remember with these is that a stock that's down 90% was once a stock that was down 80% and then halved in value again.
As you may have noticed from my writings on here (and JWM newsletters if you haven't subscribed you should ask to be added) I enjoy jotting my thoughts down and I'm not afraid to use unconventional (some might say direct/rude) phrases. While writing this article, I decided to look back at some of my old notes on companies and here are some of my favourites (I'm not going to name or shame the companies here but there's a good chance you could probably guess most of them).
Hmmm, it looks like instead of writing about how I generate ideas instead I have gone off on a wild tangent about company types, silly stock notes and whatever else has popped into my mind.
In fairness though, often my investment research and idea generation process is just as eclectic and chaotic. Could I improve this process? Almost certainly.
Maybe I should just stick to an one idea and not bounce around as my questions take me? Eh who knows.
I like the way I'm doing this at the moment (it's a lot of fun and keeps it interesting).
Anyways, I have some actual work to do (maybe one day I'll make my writings and thoughts a $1 a week subscription so I can call it work but until then), so until next time,
Cheers,
Tyso
**like with everything I write, this isn't advice. Seriously, do not act on it. The only time I am giving you advice is if you are a client of mine, are paying me, I know your personal circumstance and you have a written personalised copy of it**