7 ways to find stock ideas: improving your search strategy
Crucial to any successful investment process is having a good "search" or "origination" strategy, i.e. ensuring that you are constantly seeing a good "funnel" of investment targets. Part of that search process is having a well-through through set of investment checklists so that you can quickly filter out the low probability time-wasters. But equally, it's important to think about the top of the funnel - how to find new ideas?
Are you getting enough good investment ideas coming in? Are you losing out because you don't have the right sources? Or are you missing out because you're not paying enough attention?
A famous example of this kind of "sin of omission" was given by Warren Buffet who said he committed a major mistake by not buying Wal-Mart at the right time - he suggests that this oversight may have cost his company, Berkshire Hathaway, more than US$8 billion!
Where can I find the good ideas?
That's the million dollar/pound/euro question and unfortunately, there is no one deﬁnitive answer. It just requires a lot of hard graft but, as ever, having a systematic approach helps. In no particular order, here are 7 search paths that may be worth building into your process, if you aren't already. Using others? Let us know in the comments below.
The 7 Best Places to Look
1. Your Own Backyard - Peter Lynch was famous for arguing that you should buy what you know, ensuring that you stay within a defined circle of competence. Lynch says he would rather invest in "pantyhose rather than communications satellites," and "motel chains rather than fiber optics". It's worth reflecting in your daily life experience to see if this throws up any ideas or opportunities. Note - this is not the same thing as accepting tips from your mates - see below.
2. Screening - It will come as no surprise that we are big advocates of quantitative screening as a way to generate ideas. This can come into three forms, all of which are worth considering:
Checking daily hotlists or a simple single criteria screens like the 52-week low list if you're a contrarian, or single metric value lists like Low P/E, P/FCF, P/B or relative strength lists if you're a momentum investor.
Following Guru screens based on the approaches of investors you respect (like Benjamin Graham or Warren Buffett). We now run over 50 of these screens now on Stockopedia PRO.
Running your own screens, based on metrics you've found useful (and ideally back-tested).
3. Stock Blogs & Social Investing Sites – There's also a growing number of high quality blogs with analysis that rivals the City at times. In the UK, the best stock-picking focused blogs include UK Value Investor, Richard Beddard of iii, Expecting Value, Mark Carter, Valuehunteruk, ValueStockInquisition and Wexboy. Bulletin boards can also be a useful source of ideas and ways to track "scuttlebutt", for example the Motley Fool in the UK or Seeking Alpha & The Corner of Berkshire & Fairfax Message Board in the US. On some sites, you must be careful given the potential for "pump and dump" scams, so never invest without doing your own research. It's also worth being aware of the herding instinct that can exist on social media sites - often, they are most useful as a way to test out your own thinking and seek out contrarian perspectives. Oh, and ignore your mates! It's possible that a tip from a friend might pay off, but usually it won't. Mixing investing with your socialising may be a recipe for disaster.
4. Follow Trades - Although investing success is all about variant perception, that doesn't mean you can't draw inspiration from others. It's worth building a list of great investors whose process and philosophy you share. As discussed above, you may be able run screens based on their approaches, or alternatively, you can just look at their holdings! As seems to be the case with most things in investing (liquidity, choice of stocks, Reg FD), life is better in the States in this respect. Over there, any money manager with assets over $100 million is required to file a quarterly 13-F statement disclosing holdings (this data is then aggregated on sites like gurufocus.com or marketfolly.com). In the UK, however, large shareholders are only required to flag long holdings above 3% of a company’s issued equity. This means that small funds often do not appear on the filing radar at all unless they invest in very small companies. Nevertheless, using sources like TrustNet, you can still get a reasonably good handle on what's happening. For example, let's say your investing style mirrored the Fidelity Special Situations Fund - you can easily see a list of its top 10 holdings here on TrustNet (although beware the index-tracking distortion).
5. Fund & Hedge Letters – Again, this is more a US phenomenon but there are some inspirational (and free!) letters by fund and hedge fund managers that articulate their investment theses for various investments. Amongst the UK letters, it's worth reading Tim Price, Niels Jensen & Hugh Hendry, while the best US letters include Warren Buffett (of course), Howard Marks, Seth Klarman, the Sequioa Fund and the Pabrai Funds. Have a good look around HedgeFundLetters.com which just has some fantastic content. There are also some emerging UK fund management & broker blogs (e.g. MoneyMovesMarkets & the Share Centre), although the US is still way ahead in this area...
6. Business Press – We're big believers in being informed and up to speed with world/market/macro-events (by reading the Financial Times & the Economist etc) but we would question how effective this is really for generating new ideas. It's likely to be arbitraged out, for the most part. Michael Price apparently emphasises reading with purpose, which makes sense, i.e looking for changes that could drive an opportunity such as new management, M&A, lawsuits & restructuring (as does Greenblatt). However, another ideas is to follow the trade press/sites. These publications can be a great source of differentiated insiight since they are less often used by the average investor.
7. Brute Force: When asked how to find stocks, Buffett once remarked "begin with the letter A and work your way down". This refers to the fact that, when Buffett started his partnership, he allegedly went through 10,000 pages of a dry Moody's stock manual TWICE searching for stocks. Of course, there's no need for dusty manuals - you can look through our listings from A to Z looking for undervalued stories with little to no coverage (or you can screen and save yourself hours!).
1. The Siren Song of Brokers - While broker reports can be very persuasive, we'd emphasise the importance of recognising that brokers tend to be institutionallly biased. A strategy based on following consensus broker buys has been shown to underperform. Nevertheless, that's not to say that broker reports aren't sometimes incredibly useful context for a potential investment. Furthermore, a strategy focused on investing in portfolios of stocks which see a significant change in the consensus recommendation has been shown to work (as the focus on the delta eliminates the bias).
2. Tipsheets - We're also sceptical about the value-added of getting ideas from tipsheets, unless it's a seriously heavy-weight / educational newsletter backed by some quantitative muscle (e.g. the Manual of Ideas). There tends to be quite a lot of smoke and mirrors in this space and, when real money is at stake, few tipsters will be able to match their claimed ROI. After all, if someone genuinely had confidence in their ability to predict the future, why would they be willing to sell you that information? In fact, the record of even the professional analyst community is appalling with studies showing the average 1 year forecast having an error margin of 46%, and average 2 year forecasts having an error margin of 95%...
But Do Your Own Research (DYOR)
No matter how you find any idea, remember: this is only a starting point. You still need to do your own work, otherwise you won’t have the necessary belief to hold the stock through the inevitable periods of volatility for those big potential gains.
And Use a Watchlist
Finally, it's worth having a watchlist to help you to create discipline around your buying process. As Buffett has pointed out, compelling values are like fast moving elephants so you need to stay alert. A watchlist is essentially just a list of the most attractive companies you’ve found in your research. It's advisable to keep one (or more) religiously, including a valuation estimate and a target price at which you'd be willing to buy the stock. That way, you’ll spot when your stocks hits an attractive price point, rather than being distracted by market noise. On any given day, Mr Market won't necessarily be offering you a price that matches your watchlist valuation but don't let that discourage you (and don't lose the discipline of maintaining and checking it). A close eye on your watchlist will pay off in the fullness of time!
A more automated variant of a watchlist is to place ‘limit orders’ a broker at your "buy" prices - this enables you to automatically buy a share should it fall below your calculation of intrinsic value, regardless of whether you happen to be watching the market. The serious risk with this approach, however, is that the price could fall for a reason that impacts intrinsic value, e.g. company-specific news of a failed drill or flawed product launch, so you may live to regret that buy order going through, after all!
Got any other suggestions for how to find stock ideas? We'd love to hear them.
First published here