Showing posts with label scuttlebutt. Show all posts
Showing posts with label scuttlebutt. Show all posts

Monday 18 May 2020

Generating Ideas

The value investing model needs to be fed stock ideas. These ideas can come from different sources, some of which are more fruitful than others. I look at seven.


1.  The first source is bad news. 

Stories about companies often emphasize an extreme element of an event. These extremes get amplified in headlines. Headlines drive human reaction, sometimes too far. This can cause stock price
swings deeper than would a more sober take on the facts.


Overreactions don’t just come from individual investors. They come from professional money managers as well. For example, a hedge fund doesn’t want to scare off its limited partners when it reports holdings at the end of a quarter.  As such it may dump a perfectly good company going through some passing embarrassment.


Sometimes a news-driven stock price drop may be warranted, but overdone. Take Anheuser-Busch, the maker of Budweiser beer. In 2005, newspaper articles appeared suggesting that beer’s days were over. Alternatives like vodka with Red Bull were gaining ground with younger drinkers. I analyzed AnheuserBusch and found it to still have a thriving core business. But the stock price dropped anyway.

As I was turning this over, dad invited me to the baseball game in San Francisco. I can’t remember who the visiting team was, or who won. But I do remember what I saw:
people drinking a lot of beer.

My observation hardly qualified as advanced market research. Plus it happened in an American ballpark, a natural context for beer drinking. But it was real. Beer’s days weren’t over. Shortly afterward I paid $45 per share for 
stock in Anheuser-Busch.

Three and a half years later, in November 2008, the company was acquired for $70 per share. Including dividends, that investment delivered an average annual return of around 15 percent. I neither sought nor liked the buyout. 
 But taxes on gains are the preferred kind of financial pain.

Other times a news-driven stock price drop is fully justified. For example, Volkswagen’s share price plunged following an emissions scandal that emerged in September 2015. 
 While the situation is still playing out as of this writing, it  appears that there was in fact an organized effort within the company to skirt regulations. That’s bad. Plus, Volkswagen didn’t register as good before the crisis. Its ROCE was underwhelming. To the astute investor hoping to hold for decades, the situation presented little opportunity.

On rare occasions a news-driven stock price change is totally unjustified. This can happen because a story affecting one company leads to trading in the stock of another. For example, online messaging company Twitter chose TWTR as its stock ticker symbol in preparation for its November 2013 IPO. This caused a wild surge-and-crash cycle in TWTRQ, the common stock of bankrupt electronics retailer Tweeter Home Entertainment Group.


Bad news can involve real tragedies. Security breaches compromise privacy, train crashes cause injury, and foodborne bacteria spark illness. No investor of conscience wishes for these mishaps.

But sensationalist reporting can trigger dislocations that don’t make sense. The gap between price and value yawns. The astute investor is meant to bridge it. Good investing has no friend like bad journalism.


2.  A second source of ideas is
spin-offs. 
A spin-off is the public listing of a company that was  previously part of another listed company.

The spin-off process generally starts with a distribution of shares in the newly independent entity to the old parent’s shareholders in the form of a dividend. Then those new shares start trading.


Often, some of the old parent’s shareholders are institutional investors. When their spin-off shares start trading, they may sell them automatically. This is because the new stock doesn’t meet their formal investment criteria, such as a minimum market cap. This forced selling can depress the price of shares in companies that, if they’re both understood and good, are worth owning.


3.  A third source is regulatory filings. 

Many governments require large investors to periodically report their holdings. These filings are public. One can compare reports between periods to see which stocks talented professionals bought. 

In America, money managers with at least $100 million in assets under management are required to file a quarterly report that lists—with some exceptions—their U.S. stock holdings. Called a 13F, the report is due 45 days after the close of a quarter. They’re posted at www.sec.gov. Check midway through February, May, August, and November.

Mining 13Fs has many limitations. Understanding them helps to make the tactic work.


The first limitation is that one has to know which professionals are worth following. Outperforming mutual fund managers are easy to spot, since their track records are public and clear. But private fund managers may share their records only with clients. And professionals that run portfolios inside larger companies—even listed ones—may never detail their histories.

One can’t really know if a professional is worth following before seeing a track record. Fame is not a proxy for performance. I am routinely struck by the high profile of some perennial laggards, and the anonymity of some total stars.


A second limitation is that 13Fs disclose only long positions. 

They don’t disclose short positions. This makes them useless for studying managers that pair long and short positions in what are effectively single bets. It’s potentially dangerous to mistake the visible long half of such a bet as the full bet.

Third, 13Fs don’t disclose the prices paid for shares. 

One can research the low for a quarter and safely conclude that the price paid was not below that. But greater specificity isn’t available.

A fourth limitation is the time lag. 

In the 45 days since the end of the quarter, stocks just bought could already have been sold. Correspondingly, positions sold could have been reestablished.

Fifth, the filing itself can drive the price of a stock up

When a well-known professional buys something, many blindly follow. This can end any inexpensiveness that once helped to make the stock attractive.

Sixth, a stock appearing for the first time on a 13F may not have actually been bought. 

It may have been received in a spin-off. A money manager may even have started selling it between the date of receipt and the date of the filing.  It could be the opposite of an idea worth considering.

Seventh, the authority bias can push one to play copycat. 

A psychologically undisciplined investor can unthinkingly mimic a master. But masters make mistakes. It’s better to view the debut of a stock on a 13F as an invitation to analyze from scratch.

A different cognitive bias can push one away from reading 13Fs. It’s the peculiarity bias. It can make 13F mining seem parroty. Dirty, even. But that’s 
misguided. Consider an analogy.

Imagine a restaurateur with a downtown restaurant. Every quarter, the restaurateur receives in the mail a letter from a trusted authority. The letter discloses the major actions taken by the most successful restaurant in the country. One quarter it might say that the exemplary establishment raised soft drink prices by 5 percent. The next quarter, it bought a new fryer. And so forth.


Would the restaurateur throw out the letter without reading it? Of course not. It’s informative and accurate, and might contain a useful idea. It’s like the best trade magazine imaginable, free and errorless. Plus the restaurateur accepts no obligation to do whatever the better establishment did just by reading.


An investor ignoring 13Fs is like the restaurateur throwing out the letter. It’s an odd, limiting act. A better approach is to read select 13Fs fully aware of their shortcomings, secure in the knowledge that autonomy is not sacrificed. One isn’t required to replicate a hero’s trade any more than the restaurateur is required to buy a new fryer. A disclosure is not a directive.


4.  The fourth idea source is
reorganizations. 
Often shortened to reorg, a reorganization is a transformative event in a company. It could be 

  • a merger, 
  • a big change in capital structure, or 
  • the sale of a major division. 
It often involves complications that only an investor comfortable with complexity would care to sort out.

Such complications repel many. This limits the universe of potential buyers. A lower share price can result.


5.  A fifth source is
small capitalization stocks
Also called small-caps, these issues generally have market caps under $2 billion.

Companies this size can be hard for institutional investors to buy, for two reasons. 


  • For one, they may be prohibited by charter from buying stocks with a market cap below some threshold. 
  • Second, even if they’re allowed to buy small-caps, it might not be useful for them to do so.


Picture a $50 billion mutual fund that sees promise in a $500 million market cap firm.  Even if it buys
 10 percent of the company, and that stake doubles in price, the needle on the fund’s overall performance would barely budge. So the investment wouldn’t be worth making.

These two factors leave many small-cap stocks untouched by a big part of the asset management universe. The result can be lower share prices worth pursuing for those running smaller amounts of capital.


Small-cap investing can take on some of the characteristics of
activism. Activism is agitating for change in owned companies. It can come with small-cap investing for two reasons. 

  • First, sometimes it’s necessary. Small-cap company management teams may take advantage of the absence of big institutional investors to do things that they wouldn’t with greater oversight. 
  • Second, it’s possible. Small-cap executives may be more accessible than large company executives. Presidents quickly returning e-mails is not unusual. 
In short, small-cap investing can occasion a deeper involvement with holdings, something that the astute investor readies for.

6.  A sixth source is
stock screeners
Stock screeners are Internet tools that filter stocks according to quantitative parameters. They’re often based on valuation metrics. One might fetch a list of stocks ranked by their price to book ratio, for example.

Stock screeners aren’t my favorite source. To the long-term holder interested in first understanding a business and seeing if it’s good, starting with valuation is putting the cart before the horse. Additionally, stock screeners can call attention to companies in outlying financial situations that wouldn’t interest someone looking to hold for life. Nonetheless, many strong investors get good at tapping this source for ideas.


7.  Seventh is
serendipity
Serendipity is the mental preparedness to receive tips from everyday life. It requires being engaged with the world. While driven by chance, it doesn’t strike randomly. It favors the open mind.

I first became interested in the Swedish company Clas Ohlson when I noticed that every time I went into one of their Stockholm hardware stores, there seemed to be
a lot of customers buying a lot of things. I analyzed the company and found it to be good. Had I not been receptive to ideas that crop up unexpectedly, I might not have noticed it.

Incidentally, this particular find didn’t play out perfectly. The stock never got inexpensive enough for me to buy. Plus, I got a little overzealous in my search for disconfirming evidence.


During travels around Sweden, I would pop into stores just to make sure that the chain’s appeal wasn’t limited to Stockholm. It wasn’t. They all had customers. Then late one afternoon at the end of a weekend in the city of Helsingborg, I walked into the Clas Ohlson store on the main pedestrian mall.  Empty.
Gotcha, Clas Ohlson. As I was peeking down the aisles to make sure that  I hadn’t missed anyone, a woman called over from behind a counter, “Pardon, but we’re closed.”

Serendipity is also useful in reaching conclusions about companies already under consideration. In 2012 I was analyzing Tesco, the British grocer. Investors I admired owned it. Also, I’d recently been floored by its express store on 
Monck Street in London. It had everything that I’d come for, all located right where I expected.

Serendipity intervened the next month, back in California. I noticed an ad for a new chain of supermarkets called Fresh & Easy. It turned out to be owned by Tesco. I visited the store closest to my house, in the city of Mountain View. Product quality was high, prices were fair, and the staff was attentive. Of course the staff was attentive—
I was the only customer. I stopped my analysis. Since then Tesco’s stock price has plunged, due in part to a drop in same-store sales to which my neighborhood Fresh & Easy clearly contributed.  It’s closed now.

Serendipity is great with consumer-facing industries like retail. They’re exposed. But one may be familiar with other, less universally visible industries because of a job or background. It works there, too.


Serendipity has the pleasant effect of boosting the relevance of ordinary environments. Everything is evidence. The logos on people’s shoes, the number of passengers on the plane, the brand on the broken escalator—all can inform judgments about what people buy, what companies make, and what products work. This doesn’t condemn one to a life at a heightened state of alert. Rather, it offers a spigot of ideas whose handle the astute investor controls.





#The seven sources are mere inspirations for the model. 

None of them credential an idea to pass through with preferential treatment. In fact, once one feeds an idea into the model, it’s best to forget where it came from.

The advantages of this practice are clear. When we forget that we’re looking at a company because it’s a spin-off, it’s owned by a hero, or its stock price plunged, we keep a whole raft of cognitive biases at bay. We get raw material worth processing, plus the clear mind needed to process it well.




Summary

Promising sources of investment ideas include:

1. Bad news
2. Spin-offs
3. Regulatory filings
4. Reorganizations
5. Small-caps
6. Stock screeners
7. Serendipity

Thursday 30 September 2010

Philip Fisher: Growth Stock Investigator

Legendary Investor

Philip Fisher: Growth Stock Investigator
Matthew Schifrin, 02.23.09, 6:00 PM ET

Who was Philip Fisher?
Most Forbes readers are familiar with Ken Fisher, money manager billionaire and longtime Portfolio Strategy columnist in Forbes magazine. However, what isn't as widely known among younger investors is that Ken Fisher comes from investing royalty. His father was Philip Fisher, who, starting in 1931, ran a small Northern California investment counseling firm. In 1958, Phil Fisher wrote the first investment book ever to make The New York Times bestseller list, Common Stocks and Uncommon Profits. It also became required reading in the investments class at Stanford's Graduate School of Business (where Phil taught for a time).

The book laid out senior Fisher's 15-point strategy for finding great long-term growth stocks at a time when most investors and strategies swung with business cycles. His methods were so convincing that a young Warren Buffett went to visit with Fisher and eventually incorporated a good deal of Fisher's methods into his own stock selection process. Buffett later described his strategy as 15% Fisher and 85% Benjamin Graham.


As Ken Fisher recounts in the forward to his father's classic investment tome, his father was a bit impatient and the young Fisher only worked at his father's firm briefly. But Fisher went on hundreds of company visits with his father in the 1970s and absorbed his father's investigative style of investing. Still, young Fisher's response to people who would often ask him which experience with his father was his favorite was, "The next one."

Ken's strategy, which focuses largely on stocks undervalued according to their price-to-sales ratios, is much more straight value in it's approach. He seeks stocks that are cheap because they have an undeserved bad image. His father, who wrote his book during a time of great prosperity that resulted in a long post-World War II bull market, wanted stocks he could hold forever because they were well managed and would continue to grow. In fact, by the time Philip Fisher died at the age of 96 in 2004, he still held shares of Motorola that he had purchased 21 years earlier. The stock had appreciated more than 20-fold versus a seven-fold appreciation of the S&P 500.

Phil Fisher's Stock-Picking Strategy
Phil Fisher's 15-point approach essentially attempts to determine whether a company is in a position to continue to grow sales for several years, has an innovative and visionary management, strong profit margins, effective sales organization and high-quality management. Fisher also argued against over-diversifying and, in his heyday, tended to hold only about 30 stocks. This is one of the Buffett strategies borrowed from Fisher as was his don't follow the crowd approach.

Not insignificant in Fisher's approach to growth stock investing was something he called "scuttlebutt." This was the process of veering from printed financial stats or company disclosures. Fisher felt strongly that investors should "investigate" potential portfolio holdings by questioning customers, competitors, former employee's and suppliers, as well as getting information from management itself. The art to this was not just in the answers Fisher got, but in asking the right questions.

Thanks to help from the American Association of Individual Investor's Stock Investor Pro software, Forbes.com recently created a Philip Fisher screen. Below are the criteria used and 10 stocks that passed our Fisher test. Of course, true Phil Fisher devotees will need to do the "scuttlebutt" part of the analysis on their own.

*Net profit margin for the last 12 months and each of the last five fiscal years is greater than the industry's median net profit margin for the same period.
*Sales have increased on a year-to-year basis over each of the last three years (Y4 to Y3, Y3 to Y2, Y2, to Y1) and over the last 12 months (Y1 to 12 months).
*The three-year growth rate in sales is greater than or equal to the industry's median sales growth rate over the same period.
*The company is not expected to pay a dividend in the next year (indicated divided is zero).
*The ratio of the current price-earnings ratio to the estimated growth rate in earnings per share (PEG ratio) is greater than 0.1 and less than or equal to 0.5.


Company Business Price Market Cap Five-year PEG Ratio Five-Year Sales Growth Net Profit Margin
America Movil Communications Services $31.05 $53.5 billion 0.2 39.1% 31.2%
NII Holdings Communications Services $20.56 $3.4 billion 0.9 33.4% 11.6%
Inverness Medical Innovations Biotechnology & Drugs $25.09 $2.0 billion 32.3% -4.2%
Sohu.com Computer Services $45.61 $1.8 billion 0.2 45.8% 31.4%
General Cable Communications Equipment $19.61 $1.0 billion 26% 3.9%
Arena Resources Oil & Gas Operations $26.8 $1.9 billion 0.1 125.9% 37.6%
EZCORP Retail (Specialty Non-Apparel) $13.87 $599.3 million 0.3 17.3% 11.5%
Cabela's Retail (Specialty Non-Apparel) $6.32 $421.4 million 0.6 13.9% 3.2%
Team Business Services $16.49 $310.5 million 0.3 39.1% 5.2%
Volcom Apparel/Accessories $9.52 $232.0 million 0.2 36.3% 11.2%
Continucare Health Care Facilities $1.96 $117.2 million 0.3 21.2% 5%
Source: AAII Stock Investor Pro.

http://www.forbes.com/2009/02/23/philip-fisher-growth-personal-finance_philip_fisher.html

Philip A. Fisher and `Scuttlebutt'

Philip A. Fisher and `Scuttlebutt'

July 11, 2000

I first encountered the word `scuttlebutt' in the novel `Battle cry', story of a US Marine Corps battalion against the background of WW II, by Leon Uris. Almost twenty-five years later, I encountered it again in `Common stocks and Uncommon profits', a book on investment, by Philip A. Fisher. Some words remain stuck in your mind for reasons unknown. During the first encounter I had not bothered to find out the meaning but this time I opened my copy of COD and learned that `scuttlebutt' is a colloquial word, meaning `rumor or gossip'. 
Phil Fisher is a name to reckon with in the field of security investing. His book, mentioned above, first appeared in 1958 and has remained a `must read' since then for all those interested in the art and science of investing. The book carries a small chapter of three pages titled `What "Scuttlebutt" Can Do' and according to some, those three are amongst the most important pages of the book. 
Cold figures and dry notes in any company annual report do not tell the whole story. Every company has some very strong points and also some that are worth hiding. The research team may be on the verge of a breakthrough that may lead to huge profits for many years to come, or the union leaders may be plotting a strategy to trap the management, or some key officials may be planning a new company in direct competition. These events when actually happen will have far reaching effects on the performance but the annual report may not carry any clue to help the investor. Yet, these are of great interest to him because future is all he cares for. Now, if he can not get the information through official sources, he has to use some back channels and that is where scuttlebutt comes in. 
Fisher has explained the importance of scuttlebutt very well in the book. He says: 
"The business `grapevine' is a remarkable thing. It is amazing what an accurate picture of relative points of strength and weakness of each company in an industry can be obtained from a representative cross section of the opinions of those who in one way or another are concerned with any particular company. Most people, particularly if they feel sure there is no danger of their being quoted, like to talk about the field of work in which they are engaged and will talk rather freely about their competitors. Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge."
To get such a picture, one has to visit the company, talk to its customers, vendors, employees, ex-employees and dealers etc. The word `scuttlebutt' used by Fisher is very apt because all those mentioned do not provide any hard quantifiable data; they offer opinions that are subjective. Most of what they tell, falls under the category of `gossip' but if analyzed well, it never fails to give an insight. All investors have their own method of collecting scuttlebutt but most of them don't give it as much importance as it deserves. Analyzing a balance sheet is more cerebral and more satisfying. It gives a `high' of a different kind but the high does not get converted into success if the scuttlebutt is inferior. 
Having read so much about the scuttlebutt method, I decided to try it out. Since visiting companies and getting to talk to people there is difficult I chose the easier path of visiting several branches of banks, both private and nationalized. Currently all branch managers are eager to talk to you because all of them want your account and deposits. The information obtained was very interesting. Since it was all hearsay I will not take names but would like to give a sample. In one bank I was told "We are young and dynamic. They belong to the Middle Ages. Or "We have a wide shareholding pattern but they are really a family owned concern." At another place it was "We are very cosmopolitan and diversified, they have a typical south Indian maharashtrian mentality. Try getting a TOD from then and see how many forms you have to sign" About one bank I was told that the chairman and the managing director do not see eye to eye. Many such interesting bits of information came my way. All were pieces of gossip but they all added little extra sharpness to the picture in my mind. 
Employees, if they feel secure, give lots of helpful information. Inventory is a big issue in manufacturing companies, and its valuation is a complicated affair. If an employee tells me that the company has a lot of dead inventory, I change my discounting factor from 80% to 70%. If more than three persons from the materials division say the same thing I reduce it further. If four out of five employees make disparaging remarks about the management, I revalue long term prospects for the company. No company can go places if the work force is dissatisfied. I know of a company where a relatively simple product has been under design for more than five years. Can this company stand against competition? I doubt. 
More than employees, ex-employees prove more valuable because they are not scared of voicing their opinions. However, Fisher warns that though they may provide valuable insight, their opinions should not be accepted without ample verification because many of them have an axe to grind. Drivers and peons fall in the same category. They come to know many things before the rest of the crowd, but one has to take what they say with not a pinch but a sack of salt. 
In the ultimate sense, an investor chooses to become a partner with the promoters of the company when he purchases a stock. If I do not like a person and his ways of running his business, I will definitely hesitate before deciding to own a part of that business. Personal chemistry does play a role. Many investors like to know about the CEO before they invest and they do not trust the articles appearing in magazines but collect information through their own sources. Personality of the CEO does contribute in the decision making process, especially with women, though not to a great extent. "Ratan Tata looks like a gentleman and gives me confidence" or " So and so from the Birla family does not smoke, does not drink and is a vegetarian" or "The new CEO (of a multinational) is really using this assignment as a stepping stone and will do any thing to please his bosses back home", are not statements to be ignored. This information goes beyond the cold figures of the annual report but it helps in getting a sharper view.
Philip Fisher always took a very long-term view. His famous statement " If the job has been correctly done when a common stock is purchased, the time to sell it is -almost never!" is indicative of that policy. Fisher also believed in having few outstanding companies in his portfolio. He once told John Train, another investor and author " I don't want a lot of good investments, I want a few outstanding ones." To have a few outstanding ones, one has to study quite a few and study them well. 
In his book Fisher provided fifteen points for the investor for examining a given stock and interestingly use of scuttlebutt appears in four of them.  
  1. He suggests use of scuttlebutt for learning about company's cost analysis,
  2. and accounting controls. 
  3. He again suggests use of it while finding out whether the company has short range or long range outlook in regard to profits. 
  4. Finally when it comes to the integrity of the management group, he again depends upon scuttlebutt. He has this to say, " The management of a company is always far closer to its assets than is the stockholder. Without breaking any laws, the number of ways in which those in control can benefit themselves and their families at the expense of the ordinary stockholder is almost infinite." He then says, "There is only one real protection against abuses like these. This is to confine investments to companies, the managements of which have a highly developed sense of trusteeship and moral responsibility to their stockholders. This is a point concerning which the "scuttlebutt" method can be very helpful."
Fisher felt that there is no way of knowing management's integrity but through scuttlebutt. There is nothing wrong if some services are purchased from a relative of the director or CEO but only scuttlebutt will inform us whether those services are being purchased at an appropriate price. If amounts disproportionate to the services received are being paid, it is the shareholder that is getting robbed of his legitimate profit.
All said and done, it is very difficult for an individual investor to follow the scuttlebutt method, because he has neither the time nor the network, but those young men and women who wish to pursue a career in security investment can start building their network at a young age. By the time they mature they will have an intangible asset of infinite value.
The saying, `No smoke without a fire' works in security investing too. Experience teaches us to notice the smoke but scuttlebutt helps us to locate the fire and judge its intensity. 

http://www.valuenotes.com/akanet/AKPhilF.asp?ArtCd=18168&Cat=F&Id=35