Money and Finance
There's always something you won't like about the company you're researching. More to the point, if you can't find anything wrong with the company, you're not looking hard enough.
Some of the most common negative factors that I come across in my research are:
- Considering Management's "capacity To Suffer"
Earlier this week, Brattle St. Capital shared an interview transcript (originally posted on ValueWalk) with noted investor Tom Russo in which Russo discussed the importance of investing in companies with management teams that have the "capacity to suffer":...
- The Difference Between A Good Company And A Great Company
Consider the largest stock holding in your portfolio. If I were to ask you to list ten reasons why you own the stock, what would you say? You might talk about the company's strong competitive position, its attractive profit margins, its solid balance...
- Why You Should Probably Own Fewer Stocks
I think the average person could know three or four or five companies very well. They could lecture on those three or four or five companies, and if one or two of 'em becomes attractive, they buy 'em...You have to know the story. - Peter...
- What To Do When A Sell-off Strikes Your Stock
We've all been there. You check your stocks in the morning, take a sip of coffee, only to find -- spppittt! -- one of your stocks is down big, real big. At this point many questions begin to race through your mind -- What happened? Did I miss something?...
- High Yield Reads - 7/13/14
Summary of recents posts and pieces of interest, sometimes enduring, to investors: Josh Peters on dividend and buyback debate: the record for buybacks was set in 2007 near previous market highs, then when prices improved companies were concerned with...
Money and Finance
When to Stop Researching a Stock
1. Don't look for perfect companies -you'll never find them. Just look for imperfectly priced ones.
— Amni Rusli (@AmniRusli) June 6, 2014The above tweet from Amni Rusli (you can follow her on Twitter and I recommend doing so) struck a chord with me. In my eleven years of researching stocks, I have yet to come across a "perfect" one.There's always something you won't like about the company you're researching. More to the point, if you can't find anything wrong with the company, you're not looking hard enough.
Some of the most common negative factors that I come across in my research are:
- Concerns about the company's durable competitive advantage (if it has one)
- Misaligned management incentives
- A bad recent capital allocation decision (e.g. paying too much for an acquisition)
Sometimes these factors are enough for me to walk away from the research idea, yet if I like most everything else about the company, I'll keep researching.
WD-40 Company (WDFC) is a good example of this -- I love the business, think management is doing a fine job, but really don't like that it uses EBITDA as a performance and bonus measure. Still, I wouldn't not buy WD-40 at the right price simply because it uses EBITDA.
If the company you're researching meets at least 80% of the criteria you look for in a stock and is trading at a good to fair price, that's an attractive opportunity. Don't let perfect be the enemy of good, as the saying goes, and miss the opportunity because you're looking for that last 20%.
But watch out for these red flags
It's one thing if the negatives are fairly benign, but there are a few negatives that I consider massive red flags and will immediately stop researching the stock if I find one of them.
- Untrustworthy management: If there's anything in management's background that is particularly off-putting to you, just walk away. A common exercise is to ask yourself if you'd trust them to watch your kids/dog/cat while you were away on vaction.
- Blackbox revenue stream: To borrow a phrase from Peter Lynch, if you can't illustrate with a crayon how the business makes its money, you shouldn't own the stock.
- Aggressive accounting: This can be tricky to detect. Here's a tip I picked up from my friends John DelVecchio and Tom Jacobs who wrote What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio -- focus on revenue recognition as it is crucial to confidence in everything below it on the income statement and, by extension, the cash flow statement. One simple test you can run is looking at Days Sales Outstanding (DSO), explained here.
- Government entity as a major shareholder: Government owners have different motivations than regular shareholders.
- Unethical actions: Similar to the first point, but different in the sense that the unethical action could have been made by someone outside the executive suite. This speaks to a lack of risk management within the company and reflects poorly on management.
When do you stop researching a company? I'm curious to know. You can let me know in the comments section below or on Twitter.
Stay patient, stay focused.
Best,
Todd
@toddwenning on Twitter
- Considering Management's "capacity To Suffer"
Earlier this week, Brattle St. Capital shared an interview transcript (originally posted on ValueWalk) with noted investor Tom Russo in which Russo discussed the importance of investing in companies with management teams that have the "capacity to suffer":...
- The Difference Between A Good Company And A Great Company
Consider the largest stock holding in your portfolio. If I were to ask you to list ten reasons why you own the stock, what would you say? You might talk about the company's strong competitive position, its attractive profit margins, its solid balance...
- Why You Should Probably Own Fewer Stocks
I think the average person could know three or four or five companies very well. They could lecture on those three or four or five companies, and if one or two of 'em becomes attractive, they buy 'em...You have to know the story. - Peter...
- What To Do When A Sell-off Strikes Your Stock
We've all been there. You check your stocks in the morning, take a sip of coffee, only to find -- spppittt! -- one of your stocks is down big, real big. At this point many questions begin to race through your mind -- What happened? Did I miss something?...
- High Yield Reads - 7/13/14
Summary of recents posts and pieces of interest, sometimes enduring, to investors: Josh Peters on dividend and buyback debate: the record for buybacks was set in 2007 near previous market highs, then when prices improved companies were concerned with...