The Stock Exchange For Beginners - Part 2
In my previous message about the stock exchange for beginners, I tried to convey some of the realisations that a new investor needs to make to help him or her become successful.
This time, I am going to offer a few thoughts on what I believe helps me to be successful and a few examples of what can and may go wrong. As ever, I hope that this isn't below your level of either confidence or competence as I don't wish to insult. However, I have found that there seem to be far more people that want to understand finance 'a little better' than there are people who can lecture on the subject.
Firstly to an example. Back in the mid 90's I joined an Investment club in the UK. I knew a couple of the members from a local health club I was a member at. Knowing that I was (a) keenly interested in investment and (b) more knowledgeable than most of them, I was invited along.
Suffice to say that on the first evening, I realised that I had been invited along to do all the work! I enjoyed the work so that didn't actually bother me. I also could purchase some additional investment tools 'for the club' which I couldn't justify for myself.
The main work of analysis was carried out by myself and another member who is a long-time friend and no mug in the world of shares and investment himself. We were using as our template a theory offered by Jim Slater which centred around price / earnings growth ratios. In short, it was highly successful.
At the end of the first year, we were 'up' by around 80%. Admittedly, this was during the tech-boom bull and any idiot could get 30% pa without trouble or effort, but still we were very impressed. The second year started well too and within 6 months of year two, our small company growth share portfolio (the only portfolio) was up comfortably over 100%. Nice work if you can get it.
For those of you that haven't been a member of an investment club and don't know, they are a democracy. Every opinion counts equal in a vote to buy or sell, whether they understand investment - or not. Here was our trouble. If you can believe it, making an enormous profit was 'boring' and they needed 'excitement'. To me, making money as quickly as we did was not merely exciting - it was thrilling!! But, when we wanted to sell they wouldn't and when we offered rock solid buy predictions they disliked something and again, we wouldn't.
I think our lowest point was not buying shares in a UK pizza delivery firm (that was growing very quickly and would have turned into a great investment) because (and I kid you not) one of the founding members didn't like 'Italian food'. Who cares?
The club ended rather badly with arguments and falling outs. Several years later it still has a couple of holdings in shares that might 'one day turn around'. Fat chance!!!!
So here is the tip: why do you want to invest? This needs analysis.
My friend and I invested because we were willing to put in the effort, wanted to increase our holdings, make money and frankly, we like winning in a global market against the nation's smartest minds!!
Our other members however, were there to gamble. It was just fun. Who cares about the result? We all meet in a pub, have a meal, chat about shares and throw some money at the market. We wanted profits, they wanted a social group.
After being up by over 100% after 18 months, we closed the club at a loss of both money and friendship. Ridiculous.
What about you? Why do you want to invest? If you want to gamble, take up sports betting. You get to watch a game as well as be financially involved - that sounds much better.
Do you plan to follow the market? If you don't, best to keep away.
I'm not the world's greatest at tracking a market - I can admit it. Each day, I look at the shares in my portfolio, funds I advise clients about, prospective investments I am mulling over, general financial news and read a few posts by other advisers / analysts online. And yet, if I'm honest, I worry that don't pay enough time each day to the markets.
If you want to make serious decisions, with serious amounts of money and (hopefully) make serious amounts of profit, you need to be - SERIOUS!!!
Personally, I don't like the idea of gambling much. I consider myself to be either a speculator or an investor, not a gambler. When I first started investing, I didn't know the difference (though I started at 18 and had no-one to guide me). That meant that all my investments were gambles. Mostly, they weren't so hot.
These days, I assess and analyse much more. I avoid 'turnarounds', since I don't think they turn around too often. Greater life experience has taught me to recognise that most companies that need to turn, or might turn, are already dead - they just don't know it yet.
I also have learned my lesson with 'development' companies. You know the thing, one great idea that 'if' they get to market will make 'tens of millions'. I own shares in a couple that I bought years ago. Broadly, I was right to buy. Of all the development stocks I could have bought, these actually did develop and do make products. They just don't make profits yet - years after I bought.
One of my development picks actually dominates the bluetooth market. That's right, I invested in the company that developed much of the bluetooth technology we use today! How could it not make a bundle of money? Am I a genius or what? Years later, I am still down 65%.
Another has an amazing fuel saving device for gear boxes in cars, lorries and off-road vehicles. In this age, you'd think that fuel saving technology would be all the rage. Over the years, I have bought more shares in the lows and sold them in the highs to make some 'trading' profits. But still my initial investment (I think 8 years ago) is down.
Though I may not have realised it at the time, these were not investments, they were gambles. So is the stock exchange really a place for beginners?
An investment is in a company that has products, a defined market and notable market share, profits, a track record and much more. Remember that. Think about Warren Buffett - he makes investments, good ones at that.
I'm also quite traditional about investing. I have never spread bet, used an option or future or sold short. I don't use leverage. If I can't figure out what might go wrong, FOR CERTAIN, I'd rather not do it. I buy, I hold and I sell. That's it.
I have no doubt that these admissions mean that I miss out on all sorts of possible investment opportunities. There are all sorts of weird and wonderful investments out there, but I invest and I don't like to gamble.
If you think about it though, what I just said doesn't really hold me back. I own some coins, stamps, comics, unit funds, shares, books and art - I did mention that I speculate didn't I? And if the world suddenly has a crisis, it means that I own actual, physical assets as well as just share certificates.
So that brings me to another point ... can you focus?
Ideally, you need to know quite a lot about certain areas and use that knowledge for your investment benefit. The art and books I own are mostly related to cricket. I love cricket and know a lot about the game and it's history - which means that I know when I see something of value. If it has value now, it probably will have for some time to come. Whether I buy at a good price or not, value and scarcity count.
Who'd imagine ME telling you that the stock market isn't everything?
Investment risk is lowered by knowledge. Every time. If you are buying shares on the stock exchange, what does the seller know that you don't? What do you know that the seller does not? You can bet your life that the buyer or seller opposite you in any transaction has done some serious research. If you don't do yours, who do you think will win? You or the market?
So of all the things that I might have said about investing, I haven't really made it sound 'sexy' yet. Have I? The truth is, investing isn't really very sexy. Lap dances are sexy. Pop stars are sexy. Carmen Electra is sexy. Investing is graphs, moving averages, annual reports, company statements, calculators and work. Not so sexy. It's kind of like being an accountant but with marginally more life and a few graphs.
But the great thing about investment is that in the long run, you decide whether you'll be successful or not. The harder you work at it, the luckier you will be. If you are just starting out, think about YOU first, not the market or companies. Decide on what you want to specialise on, whether the stock market for beginners is a place to invest and how you will approach it.
It might help to find areas in which you have useful knowledge already. Either that or decide on an area and slowly become an expert. What do I mean? Well, if you worked in a bank for 10 years, you must know something about banking. When you read an annual report from a bank, do you laugh and see through the waffle or does it make real sense? If you can see through the waffle of some far off CEO and CFO, you can start to compare the relative prospects in the same market of competing firms. Hey - that could be an opportunity!
If you really know about banking, you can compare the product offerings and service as well as the annual reports. You might still know some bank staff that are happy to tell you honestly that they are being 'creamed' in the market or whatever. Before you know it, you have a picture building of a competitive market. Before long, you will REALLY understand the investment potential of several companies. That will put you far ahead of many other investors.
As I said earlier, investment risk is lowered by knowledge - EVERY TIME.
Would your profits improve with help from a great market advice service?
To read more about very similar topics, please visit:
http://www.stockexchangesecrets.com/the-stock-exchange-for-beginners.html
Sunday 6 September 2009
The Stock Exchange For Beginners Guide - Part 1
The Stock Exchange For Beginners Guide - Part 1
As I start my guide, about the Stock Exchange For Beginners, where should a newbie really start?
Firstly, I believe, with a realisation.
The stock exchange is rarely a place where anyone 'gets rich quick'. Offhand, I don't know where anyone does that, but certainly not in investments. Sure, some occassional stocks and shares will rise quickly making their owners money, but rarely will you become rich. Bear in mind that if an investment doubles in one year (which is pretty rare) you needed to be already wealthy to make a lot of money. If you invested a thousand, you will have just 'made' a thousand. You aren't wealthy or rich yet.
There are ways for an investor to make enormous profits, but as ever, they involve enormous risks. Things like options and futures really are NOT for the beginner with limited resources. They are highly technical, involve the potential to lose all of your investment quickly and need constant monitoring. I know that I am quite traditional in this sense, but many options appear to me as if they are little more than a gamble. That is not how a prudent investor operates! Instead look for reliable and predictable companies, quoted on the stock exchange and suitable for beginners.
Second realisation is this ... It isn't easy for beginners to make money on the stock exchange . If everyone could become a billionaire by investing, Warren Buffett would not be famous. It takes time, study and effort and most importantly - independent thought. Not everyone has the will or stamina to carry that through. I know that mine wavers from time to time. Who doesn't suffer setbacks and confidence knocks?
Thirdly, though it may be a 'hobby', the stock exchange isn't 'fun'. The world of investment is dominated by investment banks and their bankers. They do all the big deals, float companies, issue bonds, trade stocks, bonds, currencies and commodities and make lots of money. They employ some of the world's brightest young MBA's to figure out new and improved profit making ventures. They do all this because it is a business, with real money and real profits. Nobody is playing around.
If you want to be successful, you too need to view it as a business. Here is tip number one: if you are interested, go and do some reading about Benjamin Graham. Buy his books and digest. It will take a while, but it is the proper place to start. It was Ben Graham that first coined the idea successful investment is businesslike.
All that said, the little guy can still make money investing. I know, I do. Why can't you? Funds find it hard to invest in small companies, maybe that offers you an edge. Often, money managers are so busy working their 15 hour days that they miss wider discoveries in society. Just by going to the mall or supermarket, you might spot lines selling well and get a head start on the analysts. If that approach sounds good, you might like to grab a book by Peter Lynch - he offers guidance on how he finds winners, or as he puts it 'tenbaggers'.
If you really want to do well in investment on the stock exchange, then you need to approach it as if it were your own business. A part-time business perhaps, but still a business.
The stock exchange for beginners can be a daunting way to make a second income. Fear not, with time, you can learn the skills. But, I warn you again that it takes effort, independent thought and study to really do well.
http://www.stockexchangesecrets.com/stock-exchange-for-beginners-1.html
As I start my guide, about the Stock Exchange For Beginners, where should a newbie really start?
Firstly, I believe, with a realisation.
The stock exchange is rarely a place where anyone 'gets rich quick'. Offhand, I don't know where anyone does that, but certainly not in investments. Sure, some occassional stocks and shares will rise quickly making their owners money, but rarely will you become rich. Bear in mind that if an investment doubles in one year (which is pretty rare) you needed to be already wealthy to make a lot of money. If you invested a thousand, you will have just 'made' a thousand. You aren't wealthy or rich yet.
There are ways for an investor to make enormous profits, but as ever, they involve enormous risks. Things like options and futures really are NOT for the beginner with limited resources. They are highly technical, involve the potential to lose all of your investment quickly and need constant monitoring. I know that I am quite traditional in this sense, but many options appear to me as if they are little more than a gamble. That is not how a prudent investor operates! Instead look for reliable and predictable companies, quoted on the stock exchange and suitable for beginners.
Second realisation is this ... It isn't easy for beginners to make money on the stock exchange . If everyone could become a billionaire by investing, Warren Buffett would not be famous. It takes time, study and effort and most importantly - independent thought. Not everyone has the will or stamina to carry that through. I know that mine wavers from time to time. Who doesn't suffer setbacks and confidence knocks?
Thirdly, though it may be a 'hobby', the stock exchange isn't 'fun'. The world of investment is dominated by investment banks and their bankers. They do all the big deals, float companies, issue bonds, trade stocks, bonds, currencies and commodities and make lots of money. They employ some of the world's brightest young MBA's to figure out new and improved profit making ventures. They do all this because it is a business, with real money and real profits. Nobody is playing around.
If you want to be successful, you too need to view it as a business. Here is tip number one: if you are interested, go and do some reading about Benjamin Graham. Buy his books and digest. It will take a while, but it is the proper place to start. It was Ben Graham that first coined the idea successful investment is businesslike.
All that said, the little guy can still make money investing. I know, I do. Why can't you? Funds find it hard to invest in small companies, maybe that offers you an edge. Often, money managers are so busy working their 15 hour days that they miss wider discoveries in society. Just by going to the mall or supermarket, you might spot lines selling well and get a head start on the analysts. If that approach sounds good, you might like to grab a book by Peter Lynch - he offers guidance on how he finds winners, or as he puts it 'tenbaggers'.
If you really want to do well in investment on the stock exchange, then you need to approach it as if it were your own business. A part-time business perhaps, but still a business.
The stock exchange for beginners can be a daunting way to make a second income. Fear not, with time, you can learn the skills. But, I warn you again that it takes effort, independent thought and study to really do well.
http://www.stockexchangesecrets.com/stock-exchange-for-beginners-1.html
Peter Lynch and the ' Ten Bagger '
Peter Lynch and the ' Ten Bagger '
Peter Lynch, the fund manager legend from the Fidelity Magellan fund first used the phrase ' ten bagger ' in his excellent book, One Up On Wall Street. The term actually comes from baseball, but Lynch uses it to describe stocks which have risen in value by ten or more times! To the amateur or newbie, the idea of making a 1,000% profit may seem a little extreme, but Lynch built a reputation and his fund on this very ability.
For example, in the UK between July 1996 and July 2006, there were a number of companies that can be described as ten baggers. In fact, there were 19! A few had passed the 1,000% growth mark and then fallen back in price, but the opportunity was there.
The largest of these share prices grew by a staggering 3,049% (Anglo Irish Bank Corporation PLC), the lowest was Goodwin PLC, up by a very respectable 904%.
Other notable performers included: Numis Corporation PLC at 2,021%, Savills PLC at 1,271% and Amstrad PLC at 997%.
As you may imagine, this period included the dot com boom and bust, so companies that showed amazing growth, only to lose the vast majority of the gains are not included in the 19.
The sectors which are best represented in the list of 19 ten baggers are not what you might expect. Rather than being the glamorous sectors like telecoms or mining, they are actually finance, real estate and construction.
UK stock market legend Jim Slater described in several of his books that, 'elephants don't gallop'. The companies seem to prove him to be correct as the majority of the firms are small by FTSE standards (even after the tremendous growth).
Peter Lynch revelled in the fact that his family could spot rising stock market stars before Wall Street could. Thus, his theory that with the right mindset and effort, anyone could become a successful investor. Having spotted firms that seemed to be trading successfully and had products that people wanted, he would then swing into action and investigate thoroughly.
To read more related articles, please visit:
http://www.stockexchangesecrets.com/ten-bagger.html
Peter Lynch, the fund manager legend from the Fidelity Magellan fund first used the phrase ' ten bagger ' in his excellent book, One Up On Wall Street. The term actually comes from baseball, but Lynch uses it to describe stocks which have risen in value by ten or more times! To the amateur or newbie, the idea of making a 1,000% profit may seem a little extreme, but Lynch built a reputation and his fund on this very ability.
For example, in the UK between July 1996 and July 2006, there were a number of companies that can be described as ten baggers. In fact, there were 19! A few had passed the 1,000% growth mark and then fallen back in price, but the opportunity was there.
The largest of these share prices grew by a staggering 3,049% (Anglo Irish Bank Corporation PLC), the lowest was Goodwin PLC, up by a very respectable 904%.
Other notable performers included: Numis Corporation PLC at 2,021%, Savills PLC at 1,271% and Amstrad PLC at 997%.
As you may imagine, this period included the dot com boom and bust, so companies that showed amazing growth, only to lose the vast majority of the gains are not included in the 19.
The sectors which are best represented in the list of 19 ten baggers are not what you might expect. Rather than being the glamorous sectors like telecoms or mining, they are actually finance, real estate and construction.
UK stock market legend Jim Slater described in several of his books that, 'elephants don't gallop'. The companies seem to prove him to be correct as the majority of the firms are small by FTSE standards (even after the tremendous growth).
Peter Lynch revelled in the fact that his family could spot rising stock market stars before Wall Street could. Thus, his theory that with the right mindset and effort, anyone could become a successful investor. Having spotted firms that seemed to be trading successfully and had products that people wanted, he would then swing into action and investigate thoroughly.
To read more related articles, please visit:
http://www.stockexchangesecrets.com/ten-bagger.html
Stocks cannot go up ten fold, unless they first go up two and four and six and then eight fold.
It's all about the next 10 baggers !
However stocks cannot go up ten fold, unless they first go up two and four and six and then eight fold. This is an indisputable fact on Wall Street, where very few things are factual or indisputable.
If a stock is going to go up 10 fold, odds are it will sooner or later show its face.
http://nationalstockreview.ning.com/
However stocks cannot go up ten fold, unless they first go up two and four and six and then eight fold. This is an indisputable fact on Wall Street, where very few things are factual or indisputable.
If a stock is going to go up 10 fold, odds are it will sooner or later show its face.
http://nationalstockreview.ning.com/
How to pick multi-baggers
How to pick multi-baggers
Here is the Motilal Oswal guide to hitting sixers in the stock markets
N Mahalakshmi / Mumbai March 29, 2004
"To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks."
- Benjamin Graham
For most investors in stock markets, all that matters is a couple of stock tips which can make them really rich. Just a few stocks which could probably multiply some 10 or 20 times in value.
And it is not that stock markets do not present such opportunities. Of course, they do. Unfortunately, ordinary investors lack the vision to spot such opportunities.
During 2003, for instance, there were 734 companies which tripled in value and created wealth of at least Rs 100 crore. How many of these stock did you own? For many of us, the answer is probably none.
But don't fret. The market is going through a corrective phase now, presenting investors with a good opportunity to pick up stocks cheap. And to help you do that we bring to you insights from the Motilal Oswal Wealth Creation Study for 2003 which analyses the process of wealth creation in mutli-baggers.
Some hot tips from the study and with a little bit of luck, you could expect to buy into some mutli-baggers which can change the complexion of your portfolio.
Here are the key lessons from the study:
■Bad businesses can never create a multi-bagger, though they can create transitory multi-baggers during short phases when the conditions are good.
■Bad managements with good businesses are likely to create only transitory gainers.
■Overpriced shares have no chance of becoming multi-baggers ever.
So the only way one can hope to find lasting multi-baggers is by buying into great businesses run by good managements purchased at huge margin of safety.
When can you find multi-baggers?
According to the study, every period is not amicable for a multi-fold increase in stock prices and unless there are more than 25-30 multi-baggers of reasonable sizes spread across industries in the market, it is quite likely that the common investor would miss an opportunity to spot them.
A study of the bi-annual data of all the companies since 1990 reveals that the latest bull run has seen the maximum number of triplers with at least Rs 100 crore of net-wealth created in two years. The study also reveals that the bull run of 2003 is different from the bull runs in 1998-2000 and 1990-92.
This time, the study says, the rally provided a conducive environment to find multi-baggers in general. The factors that propelled the bull run were:
■Drop in interest rates from 12 per cent to 6 per cent
Values in business markets are relative. The relative valuation of stocks over bonds has increased significantly. It was at the historically highest level of 1.53 in March 2003. It was at its worst at 0.13 when the Sensex P/E was 70 in 1992.
The Sensex rally in 1998-2000 was very sector-specific and it did not have a non-tech earning support. The Sensex tech weight was quite limited and the rally could not sustain at a relative value of 0.32.
■Acceleration in corporate earnings
Drop in the interest cost has led to an increase in the corporate profits. Last year, corporate profits went up by 44 per cent even though sales growth was only 11 per cent because interest cost was very muted.
■Severe depreciation in 2003
Though the relative value increased, investors remained at a distance from the stock market in 2002-03. They decided to put their money in bonds because bond prices were going up whereas stock prices were falling. Now that the bond rally is over, investors will flock back to stocks.
Why some multi-baggers destroy wealth eventually
Having said that, it is not that one could get rich for ever by buying multi-baggers. The study says there are two types of multi-baggers: Enduring multi-baggers and transitory multi-baggers.
Enduring multi-baggers are those companies whose wealth creation is long-lasting and correction from the peak valuation is limited. In fact, they continue to exist as multi-baggers even after the correction.
Top enduring baggers
Company
Net wealth created (Rs Cr)
Wipro
36322.49
Infosys Technologies
33738.74
ICICI Bank
16221.37
Satyam Computer Services
10196.78
HDFC Bank
7968.43
Cipla
6607.20
Sun Pharmaceuticals Ind
5208.66
Moser Baer (India)
2801.60
Zee Telefilms
2387.25
Nirma
2226.75
The enduring multi-bagging companies like Infosys, Wipro, HDFC Bank, Dr Reddy's, Hero Honda and Cipla are typically few and difficult to be spotted, and most of the time they appear to be expensive at the time of buying because of the lack of faith in their longevity and size of growth.
Transitory multi-baggers, on the contrary, are easier to be spotted but they always end up giving nasty end results. Corrections are typically almost 100 per cent. Cyclicals broadly come under this category. The tragedy with this class of companies is that if you cannot sell in time, nothing is left in your hand.
Top transitory baggers
Company
Net wealth created (Rs Cr)
Pentamedia Graphics
-1238.35
NIIT
-1050.78
Silverline Technologies
-1008.99
Pentasoft Technologies
-911.24
Trigyn Technologies
-763.68
SSI
-493.21
DSQ Software
-379.38
Himachal Futuristic
-318.05
Morepen Laboratories
-253.91
Vikas Wsp
-170.69
But as correction is inevitable, market as a whole is left high and dry with a bad experience. These companies are plenty and easy to be found, and they attract a lot of crowd.
The study looked at the sustainability of the companies that were multi-baggers during the period between 1998 and 2000 when 115 companies more than tripled. The assumption: All these stocks were purchased on April 1, 1998, and sold on December 31, 2003.
The result reveals that most of the multi-baggers were transitory in nature during this period and they threw back all the wealth that had been created on their journey upwards.
What is the winning strategy?
"Stocks are simple. All you do is buy shares in a great business - with managers of the highest integrity and ability - for less than the business is intrinsically worth. Then you own those shares forever."
- Warren Buffet
According to Raamdeo Aggarwal, managing director, Motilal Oswal, there are three factors investors must look at: Business, management and the price of the stock relative to its value.
Business:
Improvement in business conditions leads to a change in earnings trend. That is typically the starting point of dismantling the pessimism on the stock. The study finds that a positive change is a must for any type of stock though such change can be temporary or permanent.
The problem arises when the business condition or the opportunity is temporary in nature. Take the example of private banking system - the switch in favour of private banking system is long lasting and permanent in nature. Similarly the changes happening in businesses like pharma, infotech services, auto ancillary and consumer non-durables will have a lasting impact.
However, the changes in fortunes of businesses like steel, cement and shipping are driven by mere price changes and, hence, transitory in nature.
Management:
Management plays a major role in creation of enduring multi-baggers. But how does one judge whether a management is good or bad? The study examined capital allocation of some companies. It is clear that SSI could not manage its capital allocation properly while Infosys could make a come-back due to its superior and sustained capital productivity.
The study observed that in businesses like banking and pharma, the importance of management is clearly visible. As the assessment of new private sector for the period 1998-2003 reveals, good managements can make a difference to the wealth created. For instance, HDFC Bank gained 361 per cent in market-cap during the five-year period when its net worth grew by 687 per cent. At the same time, Global Trust Bank saw its market-cap erode by 73 per cent as its net worth was down 99 per cent.
In cyclical businesses, management efficiency is even more necessary because every business cycle brings different challenges. Allocating capital at the time of cyclical downturn requires a lot of conviction because it may be found to be against popular opinion. Similarly, resisting huge build-up capacity at the peak of the cycle requires insightful management. Hence, the contribution of good managements cannot be undermined in cyclical businesses, too.
In essence, weak managements will lead only to transitory gainers whereas good managements can shine only if business performance helps.
As per Warren Buffet: "With a few exceptions, when management with a reputation for brilliance tackles a business with a reputation for poor fundamentals, it is the reputation of the business that remains intact."
So it boils down to the fact that for the making of enduring multi-baggers, a good business with a good management is necessary.
Price/value:
"Have the purchase price be so attractive that even a mediocre sale gives attractive returns."
- Warren Buffet
One factor, which is absolutely important for making a multi-bagger, is gross under-valuation or huge margin of safety in price at the time of purchase.
The study refers to the work by Tweedy Brown and Co entitled What has worked in investing. Some of the pointers to under-valued stocks are one or more of the following:
■Low price in relation to asset value
■Low price in relation to earnings and cash flows
■Sustained purchase by insiders
■A significant decline in stock prices
■Small market capitalisation with growth
The study concludes that the above findings are relevant in the Indian context, too. Also, the best time to get a huge margin of safety is when:
■Business conditions are unfavorable and near-term prospects look poor.
■When low prices of stocks reflect the current pessimism either in a particular stock or in the market as a whole.
■When a large company's performance is hit and the pessimism is fully reflected in the price.
Low P/E and P/B works because:
■The reinvested earnings are substantial in relation to the price paid. The effect of large earnings addition year after year keeps adding to the intrinsic strength of the stock and, hence, can't be ignored by the market for long.
■The bull market is typically very generous to low-priced issues and thus will raise the typical bargain issue to at least a reasonable level.
■There could be chances of smaller companies with high earnings being taken over by larger ones as a part of diversification programme.
http://www.business-standard.com/india/news/how-to-pick-multi-baggers/147266/
Here is the Motilal Oswal guide to hitting sixers in the stock markets
N Mahalakshmi / Mumbai March 29, 2004
"To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks."
- Benjamin Graham
For most investors in stock markets, all that matters is a couple of stock tips which can make them really rich. Just a few stocks which could probably multiply some 10 or 20 times in value.
And it is not that stock markets do not present such opportunities. Of course, they do. Unfortunately, ordinary investors lack the vision to spot such opportunities.
During 2003, for instance, there were 734 companies which tripled in value and created wealth of at least Rs 100 crore. How many of these stock did you own? For many of us, the answer is probably none.
But don't fret. The market is going through a corrective phase now, presenting investors with a good opportunity to pick up stocks cheap. And to help you do that we bring to you insights from the Motilal Oswal Wealth Creation Study for 2003 which analyses the process of wealth creation in mutli-baggers.
Some hot tips from the study and with a little bit of luck, you could expect to buy into some mutli-baggers which can change the complexion of your portfolio.
Here are the key lessons from the study:
■Bad businesses can never create a multi-bagger, though they can create transitory multi-baggers during short phases when the conditions are good.
■Bad managements with good businesses are likely to create only transitory gainers.
■Overpriced shares have no chance of becoming multi-baggers ever.
So the only way one can hope to find lasting multi-baggers is by buying into great businesses run by good managements purchased at huge margin of safety.
When can you find multi-baggers?
According to the study, every period is not amicable for a multi-fold increase in stock prices and unless there are more than 25-30 multi-baggers of reasonable sizes spread across industries in the market, it is quite likely that the common investor would miss an opportunity to spot them.
A study of the bi-annual data of all the companies since 1990 reveals that the latest bull run has seen the maximum number of triplers with at least Rs 100 crore of net-wealth created in two years. The study also reveals that the bull run of 2003 is different from the bull runs in 1998-2000 and 1990-92.
This time, the study says, the rally provided a conducive environment to find multi-baggers in general. The factors that propelled the bull run were:
■Drop in interest rates from 12 per cent to 6 per cent
Values in business markets are relative. The relative valuation of stocks over bonds has increased significantly. It was at the historically highest level of 1.53 in March 2003. It was at its worst at 0.13 when the Sensex P/E was 70 in 1992.
The Sensex rally in 1998-2000 was very sector-specific and it did not have a non-tech earning support. The Sensex tech weight was quite limited and the rally could not sustain at a relative value of 0.32.
■Acceleration in corporate earnings
Drop in the interest cost has led to an increase in the corporate profits. Last year, corporate profits went up by 44 per cent even though sales growth was only 11 per cent because interest cost was very muted.
■Severe depreciation in 2003
Though the relative value increased, investors remained at a distance from the stock market in 2002-03. They decided to put their money in bonds because bond prices were going up whereas stock prices were falling. Now that the bond rally is over, investors will flock back to stocks.
Why some multi-baggers destroy wealth eventually
Having said that, it is not that one could get rich for ever by buying multi-baggers. The study says there are two types of multi-baggers: Enduring multi-baggers and transitory multi-baggers.
Enduring multi-baggers are those companies whose wealth creation is long-lasting and correction from the peak valuation is limited. In fact, they continue to exist as multi-baggers even after the correction.
Top enduring baggers
Company
Net wealth created (Rs Cr)
Wipro
36322.49
Infosys Technologies
33738.74
ICICI Bank
16221.37
Satyam Computer Services
10196.78
HDFC Bank
7968.43
Cipla
6607.20
Sun Pharmaceuticals Ind
5208.66
Moser Baer (India)
2801.60
Zee Telefilms
2387.25
Nirma
2226.75
The enduring multi-bagging companies like Infosys, Wipro, HDFC Bank, Dr Reddy's, Hero Honda and Cipla are typically few and difficult to be spotted, and most of the time they appear to be expensive at the time of buying because of the lack of faith in their longevity and size of growth.
Transitory multi-baggers, on the contrary, are easier to be spotted but they always end up giving nasty end results. Corrections are typically almost 100 per cent. Cyclicals broadly come under this category. The tragedy with this class of companies is that if you cannot sell in time, nothing is left in your hand.
Top transitory baggers
Company
Net wealth created (Rs Cr)
Pentamedia Graphics
-1238.35
NIIT
-1050.78
Silverline Technologies
-1008.99
Pentasoft Technologies
-911.24
Trigyn Technologies
-763.68
SSI
-493.21
DSQ Software
-379.38
Himachal Futuristic
-318.05
Morepen Laboratories
-253.91
Vikas Wsp
-170.69
But as correction is inevitable, market as a whole is left high and dry with a bad experience. These companies are plenty and easy to be found, and they attract a lot of crowd.
The study looked at the sustainability of the companies that were multi-baggers during the period between 1998 and 2000 when 115 companies more than tripled. The assumption: All these stocks were purchased on April 1, 1998, and sold on December 31, 2003.
The result reveals that most of the multi-baggers were transitory in nature during this period and they threw back all the wealth that had been created on their journey upwards.
What is the winning strategy?
"Stocks are simple. All you do is buy shares in a great business - with managers of the highest integrity and ability - for less than the business is intrinsically worth. Then you own those shares forever."
- Warren Buffet
According to Raamdeo Aggarwal, managing director, Motilal Oswal, there are three factors investors must look at: Business, management and the price of the stock relative to its value.
Business:
Improvement in business conditions leads to a change in earnings trend. That is typically the starting point of dismantling the pessimism on the stock. The study finds that a positive change is a must for any type of stock though such change can be temporary or permanent.
The problem arises when the business condition or the opportunity is temporary in nature. Take the example of private banking system - the switch in favour of private banking system is long lasting and permanent in nature. Similarly the changes happening in businesses like pharma, infotech services, auto ancillary and consumer non-durables will have a lasting impact.
However, the changes in fortunes of businesses like steel, cement and shipping are driven by mere price changes and, hence, transitory in nature.
Management:
Management plays a major role in creation of enduring multi-baggers. But how does one judge whether a management is good or bad? The study examined capital allocation of some companies. It is clear that SSI could not manage its capital allocation properly while Infosys could make a come-back due to its superior and sustained capital productivity.
The study observed that in businesses like banking and pharma, the importance of management is clearly visible. As the assessment of new private sector for the period 1998-2003 reveals, good managements can make a difference to the wealth created. For instance, HDFC Bank gained 361 per cent in market-cap during the five-year period when its net worth grew by 687 per cent. At the same time, Global Trust Bank saw its market-cap erode by 73 per cent as its net worth was down 99 per cent.
In cyclical businesses, management efficiency is even more necessary because every business cycle brings different challenges. Allocating capital at the time of cyclical downturn requires a lot of conviction because it may be found to be against popular opinion. Similarly, resisting huge build-up capacity at the peak of the cycle requires insightful management. Hence, the contribution of good managements cannot be undermined in cyclical businesses, too.
In essence, weak managements will lead only to transitory gainers whereas good managements can shine only if business performance helps.
As per Warren Buffet: "With a few exceptions, when management with a reputation for brilliance tackles a business with a reputation for poor fundamentals, it is the reputation of the business that remains intact."
So it boils down to the fact that for the making of enduring multi-baggers, a good business with a good management is necessary.
Price/value:
"Have the purchase price be so attractive that even a mediocre sale gives attractive returns."
- Warren Buffet
One factor, which is absolutely important for making a multi-bagger, is gross under-valuation or huge margin of safety in price at the time of purchase.
The study refers to the work by Tweedy Brown and Co entitled What has worked in investing. Some of the pointers to under-valued stocks are one or more of the following:
■Low price in relation to asset value
■Low price in relation to earnings and cash flows
■Sustained purchase by insiders
■A significant decline in stock prices
■Small market capitalisation with growth
The study concludes that the above findings are relevant in the Indian context, too. Also, the best time to get a huge margin of safety is when:
■Business conditions are unfavorable and near-term prospects look poor.
■When low prices of stocks reflect the current pessimism either in a particular stock or in the market as a whole.
■When a large company's performance is hit and the pessimism is fully reflected in the price.
Low P/E and P/B works because:
■The reinvested earnings are substantial in relation to the price paid. The effect of large earnings addition year after year keeps adding to the intrinsic strength of the stock and, hence, can't be ignored by the market for long.
■The bull market is typically very generous to low-priced issues and thus will raise the typical bargain issue to at least a reasonable level.
■There could be chances of smaller companies with high earnings being taken over by larger ones as a part of diversification programme.
http://www.business-standard.com/india/news/how-to-pick-multi-baggers/147266/
What are value traps?
Above all else, we try to avoid value traps.
What are value traps?
Deysher: A value trap refers to a stock that looks cheap, probably is cheap, and stays inexpensive forever. It never appreciates because nothing really changes -- there‘s no growth or things don‘t get better. For some companies, it is difficult to change. The only way to make money is if they are acquired, which may never happen. Right now there are several companies that meet all of my other criteria, except that I feel they are value traps.
http://www.fundemail.com/pinnacle.html
What are value traps?
Deysher: A value trap refers to a stock that looks cheap, probably is cheap, and stays inexpensive forever. It never appreciates because nothing really changes -- there‘s no growth or things don‘t get better. For some companies, it is difficult to change. The only way to make money is if they are acquired, which may never happen. Right now there are several companies that meet all of my other criteria, except that I feel they are value traps.
http://www.fundemail.com/pinnacle.html
Manager Insight
Manager Insight: The Pinnacle Value Fund
By Lori Pizzani
June 17, 2003
...................................................................................
The Pinnacle Value Fund prefers to lean into the smallest capitalization area of the market. It likes to get up close and personal with companies that haven’t yet blipped onto mainstream analysts’ radar screens, or walk into an air traffic controller’s worst nightmare and scoop up companies that have fallen completely off radar. The fund’s manager, John E. Deysher, believes he can achieve oversized gains with undersized companies, and possibly grab some dividend yield along the way to reward investors for their wait.
That contrarian approach means shopping for bargains and hanging on to winners. While the fund is less than three months old, it’s in positive territory, and worthy of a look.
Fundemail: The Pinnacle Value Fund may be new, but you aren’t new to the mutual fund industry, right?
Deysher: Right. Before starting Bertolet Capital in January and the fund in April, I worked for 12-plus years as a portfolio manager and senior research analyst with Royce & Assoc. which manages mutual funds here in New York. Royce specializes in managing small cap value stocks. All told, I have two decades of industry experience.
Fundemail:The Pinnacle Value Fund can invest in common stocks as well as preferred stocks and convertible securities. Why the broader mandate?
Deysher: I manage the fund for total return. Our goal is to give investors a 2% or 3% yield while they are waiting for the securities to appreciate. We won’t invest in common stocks unless we think the stock can double or triple over the next two to three years.
Right now we own the preferred stock on a REIT, Price Legacy Corp., which is yielding 8-1/2%. It was structured by Sol Price who used to own Price Club before it merged with Costco in 1994. The REIT owns the real estate that 42 shopping centers sit on with key tenants like Costco, Home Depot, Lowes and Sport Authority.
Fundemail: The fund focuses its attention on the micro- and small cap universe. Why is this the sweet spot of the market for you?
Deysher: Small and micro-cap securities tend to trade under radar screens. Many are what I call “orphaned” stocks that no one pays much attention to. They often don’t get coverage from stock analysts, and that lack of interest usually makes for better values. Also, lots of other portfolio managers cannot invest in stocks under $100 million or even under $200 million so there are fewer analysts watching.
The sweet spot for us is any company under $400 million in market cap, and we have lots under $100 million. But a comfortable floor for us is within the $8 to $10 million range. We normally won’t buy companies smaller than that because they can be really fragile and are often overly dependent on a key customer, product or senior executive.
Fundemail: But if analysts aren’t covering these smaller companies, doesn’t that mean more work for you?
Deysher: Yes, it certainly does. Investing in smaller companies is much more labor intensive and requires more research. One of our biggest challenges is gathering the intelligence, which you have to do yourself. So we talk with their management, their competitors, their suppliers and others. We talk to people who often have no vested interest in speaking with us. We try to become as knowledgeable as possible beforehand so in exchange for their insight and thoughts, we can offer them information about something they didn’t know. We try to make it a two-way dialog.
Fundemail: Where do your stock ideas come from?
Deysher: We get ideas from many places, including the Wall Street Journal table showing the stocks making New Lows each day. We carefully look at SEC filings. We follow 13D and 13G ownership filings of smart, successful small company investors. We also review Warren Buffet’s Berkshire Hathaway filings every quarter. Sometimes there is an idea that we haven’t heard before that‘s small enough for us.
We have a nice network of brokers who we talk to, and we attend trade shows and trade association conferences. We read lots of publications and reports.
Fundemail: What do you ask when you talk with a small company’s management?
Deysher: We try to understand what they think are the key issues critical to a company’s success over the next few years. What are their strategic, financial and operating priorities? Do they understand the concepts of capital allocation and incentive compensation? We always wrap up our dialog by asking: Who is your toughest competitor? Who is your best vendor, and who is your best customer?
Fundemail: What do their answers tell you?
Deysher: It tells us whom they really respect and gives us insight into what they think about their company within the competitive landscape. We may also obtain new investment ideas that are worth further analysis.
Fundemail: Do you talk with the top brass at every company you own?
Deysher: We interview the CEO and/or CFO whenever we can. Some companies simply won’t talk to us. That doesn’t prohibit us from buying that company if we like it.
Fundemail: The fund has almost $2 million now. What is a comfortable number of securities for you to hold in the portfolio?
Deysher: Well, we are not yet fully invested. We have only 12% of the fund‘s assets invested now. We have about 15 or 16 securities in the portfolio right now, and are holding the other 88% in cash in a money market fund. Once we are fully invested, a comfortable number will be from 80 to100 securities.
The fund’s charter allows us to take fairly significant positions up to 10%. We will have a handful that will represent 4% or 5% of the fund. We’ll have a bunch of 2% to 4% positions. We’ll also have lots where we will own 2% or less, especially where we are just getting to know the companies. But we are diversified across industries and sectors.
Fundemail: So, you apparently aren’t afraid to hold cash?
Deysher: We’re not afraid to hold cash. I would much rather earn 1% in a money market fund than lose 10% because we paid too much for a security. Paying too much can turn a good investment into a poor one.
We’re not sure that the recent rally we’ve had is sustainable. Yes, we have now removed the uncertainty of war with Iraq. And after three years of a bear market, people are looking for a recovery. But people are just tossing money into the market now, and I’m unsure the recovery will justify current valuations. There have been a lot of managers covering their short positions and that has contributed to the rise in the market, too.
Fundemail: Conversely, you’ve indicated that down the road, too much cash could hurt the fund and you would consider closing the fund and not accepting new investments.
Deysher: That’s true. We expect that we will close the fund at some point. I don’t know if we will close it at $100 million or $500 million, but I don’t want to dilute the quality of investment ideas just to grow assets. That’s something that can happen if this kind of fund grows too large. The problem then becomes how to put that money to work. Often managers must migrate to bigger companies, or change their investment style. We call this market cap, or style creep.
Fundemail: Speaking of style, what particular characteristics do you look for in companies you invest in for this value fund?
Deysher: We look for companies that employ conservative accounting methods and have strong balance sheets. We also look for companies whose management is entrepreneurial. They have to think like owners. We also like it when they own a lot of stock in the company. When they own considerable stock, they pay more attention to capital allocation and don’t do dumb things just to satisfy Wall Street. These companies must also have an understandable business model. If I can’t understand a business model fairly quickly, we’ll move on to something else.
Fundemail: Have the recent past financial reporting scandals brought new emphasis to the concept of conservative accounting?
Deysher: Yes, the past scandals have emphasized the importance of conservative accounting. It’s certainly not new for us to look for conservative accounting. But micro-cap companies can be so much more vulnerable to economic slowdowns. We want to invest in companies that are able to survive and we weed out most others.
Fundemail: How does your value style come into play?
Deysher: We are contrarians. We invest in companies that are out of favor, but who have a strong balance sheet to get them out of their current troubles. Then we look for a catalyst to turn the company around, although we don’t require that there be a catalyst.
Once we own a company, we like it when other analysts and managers begin to pick up that company on their radar. But if a company has fallen off radar and becomes undervalued, that’s when we get interested.
Fundemail: What type of catalyst do you want to see?
Deysher: It might be a new management team that comes in, or a new shareholder base where someone with a 5% or 10% position surfaces and starts pushing for change. Sometimes, it’s the decision to begin a divestiture program, where the company has done too many acquisitions and now needs to sell off non-core assets. Conversely, they may decide to make strategic acquisitions. Sometimes a company will decide to adopt a share repurchase program or the insiders will begin accumulating shares. With all of the choices companies or managers have on where to invest capital, if they’re willing to invest in their own stock, that’s normally a pretty strong signal to us.
Above all else, we try to avoid value traps.
Fundemail: What are value traps?
Deysher: A value trap refers to a stock that looks cheap, probably is cheap, and stays inexpensive forever. It never appreciates because nothing really changes -- there‘s no growth or things don‘t get better. For some companies, it is difficult to change. The only way to make money is if they are acquired, which may never happen. Right now there are several companies that meet all of my other criteria, except that I feel they are value traps.
Fundemail: You also invest in so-called “special situation” securities. What are these?
Deysher: We do a lot of detailed work, and we aren’t afraid to traffic in turnarounds. That includes broken IPOs, which are IPOs that come to market with unrealistic expectations. Perhaps management is overly optimistic, or the IPO has been over-hyped by investment bankers. These companies come to market with rich valuations that hold up for a year or two. Then earnings drop and P/Es shrink leading to a share price decline.
A great example of a broken IPO is AirNet Systems, a $40 million market cap company we own which is a major holding. It came to market six years and got as high as $30 per share before falling to $4 recently. The company provides fast, critical air shipping for things such as organ transplants and checks that banks must physically have in order to pay.
The new check truncation legislation which will allow banks to clear checks via electronic check presentment will mean that part of AirNet’s business will disappear. But they’ve been changing their business model and providing services to businesses who need to fly cargo and charter services to individuals and groups. They’ve been growing and we think the liquidation value of their planes in higher than the current share price.
Fundemail: With the stock market up recently, are you finding pockets of value now?
Deysher: Yes. Right now the manufactured housing industry is very depressed. There’s little or no financing in manufactured housing, and unit sales have come down 65% over the last five years. So that’s an area we are interested in. Also, recreational vehicle manufacturing companies are depressed. Winnebago, for example, just warned about its earnings. The aerospace and airline industries are also quite depressed, and there are a lot of little companies that exist in that area.
Fundemail: What about your sell discipline?
Deysher: We will often sell if a security hits our price target. We have buy and sell triggers on every security that are adjusted accordingly as events unfold. That allows our winners to continue to generate profits even if they have appreciated past their target price. We are comfortable maintaining a security that has appreciated significantly so long as events continue to track a plan. Of course, that doesn’t mean that at the higher price we would initiate a position.
Did you ever hear Peter Lynch (the former Fidelity Magellan Fund guru) refer to 10-baggers? Those are stocks that appreciate 10 times their value generating significant returns. Well, one way to capture a 10-bagger is to let a security grow and appreciate. We will hold a security until we think it is fairly valued.
We’ll also sell if we’ve made a mistake -- in our facts, our judgment or our reasoning -- or if the catalyst or trigger we expected doesn’t happen. If it’s obvious that something good won’t happen after two to three years, we’ll scale back. If a company is doing well but the price just doesn’t reflect that yet, we will maintain our position.
Fundemail: What makes your fund unique?
Deysher: We’re in a really specialized asset class of neglected, overlooked and orphaned securities. Also, we can go small, really small. We also don’t think with the crowd. We take lots of contrarian stances. When others are selling, we’re buying, and vice versa. We invest on the basis of valuations and fundamentals, not popularity. Our goal is to generate meaningful long-term returns on a tax efficient basis.
My family and I have a substantial amount of money invested in the fund. That’s one of our core principals, both for us and the companies we invest in. People who run a business should have their wallet on the line everyday, just like we do.
About the author:.
Lori Pizzani, who serves as managing editor for FundEmail, is a New York-based freelance journalist specializing in mutual funds, investment management and personal finance. She is currently the editor-at-large for a nationally recognized weekly mutual fund/investment management trade publication, writes a recurring column for mutualfundcareers.com, and is a regular contributor to two publications sponsored by the Association for Investment Management and Research (AIMR). She has written for cnbc.com, and worldlyinvestor.com, as well as several highly regarded financial services magazines. She previously served as the managing editor of a monthly mutual fund trade publication. Before beginning her writing career, she worked for seven years within the mutual fund industry.
http://www.fundemail.com/pinnacle.html
By Lori Pizzani
June 17, 2003
...................................................................................
The Pinnacle Value Fund prefers to lean into the smallest capitalization area of the market. It likes to get up close and personal with companies that haven’t yet blipped onto mainstream analysts’ radar screens, or walk into an air traffic controller’s worst nightmare and scoop up companies that have fallen completely off radar. The fund’s manager, John E. Deysher, believes he can achieve oversized gains with undersized companies, and possibly grab some dividend yield along the way to reward investors for their wait.
That contrarian approach means shopping for bargains and hanging on to winners. While the fund is less than three months old, it’s in positive territory, and worthy of a look.
Fundemail: The Pinnacle Value Fund may be new, but you aren’t new to the mutual fund industry, right?
Deysher: Right. Before starting Bertolet Capital in January and the fund in April, I worked for 12-plus years as a portfolio manager and senior research analyst with Royce & Assoc. which manages mutual funds here in New York. Royce specializes in managing small cap value stocks. All told, I have two decades of industry experience.
Fundemail:The Pinnacle Value Fund can invest in common stocks as well as preferred stocks and convertible securities. Why the broader mandate?
Deysher: I manage the fund for total return. Our goal is to give investors a 2% or 3% yield while they are waiting for the securities to appreciate. We won’t invest in common stocks unless we think the stock can double or triple over the next two to three years.
Right now we own the preferred stock on a REIT, Price Legacy Corp., which is yielding 8-1/2%. It was structured by Sol Price who used to own Price Club before it merged with Costco in 1994. The REIT owns the real estate that 42 shopping centers sit on with key tenants like Costco, Home Depot, Lowes and Sport Authority.
Fundemail: The fund focuses its attention on the micro- and small cap universe. Why is this the sweet spot of the market for you?
Deysher: Small and micro-cap securities tend to trade under radar screens. Many are what I call “orphaned” stocks that no one pays much attention to. They often don’t get coverage from stock analysts, and that lack of interest usually makes for better values. Also, lots of other portfolio managers cannot invest in stocks under $100 million or even under $200 million so there are fewer analysts watching.
The sweet spot for us is any company under $400 million in market cap, and we have lots under $100 million. But a comfortable floor for us is within the $8 to $10 million range. We normally won’t buy companies smaller than that because they can be really fragile and are often overly dependent on a key customer, product or senior executive.
Fundemail: But if analysts aren’t covering these smaller companies, doesn’t that mean more work for you?
Deysher: Yes, it certainly does. Investing in smaller companies is much more labor intensive and requires more research. One of our biggest challenges is gathering the intelligence, which you have to do yourself. So we talk with their management, their competitors, their suppliers and others. We talk to people who often have no vested interest in speaking with us. We try to become as knowledgeable as possible beforehand so in exchange for their insight and thoughts, we can offer them information about something they didn’t know. We try to make it a two-way dialog.
Fundemail: Where do your stock ideas come from?
Deysher: We get ideas from many places, including the Wall Street Journal table showing the stocks making New Lows each day. We carefully look at SEC filings. We follow 13D and 13G ownership filings of smart, successful small company investors. We also review Warren Buffet’s Berkshire Hathaway filings every quarter. Sometimes there is an idea that we haven’t heard before that‘s small enough for us.
We have a nice network of brokers who we talk to, and we attend trade shows and trade association conferences. We read lots of publications and reports.
Fundemail: What do you ask when you talk with a small company’s management?
Deysher: We try to understand what they think are the key issues critical to a company’s success over the next few years. What are their strategic, financial and operating priorities? Do they understand the concepts of capital allocation and incentive compensation? We always wrap up our dialog by asking: Who is your toughest competitor? Who is your best vendor, and who is your best customer?
Fundemail: What do their answers tell you?
Deysher: It tells us whom they really respect and gives us insight into what they think about their company within the competitive landscape. We may also obtain new investment ideas that are worth further analysis.
Fundemail: Do you talk with the top brass at every company you own?
Deysher: We interview the CEO and/or CFO whenever we can. Some companies simply won’t talk to us. That doesn’t prohibit us from buying that company if we like it.
Fundemail: The fund has almost $2 million now. What is a comfortable number of securities for you to hold in the portfolio?
Deysher: Well, we are not yet fully invested. We have only 12% of the fund‘s assets invested now. We have about 15 or 16 securities in the portfolio right now, and are holding the other 88% in cash in a money market fund. Once we are fully invested, a comfortable number will be from 80 to100 securities.
The fund’s charter allows us to take fairly significant positions up to 10%. We will have a handful that will represent 4% or 5% of the fund. We’ll have a bunch of 2% to 4% positions. We’ll also have lots where we will own 2% or less, especially where we are just getting to know the companies. But we are diversified across industries and sectors.
Fundemail: So, you apparently aren’t afraid to hold cash?
Deysher: We’re not afraid to hold cash. I would much rather earn 1% in a money market fund than lose 10% because we paid too much for a security. Paying too much can turn a good investment into a poor one.
We’re not sure that the recent rally we’ve had is sustainable. Yes, we have now removed the uncertainty of war with Iraq. And after three years of a bear market, people are looking for a recovery. But people are just tossing money into the market now, and I’m unsure the recovery will justify current valuations. There have been a lot of managers covering their short positions and that has contributed to the rise in the market, too.
Fundemail: Conversely, you’ve indicated that down the road, too much cash could hurt the fund and you would consider closing the fund and not accepting new investments.
Deysher: That’s true. We expect that we will close the fund at some point. I don’t know if we will close it at $100 million or $500 million, but I don’t want to dilute the quality of investment ideas just to grow assets. That’s something that can happen if this kind of fund grows too large. The problem then becomes how to put that money to work. Often managers must migrate to bigger companies, or change their investment style. We call this market cap, or style creep.
Fundemail: Speaking of style, what particular characteristics do you look for in companies you invest in for this value fund?
Deysher: We look for companies that employ conservative accounting methods and have strong balance sheets. We also look for companies whose management is entrepreneurial. They have to think like owners. We also like it when they own a lot of stock in the company. When they own considerable stock, they pay more attention to capital allocation and don’t do dumb things just to satisfy Wall Street. These companies must also have an understandable business model. If I can’t understand a business model fairly quickly, we’ll move on to something else.
Fundemail: Have the recent past financial reporting scandals brought new emphasis to the concept of conservative accounting?
Deysher: Yes, the past scandals have emphasized the importance of conservative accounting. It’s certainly not new for us to look for conservative accounting. But micro-cap companies can be so much more vulnerable to economic slowdowns. We want to invest in companies that are able to survive and we weed out most others.
Fundemail: How does your value style come into play?
Deysher: We are contrarians. We invest in companies that are out of favor, but who have a strong balance sheet to get them out of their current troubles. Then we look for a catalyst to turn the company around, although we don’t require that there be a catalyst.
Once we own a company, we like it when other analysts and managers begin to pick up that company on their radar. But if a company has fallen off radar and becomes undervalued, that’s when we get interested.
Fundemail: What type of catalyst do you want to see?
Deysher: It might be a new management team that comes in, or a new shareholder base where someone with a 5% or 10% position surfaces and starts pushing for change. Sometimes, it’s the decision to begin a divestiture program, where the company has done too many acquisitions and now needs to sell off non-core assets. Conversely, they may decide to make strategic acquisitions. Sometimes a company will decide to adopt a share repurchase program or the insiders will begin accumulating shares. With all of the choices companies or managers have on where to invest capital, if they’re willing to invest in their own stock, that’s normally a pretty strong signal to us.
Above all else, we try to avoid value traps.
Fundemail: What are value traps?
Deysher: A value trap refers to a stock that looks cheap, probably is cheap, and stays inexpensive forever. It never appreciates because nothing really changes -- there‘s no growth or things don‘t get better. For some companies, it is difficult to change. The only way to make money is if they are acquired, which may never happen. Right now there are several companies that meet all of my other criteria, except that I feel they are value traps.
Fundemail: You also invest in so-called “special situation” securities. What are these?
Deysher: We do a lot of detailed work, and we aren’t afraid to traffic in turnarounds. That includes broken IPOs, which are IPOs that come to market with unrealistic expectations. Perhaps management is overly optimistic, or the IPO has been over-hyped by investment bankers. These companies come to market with rich valuations that hold up for a year or two. Then earnings drop and P/Es shrink leading to a share price decline.
A great example of a broken IPO is AirNet Systems, a $40 million market cap company we own which is a major holding. It came to market six years and got as high as $30 per share before falling to $4 recently. The company provides fast, critical air shipping for things such as organ transplants and checks that banks must physically have in order to pay.
The new check truncation legislation which will allow banks to clear checks via electronic check presentment will mean that part of AirNet’s business will disappear. But they’ve been changing their business model and providing services to businesses who need to fly cargo and charter services to individuals and groups. They’ve been growing and we think the liquidation value of their planes in higher than the current share price.
Fundemail: With the stock market up recently, are you finding pockets of value now?
Deysher: Yes. Right now the manufactured housing industry is very depressed. There’s little or no financing in manufactured housing, and unit sales have come down 65% over the last five years. So that’s an area we are interested in. Also, recreational vehicle manufacturing companies are depressed. Winnebago, for example, just warned about its earnings. The aerospace and airline industries are also quite depressed, and there are a lot of little companies that exist in that area.
Fundemail: What about your sell discipline?
Deysher: We will often sell if a security hits our price target. We have buy and sell triggers on every security that are adjusted accordingly as events unfold. That allows our winners to continue to generate profits even if they have appreciated past their target price. We are comfortable maintaining a security that has appreciated significantly so long as events continue to track a plan. Of course, that doesn’t mean that at the higher price we would initiate a position.
Did you ever hear Peter Lynch (the former Fidelity Magellan Fund guru) refer to 10-baggers? Those are stocks that appreciate 10 times their value generating significant returns. Well, one way to capture a 10-bagger is to let a security grow and appreciate. We will hold a security until we think it is fairly valued.
We’ll also sell if we’ve made a mistake -- in our facts, our judgment or our reasoning -- or if the catalyst or trigger we expected doesn’t happen. If it’s obvious that something good won’t happen after two to three years, we’ll scale back. If a company is doing well but the price just doesn’t reflect that yet, we will maintain our position.
Fundemail: What makes your fund unique?
Deysher: We’re in a really specialized asset class of neglected, overlooked and orphaned securities. Also, we can go small, really small. We also don’t think with the crowd. We take lots of contrarian stances. When others are selling, we’re buying, and vice versa. We invest on the basis of valuations and fundamentals, not popularity. Our goal is to generate meaningful long-term returns on a tax efficient basis.
My family and I have a substantial amount of money invested in the fund. That’s one of our core principals, both for us and the companies we invest in. People who run a business should have their wallet on the line everyday, just like we do.
About the author:.
Lori Pizzani, who serves as managing editor for FundEmail, is a New York-based freelance journalist specializing in mutual funds, investment management and personal finance. She is currently the editor-at-large for a nationally recognized weekly mutual fund/investment management trade publication, writes a recurring column for mutualfundcareers.com, and is a regular contributor to two publications sponsored by the Association for Investment Management and Research (AIMR). She has written for cnbc.com, and worldlyinvestor.com, as well as several highly regarded financial services magazines. She previously served as the managing editor of a monthly mutual fund trade publication. Before beginning her writing career, she worked for seven years within the mutual fund industry.
http://www.fundemail.com/pinnacle.html
Small Caps: Growing Value And Valuing Growth
Small Caps: Growing Value And Valuing Growth
03/26/01 11:35:03 PM PST
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by David Penn
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With the Nasdaq reeling and the economy teetering on the edge of a recession, why would anyone be interested in small-cap stocks and mutual funds? Growth, for one thing. Value, for another.
It's something that almost anyone can tell you: Small-cap stocks tend to outperform large-cap stocks on the way up and underperform them on the way down. This conventional wisdom, however, was turned on its head in the final, delirious years of the most recently ended bull market. As Greg McCrickard, manager of T. Rowe Price's Small Cap Stock Fund, put it in a recent update on the fund's strategy: "When the markets [are] really moving up and the animal spirits are in the market and people are feeling great ... people have historically looked to small caps to get that extra bit of performance. It didn't happen this time."
What did happen, according to McCrickard and others, was that large-capitalization stocks led the charge to dizzying heights in the spring of 2000 and were among the first, when the overly exuberant valuations of these large-cap companies became suspect, to come crashing down (Figure 1). While the market downturns of 2000 were widespread, the collapse of many large-cap companies may have been an opportunity for small caps. "Given that valuations were very extended for large caps and not so bad for small caps, when we finally had the correction that we saw, small caps actually did pretty well," McCrickard noted.
http://premium.working-money.com/wm/display.asp?art=124
03/26/01 11:35:03 PM PST
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by David Penn
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With the Nasdaq reeling and the economy teetering on the edge of a recession, why would anyone be interested in small-cap stocks and mutual funds? Growth, for one thing. Value, for another.
It's something that almost anyone can tell you: Small-cap stocks tend to outperform large-cap stocks on the way up and underperform them on the way down. This conventional wisdom, however, was turned on its head in the final, delirious years of the most recently ended bull market. As Greg McCrickard, manager of T. Rowe Price's Small Cap Stock Fund, put it in a recent update on the fund's strategy: "When the markets [are] really moving up and the animal spirits are in the market and people are feeling great ... people have historically looked to small caps to get that extra bit of performance. It didn't happen this time."
What did happen, according to McCrickard and others, was that large-capitalization stocks led the charge to dizzying heights in the spring of 2000 and were among the first, when the overly exuberant valuations of these large-cap companies became suspect, to come crashing down (Figure 1). While the market downturns of 2000 were widespread, the collapse of many large-cap companies may have been an opportunity for small caps. "Given that valuations were very extended for large caps and not so bad for small caps, when we finally had the correction that we saw, small caps actually did pretty well," McCrickard noted.
FIGURE 1: COMPARATIVE PERFORMANCE OF LARGE- AND SMALL-CAP STOCKS IN 2000. The Russell Large Cap Index was down 10%. The Russell Small Cap Index was down 5%.
Much of the wreckage from last year's stagnant Standard & Poor's 500 index and bearish Nasdaq was in the technology sector, so it is little surprise that many of the small-cap companies that did well were outside this arena. Richard Baker, a stock analyst for SmallCapStockNews.com, points to a number of small-cap stocks in the retail area that have done well. Many small-cap value names in the energy sector also fiddled a spritely tune while their technology and telecommunications brethren spent much of 2000 burning. As much of the excess in the stock market continues to drain out and more traditional valuation methods make a comeback, is it time for average investors to pay more attention to small-cap stocks?
WHAT ARE SMALL-CAP STOCKS?
The textbook definition of a small-cap, or small-capitalization, stock is a stock whose company's total market capitalization -- the market value of all outstanding shares -- is between about $350 million and $750 million. Small-cap companies, as one analyst put it, are the "disregarded, unrecognized backbone of America's economy." Often overlooked due to the lack of brand recognition and major institutional backing (some publicly traded small-cap companies have little, if any, analyst coverage, to boot), small-cap companies are nevertheless the small businesses that provide jobs to hundreds of thousands of Americans and often serve as important product suppliers and service providers for larger companies.
Why do small caps tend to outperform large caps? While there is no direct relationship between any given company's market capitalization and its future stock price, there is a strong relationship between a company's market capitalization and that company's ability to raise capital. A company's ability to raise capital to pay for growth and expansion, or to reduce debt, is a major factor in a company's ability to become and remain profitable, and for its stock price to appreciate. Smaller companies tend to have much less capital (in terms of overall assets) to devote to growth and expansion compared to larger companies. Issuing corporate bonds, preferred stock, secondary issues of common stock, bank loans -- all of these are more difficult for smaller companies (say, the RealNetworks of the world) than they are for larger companies (say, the General Electrics of the world).
As such, small-cap stocks usually feature higher risk-return ratios than large- or mid-cap stocks. In other words, because the risks are greater, the potential returns must be greater. This form of risk is often referred to as size risk and is among the risk-return questions that investors must ask themselves when they are searching for investment products to help them meet their goals. Size risk can also play a major factor in properly diversifying a portfolio of stocks or mutual funds. A mix of small-cap stocks in a portfolio overweighted with large-cap stocks can help sustain a portfolio's positive returns when larger issues are failing or not advancing as fast as an investor might prefer.
WHAT SHOULD INVESTORS IN SMALL-CAP STOCKS LOOK FOR?
Analyst Richard Baker has his own mnemonic to help investors remember the key characteristics of small-cap stocks that are likely to appreciate in value. His Miss acronym, which stands for management, innovative and value-added, sector, sales and earnings, helps screen out hundreds of small-cap stocks, making it easier for investors to focus on those small-cap companies that have a background of success and bright growth prospects.
"These four things actually precede a big runup in price appreciation in a given stock," Baker adds. With regard to management, he likes business development experience and, especially, subject matter expertise. Businesses started by industry veterans or those with significant academic credentials and accomplishments can often have insurmountable advantages over businesses initiated with little more than entrepreneurial enthusiasm. In the wake of the dot-com meltdown of 2000, Baker also casts a suspicious eye toward what he calls "concept stocks" -- the shares of companies that might be interesting ideas, but turn out to be lousy businesses. "They sound like a great idea," he points out. "But did they really have a market where they were generating existing revenue from customers who were really purchasing products or services?"
Another interesting aspect of Baker's methodology is his emphasis on sectors. "When you look at buying a house, you look at the proverbial three most important things: location, location, location," he reminds us. According to Baker, that's the same criteria we should keep in mind in selecting a stock: What sector or area of the economy or what industry will experience growth as a part of demographic changes, changes with technology, or changes of consumer needs? In trying to find small-cap stocks in the early stages of their growth phase, he suggests, looking at sectors can be especially helpful. On this score, some of the small-cap stocks that Baker has been impressed with recently include retailers Chico's Fas (CHCS) and Hot Topic (HOTT). (See Figures 2 and 3.)
FIGURES 2, 3: SMALL-CAP RETAILERS. SmallCapStockNews analyst Richard Baker sees strength in small-cap retailers such as Chico's FAS and Hot Topic.
As a small-cap portfolio manager, McCrickard considers his approach to be a quest for both earnings growth and reasonable share prices. "Through a combination of blending growth and value, we can have lower volatility with good returns," he explains. "We look for good businesses; we want to find companies that have reasonably clean balance sheets or the ability through generating lots of cash to get that balance sheet cleaned up pretty quickly."
Another plus as far as McCrickard is concerned is managements that have a large stake in their companies. "We like them to be on the same side of the table with us," he notes. "If they are not just employees, then they are thinking about building value over long periods."
He also thinks that studying sectors can help point the way toward areas of the economy that may be experienc-ing exceptional growth. Says McCrickard, "Really, the sectors of the market tell us where we ought to be investing." While chasing after sector performance can be a tricky game for the average investor, there is little doubt that many of the stocks that see dramatic apprecia-tion in value don't do so alone and are often part of an industrywide, sectorwide, or even economywide (in the case of our recently ended bull market) advance. "In 1993 it was health care, 1994 was technology. In 1995 it was biotech," McCrickard recalls. "You could buy biotech for less than cash on the balance sheet."
At present, he sees opportunities in the often-treacherous technology sector -- though he tends to be less sanguine on pure semiconductor stocks, for example, referring to them as the "tail end of the whip." Nonetheless, some of the companies he has been impressed by include Brooks Automation (BRKS), a company that makes robotic automation arms as well as software for the semiconductor industry, and ATMI, which manufactures consumables such as air-handling equipment for semiconductor companies. (See Figures 4 and 5.)
FIGURES 4, 5: SMALL-CAP TECH STOCKS. T. Rowe Price's Greg McCrickard thinks Brooks Automation and ATMI may be small-cap tech stocks worth watching.
"I know from being an active participant in the markets that a lot of large institutional shareholders are interested in small- and mid-caps," adds McCrickard. "I've made money in large-cap stocks. It is time to diversify and look at small caps."
David Penn can be reached at DPenn@Traders.com.
http://premium.working-money.com/wm/display.asp?art=124
Is Buy-And-Hold The Strategy For You?
Is Buy-And-Hold The Strategy For You?
03/01/01 03:17:41 PM PST
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by RM Sidewitz, Ph.D
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Buying and holding stocks may not be the best approach for everyone, especially those who are unwilling to sit back and take large losses while they wait for their stocks to climb back up.
Many investors believe that buy-and-hold is the best strategy to use for the long term when it comes to stocks. However, over a two-year period, someone who buys ABC Corp. stock at $40, sees it rise to $50, decline to $35, and then rise again, this time to $65, is not getting as good an overall return as he or she thinks (Figure 1). Why, you ask? That investor has lost the opportunity to maximize what his money can do because he has chosen to remain in the market.
FIGURE 1: LOST OPPORTUNITY. The investor may think that he or she is using the best strategy possible when using buy-and-hold for the long term. But is it really the best?
SOMETIMES THEY COME BACK
The truth is that buy-and-hold isn't the best approach for everyone. Buy-and-hold means that even when the market is falling and struggling, you sit, waiting for it to rebound to previous heights. That could take a while; it took almost a year for the stock market to return to its previous levels from the 1974 decline, 10 months to come back from the 1994 dip, but almost 24 months to regain the losses from the 1987 stock market correction. This is time that you're spending just waiting to break even.
Look at it another way. If your portfolio falls in value from $10,000 to $8,000 (or $1 million to $800,000, for that matter), it has dropped 20% in value. That means the market will have to rise 25% just for you to get back to where you were before. Waiting to get back to being even creates the phenomenon I refer to as the "involuntary investor."
The underlying premise of buy-and-hold is that it's impossible to invest in a manner that better insulates you from eventual declines, and therefore, it's in your best interest if you just remain patient. "It'll come back," buy-and-hold believers always tell you.
SOMETIMES THEY DON'T
The truth is that not all stocks rebound; some stocks simply die. Among stock favorites of earlier periods, some such as Chrysler (DCX) went through rocky times, documented in detail in the news media, but eventually triumphed, coming back from the dead.
But some others such as Pan Am (PAAN) do not have such a happy ending. Further, in 2000, many so-called long-term investors in Nasdaq-listed companies found the value of their shares continuing to fall as they were waiting for them to come back. Ultimately, the pain became more than they could bear and many investors sold off their holdings at huge losses.
That reaction is understandable; on a very subtle level, you've been told over and over again to never, ever sell! Think about it. When was the last time you heard about or read a sell recommendation from a stock brokerage research department? In fact, according to Zacks Investment Research, of the 8,000 recommendations made by analysts covering the Standard & Poor's 500 index companies in 2000, only 29 were sells. That's less than one-half of 1%!
How can that be? According to Zacks vice president Mitch Zacks: "It's not that they're oblivious to things getting worse [at companies]. But the way an analyst gets fired is to damage an existing investment banking relationship with a company or sour a future investment banking relationship. The way you do that as an analyst is coming out and telling people to sell a stock."
The unavoidable result is that there is simply no one willing to tell you to get out of the market, ever. "You'll miss the next big move if you're not in the market," you're told. You are not told that the price of waiting for the next big move is you have to sit through substantial market declines that erode your assets. That's a big price to pay.
A buy-and-hold strategy for stocks is an investment approach that takes power away from the long-term investor. But there is a better way, which I will explain in my next article.
R.M. Sidewitz is president, chief executive officer, and founder of Qi2 Technologies, LLC, an investment management company, and the managing member of Qi2 Partners LP, a domestic hedge fund. For additional information on long-term investing, go to www.longterminvestor.org.
http://premium.working-money.com/wm/display.asp?art=105
03/01/01 03:17:41 PM PST
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by RM Sidewitz, Ph.D
--------------------------------------------------------------------------------
Buying and holding stocks may not be the best approach for everyone, especially those who are unwilling to sit back and take large losses while they wait for their stocks to climb back up.
Many investors believe that buy-and-hold is the best strategy to use for the long term when it comes to stocks. However, over a two-year period, someone who buys ABC Corp. stock at $40, sees it rise to $50, decline to $35, and then rise again, this time to $65, is not getting as good an overall return as he or she thinks (Figure 1). Why, you ask? That investor has lost the opportunity to maximize what his money can do because he has chosen to remain in the market.
FIGURE 1: LOST OPPORTUNITY. The investor may think that he or she is using the best strategy possible when using buy-and-hold for the long term. But is it really the best?
SOMETIMES THEY COME BACK
The truth is that buy-and-hold isn't the best approach for everyone. Buy-and-hold means that even when the market is falling and struggling, you sit, waiting for it to rebound to previous heights. That could take a while; it took almost a year for the stock market to return to its previous levels from the 1974 decline, 10 months to come back from the 1994 dip, but almost 24 months to regain the losses from the 1987 stock market correction. This is time that you're spending just waiting to break even.
Look at it another way. If your portfolio falls in value from $10,000 to $8,000 (or $1 million to $800,000, for that matter), it has dropped 20% in value. That means the market will have to rise 25% just for you to get back to where you were before. Waiting to get back to being even creates the phenomenon I refer to as the "involuntary investor."
The underlying premise of buy-and-hold is that it's impossible to invest in a manner that better insulates you from eventual declines, and therefore, it's in your best interest if you just remain patient. "It'll come back," buy-and-hold believers always tell you.
SOMETIMES THEY DON'T
The truth is that not all stocks rebound; some stocks simply die. Among stock favorites of earlier periods, some such as Chrysler (DCX) went through rocky times, documented in detail in the news media, but eventually triumphed, coming back from the dead.
But some others such as Pan Am (PAAN) do not have such a happy ending. Further, in 2000, many so-called long-term investors in Nasdaq-listed companies found the value of their shares continuing to fall as they were waiting for them to come back. Ultimately, the pain became more than they could bear and many investors sold off their holdings at huge losses.
That reaction is understandable; on a very subtle level, you've been told over and over again to never, ever sell! Think about it. When was the last time you heard about or read a sell recommendation from a stock brokerage research department? In fact, according to Zacks Investment Research, of the 8,000 recommendations made by analysts covering the Standard & Poor's 500 index companies in 2000, only 29 were sells. That's less than one-half of 1%!
How can that be? According to Zacks vice president Mitch Zacks: "It's not that they're oblivious to things getting worse [at companies]. But the way an analyst gets fired is to damage an existing investment banking relationship with a company or sour a future investment banking relationship. The way you do that as an analyst is coming out and telling people to sell a stock."
The unavoidable result is that there is simply no one willing to tell you to get out of the market, ever. "You'll miss the next big move if you're not in the market," you're told. You are not told that the price of waiting for the next big move is you have to sit through substantial market declines that erode your assets. That's a big price to pay.
A buy-and-hold strategy for stocks is an investment approach that takes power away from the long-term investor. But there is a better way, which I will explain in my next article.
R.M. Sidewitz is president, chief executive officer, and founder of Qi2 Technologies, LLC, an investment management company, and the managing member of Qi2 Partners LP, a domestic hedge fund. For additional information on long-term investing, go to www.longterminvestor.org.
http://premium.working-money.com/wm/display.asp?art=105
The Search For The 10-Bagger Begins
The Search For The 10-Bagger Begins
03/23/06 12:10:21 PM PST
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by Thomas Maskell
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These promising stocks are elusive but not particularly rare.
Ever since Peter Lynch coined the phrase "10-bagger," investors have been searching for these elusive little gems. Defined as stocks that increase in price 10-fold, 10-baggers are elusive but not that rare. In any given year, you can find a few of them. If you lengthen your time horizon to two or three years, you can find hundreds of them. Of course, when I say you can find them, I mean you can find them after the fact. Finding them before the fact -- well, that's why we're here.
DIGGING FOR 10-BAGGERS
In a perfectly rational market, there would be no such thing as a 10-bagger. According to the magicians of manipulation, the market sees all and knows all. All available information is built into the price. Even some information that isn't available is stuffed into that price. So how can there be stocks that rocket from $1 to $10, or $10 to $100 over the course of a couple of months or a couple of years? There are two possible answers.
If the market isn't rational, how can a rational investor ever hope to spot an emerging 10-bagger? That's a tough one. But you can answer that question by looking at them to see if they share any traits. To do that, you will need a stock-screening tool like the one found at www.Reuters.com. Screening helps you identify a list of stocks that have risen in price by 100% or more in the past year. These are doubles, and while not all doubles are 10-baggers, all 10-baggers are doubles. So it's a good starting point.
I chose a one-year price increase horizon because that is the longest horizon available at Reuters. If your stock-screening tool identifies price increases spanning longer than one year, you will be able to skip the next step, which is to determine which of these doubles are potential or actual 10-baggers. A 10-bagger usually requires two or three years to mature, but it must at least double in each of three consecutive years. Thus, a one-year price screen only provides a clue to its existence. The screen may be highlighting the beginning, the end, or the middle of its move. You will have to broaden your time horizon to get a clearer picture of which doubles are truly 10-baggers.
To broaden the time horizon and narrow the field, I use www.BigCharts.com, another free service. Big Charts provides stock price charts for the majority of the companies you will uncover in your initial screen. Linked to these charts provided by Big Charts are select technical and fundamental data. Among the technical indicators are volume, the moving average convergence/divergence (MACD), the relative strength index (RSI), money flows, on-balance volume, and so forth. For the fundamentalist, there are rolling earnings per share (EPS), price/earnings ratios, and dividend yields. These are provided for time horizons ranging from one day to 10 years.
NARROWING IT DOWN FURTHER
To give you an example, using the Reuters screening tool, I uncovered 588 stocks that had doubled in the past 52 weeks. How many of those stocks are or will become 10-baggers? Big Charts will help me determine that, but looking through 588 stock charts is a daunting task. You will want to narrow the list by eliminating some stocks before you begin your chart search.
First, it's best to establish some list demographics. This will help you with your elimination criteria. For instance, the total number of stocks listed in the database is 8,915. The date of the screen was March 8, 2006. The 588 stocks featured by the screen are 6.6% of a total market. That is 588 stocks from a market whose major indexes were relatively flat. That is a very significant percentage of the total.
To help shorten the list, two descriptors may provide candidates for elimination: industry and trade exchange. The list doesn't show any industry preference. There are 79 different industries represented on the list. Since there are 190 industries in the database, it means that 6.6% of the stocks represent 42% of the industries. They are a very diverse group and span both low- and high-tech industries.
The list does indicate a significant concentration with respect to the exchanges. The OTC and NASDAQ have the lion's share of the doubles. Together, they account for more than 84% of the companies listed. By itself, the OTC represents 54% of those listed. The American Stock Exchange is better represented than the New York Stock Exchange, but neither achieves double-digit status.
There are a few more interesting demographics. For instance, the launch price of these doubles range from zero dollars per share (stocks priced below $0.01 are listed as zero) to $194.53 a share with a median beginning share price of $0.82. Another interesting observation is the degree to which these stocks increased in price. More than 100 of them were five-baggers within the 52-week time frame, with 57 of those stocks becoming 10-baggers within the year. The beginning price of these high-flyers ranged between $0.00 and $6.15 with a median launch price of $0.01.
The screen also provides some fundamental demographics. Most long-term investors would certainly argue that growth in a company's operational performance would be reflected in the growth of its stock's performance. A quick perusal of our list gives 10-bag hunters reason to doubt that. Of those stocks, 32% had a declining EPS during the year. Equally intriguing, 83% of them had three-year annual EPS growth rates that were listed as "NA" -- an indication that usually means these are newly listed companies. We will have to dig deeper to confirm that.
The sales growth is equally baffling. Of these companies, 25% had negative trailing 12-month growth rates. This statistic carried over to the three-year annual sales growth rate, with 27% being negative. EPS and sales growth are apparently not magic indicators. Fundamentalists, take note!
In stock analysis, a picture is worth a thousand words -- or, in this case, a thousand entries on a spreadsheet. But I'm not interested in blindly clicking through 588 stock charts on a computer screen. I need to narrow this list to something more meaningful. My first elimination criterion will be as practical as it is logical. The first stocks I will eliminate are those that won't make me any money. After all, that is the purpose of this search.
To make this first elimination, some simple math is in order. If we assume a 10-bagger and a trading cost of $25 per thousand shares, it is reasonable to eliminate any stock with a beginning price of $0.01 or less. The logic is simple. The cost to get into and out of the stock would be $0.05 a share. Add to that the cost of the stock and subtract it from the final price ($0.10 - ($0.05+$0.01) = $0.04), and your 10-bagger has turned into a four-bagger. Not bad, but not worth the risk. With this one calculation, we have eliminated 136 stocks -- 23% of the total.
You can use any elimination criterion that makes sense to you or reflects your risk profile. For instance, if you are like me and find the OTC to be somewhat untrustworthy, dropping OTC stocks from the list will eliminate 54% of the candidates. Other possible elimination criteria are industries (you may not like some), shares outstanding (drop the biggest numbers), or sectors (eschew the "old economy").
The key here is to eliminate based on criteria that are not causal. The search for a 10-bagger is a search for cause (and support) and effect. The effect is a 10-fold increase in price. The cause (and support) is the performance of the company or the madness of mobs or the manipulation of markets. Our hope in this venture is to determine why these stocks launched -- performance, madness, or manipulation? Keeping this in mind, it is unlikely that the exchange caused the price increase. In addition, given that more than 79 industries are represented in the list, industry is also an unlikely causal indicator. Other noncausal indicators include sectors and shares outstanding.
What I am going to do is eliminate all stocks with current prices below $0.10, all OTC stocks and all American depositary receipts. This will leave a total of 254 stocks in 55 different industries and listed on the three major exchanges (Figure 1). Now I have a list that is small enough to begin charting with.
Not only is the list smaller, but its character is different. For instance, only 24% of these stocks had trailing 12-month (TTM) EPS declines (versus 32% for the original 588). Sales growth was even more dramatic, with only 9.8% showing TTM negative rates (versus 25%). However, it is clear by the screens and the subsequent eliminations that the market is willing to bid up the price of stocks with declining fundamentals. What do they see that we don't? Maybe the charts will tell us.
Next time, I'll look more closely at the charts. However, if you want a head start, you can peruse the 254 charts listed in Figure 1 at your leisure. I start with a five-year weekly chart with volume, P/E, and rolling EPS indicators. Focus on the period just before the stock makes its move. Remember that you are seeking cause and support. What caused the stock to move? And what kept it moving?
HOMS QDEL IVAC MCU TFSM
AQQ BABY LUFK ANX AQNT
BFT ZVXI JOYG AVM ATRO
PKS SCHK JLG MTXX LMIA
NFLX SPNC JCTCF HITK CRDN
MIND TIE IIIN CBRX AMR
UHAL CUP IPII ALKS AAI
MAIN DXPE RMIX MNTA NICH
LUB FLS USG ASGN GIL
DBRN IIN ORA ESCL GIII
GES ABIX STRL ARP LKQX
URGI GHM MVCO AIX RUM
PETS BLD FWLT TGIS LBIX
OATS FLOW WVVI ASF HANS
GAP CMCO LMS ADST NUVO
FC CECE DESC FTK RGEN
ILMN ERS PLXS RTK CELG
OYOG ARS ELTK BBC ABAX
BRLC BGC XWG SIRF PDLI
AXTI BOOM MFLX RBAK LIFC
ESLR WIRE PWEI RWC NVAX
NMGC BXL CMT CELL POZN
BTUI HOM NWD STXN ABGX
TRID ACLI MED GLW REGN
ANAD AIRM ICON CIEN ALNY
ASYT MDM AUY OPTC GNBT
RMBS GGR SA BKHM ADLR
CVV GMXR TRE ITRI VRTX
BRCM TGC GRS NOIZ VPHM
WFR GPOR CLG FNSR ZONA
EMKR TMY DEZ IFO CBST
DIOD SWN MNG RCCC RNAI
ASYS ABP MRB TWTC CYTX
NETL FTO DMX INLD AMLN
MPWRE FPP SVL SBAC CERS
AMD PLLL SKP DCEL ARNA
LPSN ARD GROW NWRE AVII
ARTG APAGF ITG LANV RNVS
BITS MEK DHIL BWNG MYOG
SILC TGE NDAQ SNTO NRPH
VTAL ALY EFH PANL BCRX
CRM NTG TRAD TALX KNDL
HCO ENG CME GIGM ACAD
LGTY MDR AX TRDO BMRN
NUAN SWB ATI KNOT THLD
AZPN GAIA BSM AKAM CGPI
ICCA RONC NURO RATE AOB
ATEA NTRI HOLX KOMG HBX
LNUX DIET CASM SNDK QSC
INFA CVO NMTI LCRD ISV
PRLS CTTY RHAT ININ
Figure 1: FIVE-YEAR WEEKLY. These charts can give you a head start on looking for 10-baggers.
Thomas Maskell is an amateur investor with a large risk aversion and a small nest-egg. In addition, he has a degree in engineering and a master's degree in business administration, which means he knows just enough to be dangerous but not enough to be rich.
http://premium.working-money.com/wm/display.asp?art=633
03/23/06 12:10:21 PM PST
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by Thomas Maskell
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These promising stocks are elusive but not particularly rare.
Ever since Peter Lynch coined the phrase "10-bagger," investors have been searching for these elusive little gems. Defined as stocks that increase in price 10-fold, 10-baggers are elusive but not that rare. In any given year, you can find a few of them. If you lengthen your time horizon to two or three years, you can find hundreds of them. Of course, when I say you can find them, I mean you can find them after the fact. Finding them before the fact -- well, that's why we're here.
DIGGING FOR 10-BAGGERS
In a perfectly rational market, there would be no such thing as a 10-bagger. According to the magicians of manipulation, the market sees all and knows all. All available information is built into the price. Even some information that isn't available is stuffed into that price. So how can there be stocks that rocket from $1 to $10, or $10 to $100 over the course of a couple of months or a couple of years? There are two possible answers.
- First, there are hundreds of companies increasing their sales and profits 10-fold, or
- second, the stock market isn't rational.
If the market isn't rational, how can a rational investor ever hope to spot an emerging 10-bagger? That's a tough one. But you can answer that question by looking at them to see if they share any traits. To do that, you will need a stock-screening tool like the one found at www.Reuters.com. Screening helps you identify a list of stocks that have risen in price by 100% or more in the past year. These are doubles, and while not all doubles are 10-baggers, all 10-baggers are doubles. So it's a good starting point.
I chose a one-year price increase horizon because that is the longest horizon available at Reuters. If your stock-screening tool identifies price increases spanning longer than one year, you will be able to skip the next step, which is to determine which of these doubles are potential or actual 10-baggers. A 10-bagger usually requires two or three years to mature, but it must at least double in each of three consecutive years. Thus, a one-year price screen only provides a clue to its existence. The screen may be highlighting the beginning, the end, or the middle of its move. You will have to broaden your time horizon to get a clearer picture of which doubles are truly 10-baggers.
To broaden the time horizon and narrow the field, I use www.BigCharts.com, another free service. Big Charts provides stock price charts for the majority of the companies you will uncover in your initial screen. Linked to these charts provided by Big Charts are select technical and fundamental data. Among the technical indicators are volume, the moving average convergence/divergence (MACD), the relative strength index (RSI), money flows, on-balance volume, and so forth. For the fundamentalist, there are rolling earnings per share (EPS), price/earnings ratios, and dividend yields. These are provided for time horizons ranging from one day to 10 years.
NARROWING IT DOWN FURTHER
To give you an example, using the Reuters screening tool, I uncovered 588 stocks that had doubled in the past 52 weeks. How many of those stocks are or will become 10-baggers? Big Charts will help me determine that, but looking through 588 stock charts is a daunting task. You will want to narrow the list by eliminating some stocks before you begin your chart search.
First, it's best to establish some list demographics. This will help you with your elimination criteria. For instance, the total number of stocks listed in the database is 8,915. The date of the screen was March 8, 2006. The 588 stocks featured by the screen are 6.6% of a total market. That is 588 stocks from a market whose major indexes were relatively flat. That is a very significant percentage of the total.
To help shorten the list, two descriptors may provide candidates for elimination: industry and trade exchange. The list doesn't show any industry preference. There are 79 different industries represented on the list. Since there are 190 industries in the database, it means that 6.6% of the stocks represent 42% of the industries. They are a very diverse group and span both low- and high-tech industries.
The list does indicate a significant concentration with respect to the exchanges. The OTC and NASDAQ have the lion's share of the doubles. Together, they account for more than 84% of the companies listed. By itself, the OTC represents 54% of those listed. The American Stock Exchange is better represented than the New York Stock Exchange, but neither achieves double-digit status.
There are a few more interesting demographics. For instance, the launch price of these doubles range from zero dollars per share (stocks priced below $0.01 are listed as zero) to $194.53 a share with a median beginning share price of $0.82. Another interesting observation is the degree to which these stocks increased in price. More than 100 of them were five-baggers within the 52-week time frame, with 57 of those stocks becoming 10-baggers within the year. The beginning price of these high-flyers ranged between $0.00 and $6.15 with a median launch price of $0.01.
The screen also provides some fundamental demographics. Most long-term investors would certainly argue that growth in a company's operational performance would be reflected in the growth of its stock's performance. A quick perusal of our list gives 10-bag hunters reason to doubt that. Of those stocks, 32% had a declining EPS during the year. Equally intriguing, 83% of them had three-year annual EPS growth rates that were listed as "NA" -- an indication that usually means these are newly listed companies. We will have to dig deeper to confirm that.
The sales growth is equally baffling. Of these companies, 25% had negative trailing 12-month growth rates. This statistic carried over to the three-year annual sales growth rate, with 27% being negative. EPS and sales growth are apparently not magic indicators. Fundamentalists, take note!
In stock analysis, a picture is worth a thousand words -- or, in this case, a thousand entries on a spreadsheet. But I'm not interested in blindly clicking through 588 stock charts on a computer screen. I need to narrow this list to something more meaningful. My first elimination criterion will be as practical as it is logical. The first stocks I will eliminate are those that won't make me any money. After all, that is the purpose of this search.
To make this first elimination, some simple math is in order. If we assume a 10-bagger and a trading cost of $25 per thousand shares, it is reasonable to eliminate any stock with a beginning price of $0.01 or less. The logic is simple. The cost to get into and out of the stock would be $0.05 a share. Add to that the cost of the stock and subtract it from the final price ($0.10 - ($0.05+$0.01) = $0.04), and your 10-bagger has turned into a four-bagger. Not bad, but not worth the risk. With this one calculation, we have eliminated 136 stocks -- 23% of the total.
You can use any elimination criterion that makes sense to you or reflects your risk profile. For instance, if you are like me and find the OTC to be somewhat untrustworthy, dropping OTC stocks from the list will eliminate 54% of the candidates. Other possible elimination criteria are industries (you may not like some), shares outstanding (drop the biggest numbers), or sectors (eschew the "old economy").
The key here is to eliminate based on criteria that are not causal. The search for a 10-bagger is a search for cause (and support) and effect. The effect is a 10-fold increase in price. The cause (and support) is the performance of the company or the madness of mobs or the manipulation of markets. Our hope in this venture is to determine why these stocks launched -- performance, madness, or manipulation? Keeping this in mind, it is unlikely that the exchange caused the price increase. In addition, given that more than 79 industries are represented in the list, industry is also an unlikely causal indicator. Other noncausal indicators include sectors and shares outstanding.
What I am going to do is eliminate all stocks with current prices below $0.10, all OTC stocks and all American depositary receipts. This will leave a total of 254 stocks in 55 different industries and listed on the three major exchanges (Figure 1). Now I have a list that is small enough to begin charting with.
Not only is the list smaller, but its character is different. For instance, only 24% of these stocks had trailing 12-month (TTM) EPS declines (versus 32% for the original 588). Sales growth was even more dramatic, with only 9.8% showing TTM negative rates (versus 25%). However, it is clear by the screens and the subsequent eliminations that the market is willing to bid up the price of stocks with declining fundamentals. What do they see that we don't? Maybe the charts will tell us.
Next time, I'll look more closely at the charts. However, if you want a head start, you can peruse the 254 charts listed in Figure 1 at your leisure. I start with a five-year weekly chart with volume, P/E, and rolling EPS indicators. Focus on the period just before the stock makes its move. Remember that you are seeking cause and support. What caused the stock to move? And what kept it moving?
HOMS QDEL IVAC MCU TFSM
AQQ BABY LUFK ANX AQNT
BFT ZVXI JOYG AVM ATRO
PKS SCHK JLG MTXX LMIA
NFLX SPNC JCTCF HITK CRDN
MIND TIE IIIN CBRX AMR
UHAL CUP IPII ALKS AAI
MAIN DXPE RMIX MNTA NICH
LUB FLS USG ASGN GIL
DBRN IIN ORA ESCL GIII
GES ABIX STRL ARP LKQX
URGI GHM MVCO AIX RUM
PETS BLD FWLT TGIS LBIX
OATS FLOW WVVI ASF HANS
GAP CMCO LMS ADST NUVO
FC CECE DESC FTK RGEN
ILMN ERS PLXS RTK CELG
OYOG ARS ELTK BBC ABAX
BRLC BGC XWG SIRF PDLI
AXTI BOOM MFLX RBAK LIFC
ESLR WIRE PWEI RWC NVAX
NMGC BXL CMT CELL POZN
BTUI HOM NWD STXN ABGX
TRID ACLI MED GLW REGN
ANAD AIRM ICON CIEN ALNY
ASYT MDM AUY OPTC GNBT
RMBS GGR SA BKHM ADLR
CVV GMXR TRE ITRI VRTX
BRCM TGC GRS NOIZ VPHM
WFR GPOR CLG FNSR ZONA
EMKR TMY DEZ IFO CBST
DIOD SWN MNG RCCC RNAI
ASYS ABP MRB TWTC CYTX
NETL FTO DMX INLD AMLN
MPWRE FPP SVL SBAC CERS
AMD PLLL SKP DCEL ARNA
LPSN ARD GROW NWRE AVII
ARTG APAGF ITG LANV RNVS
BITS MEK DHIL BWNG MYOG
SILC TGE NDAQ SNTO NRPH
VTAL ALY EFH PANL BCRX
CRM NTG TRAD TALX KNDL
HCO ENG CME GIGM ACAD
LGTY MDR AX TRDO BMRN
NUAN SWB ATI KNOT THLD
AZPN GAIA BSM AKAM CGPI
ICCA RONC NURO RATE AOB
ATEA NTRI HOLX KOMG HBX
LNUX DIET CASM SNDK QSC
INFA CVO NMTI LCRD ISV
PRLS CTTY RHAT ININ
Figure 1: FIVE-YEAR WEEKLY. These charts can give you a head start on looking for 10-baggers.
Thomas Maskell is an amateur investor with a large risk aversion and a small nest-egg. In addition, he has a degree in engineering and a master's degree in business administration, which means he knows just enough to be dangerous but not enough to be rich.
http://premium.working-money.com/wm/display.asp?art=633
Search For The 10-Bagger Fundamentals
Search For The 10-Bagger Fundamentals
07/03/07 04:53:06 PM PST
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by Thomas Maskell
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Though they may not be particularly rare, these elusive stocks hold promise nonetheless.
Recently, I received an email from a Technical Analysis of STOCKS & COMMODITIES reader inquiring if he had missed the follow-up articles in my series on searching for 10-baggers. I had to tell him that he had not missed them because I had not written them, having been distracted by a more pressing writing deadline. However, I promised to use his email as inspiration, which brings us to our subject today: finding 10-baggers using the techniques of fundamental analysis.
REVIEW
Figure 1 illustrates a typical 10-bagger. It is defined as a stock that increases in price 10-fold within a three-year period. Thus, it doubles in price every year over that period. Of course, 10-baggers aren't always typical; some may explode to 10-bag status in mere months, while others may lumber past the three-year time limit. Still others may go beyond 10-bag status to become 20-, 30-, and even 50-baggers. But they all follow the basic pattern shown but not necessarily the same time frame or maximum price.
Also illustrated in Figure 1 is the basic dilemma of stock investing (or trading or speculating): the problem of perspective. When we analyze a stock, we are looking backward. When we buy a stock, we need to look forward. When we analyze, we are working with facts, relationships, trends, and history. When we buy, we are peering into a dark room hoping that the light from behind us will illuminate the room in front of us.
07/03/07 04:53:06 PM PST
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by Thomas Maskell
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Though they may not be particularly rare, these elusive stocks hold promise nonetheless.
Recently, I received an email from a Technical Analysis of STOCKS & COMMODITIES reader inquiring if he had missed the follow-up articles in my series on searching for 10-baggers. I had to tell him that he had not missed them because I had not written them, having been distracted by a more pressing writing deadline. However, I promised to use his email as inspiration, which brings us to our subject today: finding 10-baggers using the techniques of fundamental analysis.
REVIEW
Figure 1 illustrates a typical 10-bagger. It is defined as a stock that increases in price 10-fold within a three-year period. Thus, it doubles in price every year over that period. Of course, 10-baggers aren't always typical; some may explode to 10-bag status in mere months, while others may lumber past the three-year time limit. Still others may go beyond 10-bag status to become 20-, 30-, and even 50-baggers. But they all follow the basic pattern shown but not necessarily the same time frame or maximum price.
Also illustrated in Figure 1 is the basic dilemma of stock investing (or trading or speculating): the problem of perspective. When we analyze a stock, we are looking backward. When we buy a stock, we need to look forward. When we analyze, we are working with facts, relationships, trends, and history. When we buy, we are peering into a dark room hoping that the light from behind us will illuminate the room in front of us.
FIGURE 1: A TYPICAL 10-BAGGER. Here you see a chart of a stock that increases in price 10-fold within a three-year period.
Thus, investors must generate two sets of loosely connected data. The first set is historical. Its main purpose is to educate the investor as to how well a company (and its management) has met previous challenges and capitalized on past opportunities. The second set is predictive. Its main purpose is to determine how the company will handle future challenges and opportunities. The first dataset (the cause) will lead you to a good company. The second dataset (the support) will lead you to a good investment. We shall explore both.
THE FUNDAMENTALS
Investing is quite different from trading and speculating. Traders are game players, while speculators are gamblers. Traders and speculators buy stocks, while investors are business people; they buy companies.
There are three basic investment strategies: dividend, value, and growth. Of these, only dividend is a pure investment strategy. The other two are a blend of investing, trading, and a dash of speculation. But dividends have no application to 10-baggers, since 10-baggers rarely pay a dividend. Our investment approach to 10-baggers will rely heavily on the rules governing growth and value investing.
Another aspect of our fundamental analysis is confidence. By that, I don't mean bravado; I mean statistical confidence. The more statistical confidence you have, the less risk you have. They are at opposite ends of a continuum. The objective of any stock analysis should be to increase our confidence that the course we choose will be profitable. In our fundamental analysis, we will do this by comparing our selected stocks to the market as a whole.
LOOKING BACK (CAUSE)
The past and present are defined in Figure 1 as the area to the left of the move point. That is the point at which we must buy. It is like an entrance to a dark room. Beyond that entrance is the unknown. So let's compare what we know about 10-baggers at or before their move. Hopefully, their past performance will uncover some trends that carry forward into that darkroom.
Since most investors will agree that earnings drive the market, Figure 2 compares the earnings per share (EPS) of 30 recent 10-baggers to that of the overall market. About 75% of the 10-baggers have a negative EPS compared to just 10% of the overall market. Further, only 3% of all 10-baggers have an EPS over $1. The market has about 55% in the over $1 EPS range. If earnings history is our guide, 10-baggers are a poor investment.
FIGURE 2: EARNINGS PER SHARE (EPS) DISTRIBUTION. Approximately 75% of the 10-baggers have a negative EPS compared to just 10% of the overall market.
But history must be viewed over time in the search for trends and extrapolations. Figure 3 looks at the EPS of our 10-baggers before and at their price move — that is, the known data. Unfortunately, it simply confirms what we learned in Figure 2. In fact, as a group, the 10-bagger's earnings looked better a year before their move. Their median EPS was slightly better (-0.12 versus -0.13), and more of them were positive (35% versus 25%). If there was any EPS trend at the move, it was downward. Apparently, EPS trends would not help us spot these 10-baggers.
FIGURE 3: 10-BAGGER EPS. As a group the 10-baggers' earnings looked better a year prior to the move. The results here indicate that EPS trends wouldn't help to spot the 10-baggers.
In the absence of earnings, investors often look to sales to establish a valuation. The most useful sales valuation metric is the price to sales ratio (PS). In Figure 4, the PS of our 10-baggers is compared to the PS of the overall market. It is clear from Figure 4 that 60% and more of our 10-baggers come from just 22% of the market. We have found our first distinguishing fundamental metric. By narrowing our search to stocks with a PS of under 0.50, our confidence is increased from 0.4% to 1.1%. Not very high, but much better than a random pick.
FIGURE 4: PRICE-TO-SALES (PS) RATIO. More than 60% of the 10-baggers come from 22% of the market. By searching for stocks with a PS under 0.5, confidence is increased from 0.4 to 1.1.
We can do a similar analysis for several other fundamental metrics and achieve similar results. For instance, analyzing price yields a confidence level of 0.86%, twice as high as a random pick. You can also double your confidence with a P/E comparison. But confidence levels of 1% are not very encouraging, and while it may be possible to improve those results using multiple variables, I have neither the time nor the space to explore that here. So we will look to the other critical aspect of fundamental analysis — potential.
LOOKING FORWARD (SUPPORT)
To my knowledge, no one has a crystal ball. The best we can do is spot past or current trends, but a trend cannot continue into the future without support, and the support we seek depends on potential. In fact, the past is prologue only if it reveals potential. So let's explore potential from a fundamentalist's perspective.
Potential depends on two factors: capacity and leverage — in essence, the capacity of a company to become profitable and its ability to magnify that profitability through leverage. A company with excess capacity and ample leverage has tremendous potential.
Capacity is a function of sales and assets: How many units can we produce in a factory versus how many they are currently producing? A good fundamental measure of it is the sales-to-asset ratio (S/A). Figure 5 compares the S/A of the overall market to our 10-baggers.
FIGURE 5: VARIOUS CAPACITY AND LEVERAGE METRICS FOR THE MARKET AND 10-BAGGERS. Here you see a comparison of the sales to asset ratio (SA) of the overall market to the 10-baggers. The 10-baggers seem to mirror the market to the high side, which is a positive indicator.
Leverage allows the company to magnify or extract the maximum profit from a given increase in sales. There are several kinds of leverage at work in a company. They include operating leverage, financial leverage, and various other synergies such as economies of scale and learning curves. We will focus on operating and financial leverage.
Gross profit (GP) is one form of operating leverage. It represents the potential profit available from each additional sales dollar: the higher the GP, the higher the potential. For instance, a company with a net income of 1% and a GP of 35% would grow its profits 3,500% if it doubled sales and held administrative and marketing costs constant. That's the power of leverage. Figure 5 also compares the GP of the overall market and our 10-baggers.
A company can also magnify their profits through financial leverage. A good metric for assessing financial leverage is shares outstanding (SO). The fewer SO a company has in relationship to their sales, the greater the profit those sales will deliver per share. This is somewhat related to PS, but there is enough difference that it is worth looking at on its own. Figure 5 does that.
The S/A is a double-edged sword in that a low number represents excess capacity that could be used to grow the company. But a low S/A could also imply that the management is not efficiently utilizing the assets, which is a negative. The S/A data in Figure 5 suggests that our 10-baggers are at least as efficient as the market as a whole, and they have the capacity to grow sales. There are many more aspects that underlie S/A, but the fact that our 10-baggers mirror the market to the high side can be viewed as a positive indicator for now.
In fact, all the data in Figure 5 suggests that 10-baggers, from start to finish, tend to reflect the overall market when it come to S/A, GP, and SO. There is no significant difference on which to build a high confidence projection, but it does indicate those 10-baggers are not stepchildren — overlooked or unloved stocks. In essence, they are not "value" investments.
THE SAD CONCLUSION
What you can derive from the data presented here is that there is nothing in the past performance of these companies that would allow us to spot them before their move. They are not value plays, which leaves growth as our only viable investment strategy. But as Figure 6 illustrates, even growth is of little help to us. The median growth of our 10-baggers was only 2.98% before their move, well below the median for the overall market. The 10-baggers didn't outperform the market until after their price move was made. In most cases, the stock moves six to 12 months before the company moves. There is simply no fundamental reason to buy these stocks — no cause. Sadly, the only conclusion you might make based on the dismal growth rate of these companies is that they are frogs waiting to be kissed.
FIGURE 6: ANNUAL SALES GROWTH RATES. The median growth rate for the 10-baggers was only 2.98% before their move. Essentially, there is nothing in growth rates that would lead us to believe that the stocks of these companies are about to experience a 10-bagger rally.
Yet over the life of their move (three years), these stocks more than doubled the growth of the market. They do not blossom without support. Within one year of their move they are outperforming the market and, like their price, by the end of their run they are growing 10 times faster than their premove growth rate. But there is nothing in that premove growth number (2.98%) that would lead us to believe these companies were about to launch. To the fundamentalist, the room remains dark and uninviting.
Thus, fundamentals can tell us a move is under way, but it can't tell us a move is about to happen. But the move did not just happen. Somebody knows something. Perhaps the traders have the answer, but that will have to wait until next time.
SUGGESTED READING
Maskell, Thomas [2006]. "The Search For The 10-Bagger Begins," Working-Money.com, March 23.
_____ [2006]. "The Anatomy Of The 10-Bagger," Working-Money.com, September 5.
http://premium.working-money.com/wm/display.asp?art=696
Are markets mental or physical entities?
Are markets mental or physical entities?
The questions just posed are interesting when we consider flocks of gyrating birds or the behaviour of human crowds, as psi is sometimes claimed to explain the antics of the former.
And stock market behaviour is a very good example of the often irrational and highly emotional activity of human crowds.
When we look at a graph of anything, we are observing a correlation (or mathematical mapping) of highly physical events.
The essential factor to bear in mind is that stock markets are driven by the twin passions of ‘greed’ and ‘fear’, prompting sharp movements up or down.
http://www.assap.org/newsite/Docs/Shares.pdf
The questions just posed are interesting when we consider flocks of gyrating birds or the behaviour of human crowds, as psi is sometimes claimed to explain the antics of the former.
And stock market behaviour is a very good example of the often irrational and highly emotional activity of human crowds.
When we look at a graph of anything, we are observing a correlation (or mathematical mapping) of highly physical events.
- On one extreme, the plotting of average daily British temperatures is inviolate, even though various psychics have claimed to alter local conditions.
- On the other extreme, stock market performance reflects that very interesting borderland inhabited by desire and consequence.
The essential factor to bear in mind is that stock markets are driven by the twin passions of ‘greed’ and ‘fear’, prompting sharp movements up or down.
http://www.assap.org/newsite/Docs/Shares.pdf
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