After my introduction yesterday I thought I would describe my investment strategy. I think everyone has their own investment strategy, or should have, there is no right or wrong way. Research is fundamental to me to find a good investment but how much research should you do? What type of research? What is important and what isn’t?
If I am doing research the first thing I do is read through the last 2 years RNS News. I look out to see the director trading too. I will then go to broker forecasts and look for broker info. Next I’ll search Google under “news” and see what the press is like. I then search all of Google to see what other info is available. The annual report is another good sources of news and the company website investor relations page where you may well find presentations and webcast reecordings. PI World and Investormeetcompany may also hold info. If it’s a retailer I’ll visit the store and look at their website. If not too costly buy the product - try the restaurant etc. Look for reviews on Which and Tripadvisor or Trustpilot and Amazon. Get the directors’ names and search them on Linked-In, look at their history. As the research goes on and the more I keep reading I will end up with a complete picture of the company in my head and I’ll likely know more about the company than most city institutions if it’s a small cap. - you are then ahead of the game.
As I said on my opening post here, I cut my teeth on Jim Slater’s book, The Zulu Principle. I really think this is one of if not the best investing books you can buy. It makes total sense and is in plain English. Jim lists 11 main basic principles.
MANDATORY
1. Five Year Record (5 years positive earnings growth
2. Low PEG Factor (PEG below 1 - ie 10% eps growth on a PE of 10 or less)
3. Optimistic Chairman's Statement
4. Strong Financial Position
5. Competitive Advantage
IMPORTANT
6.Something New
7. Small Market Capitalisation (a small cap stock - anything in the FTSE250 or above is out)
8. Relative Strength (as in the share price movement compared to the FTSE All Share Index)
DESIREABLE
9. Dividend Yield
10. Reasonable Asset Position
11. Management Shareholding
In my early days of investing I used to look for the first 8 of these to feel I had a stock that was likely to be a winner. Over time and with experience, I’ve learned those that matter most to me, especially when looking for multi-bagger recover plays. One thing I definitely don’t make much of a big deal about is the asset position and balance sheet. Jim pointed out that balance sheets can be greatly abused and that the big dial to watch was cash-flow which can’t be tampered with easily. Big happy songs from the board and then weak cash-flow says to beware. If cash-flow looks ok to good, that is far more important to me than pouring over the accounts and looking for detail on the balance sheet. Firstly I’ve never found reading a balance sheet that easy. Secondly, I don’t enjoy it. Why spend a lot of time doing something you don’t like when that time could be spent doing research you enjoy and that may mean more? As a hunter of recovery stocks the balance sheet is not likely to look that great on any recover play, they have likely had a bruising time over years and assets will have been whittled away. I want to see what the debt is, what their cash-flow and ability is like to service that debt and while it is always nice to see lots of assets that can be called on to cover debt it isn’t the be all. The cheapest recover plays are likely to be those with a low asset base where investors have been wary in my opinion. I’d much sooner spend my time checking out the things that matter such as who are the board and what is their history? Who is the co dealing with? What is the competition like? How much interest is there in the company by investors (the less the better). I enjoy digging around, being a bit of a detective in a way, looking for the stuff others aren’t even looking for let alone found. This tells me a lot more than some dubiously valued assets tucked away that the co has that might be worth what they are valued at. Another important thing to me is doing research that I enjoy. Digging around on Google and elsewhere to find out about directors, company suppliers, customers, competitors etc is enjoyable. If you are doing stuff you enjoy you aren’t working. If you enjoy raking through balance sheets and understand them really well then that may be fun for you and there’s no harm in doing it. From my own experience the stuff that other investors haven’t found is usually what gives you the edge.
I hold a portfolio of around 15 stocks or less if I can control myself. If I have 15 equal positions in size (I never do) then each position is 6.5% of my portfolio. Now in my 24 years investing for a living I think I have had about 3 co’s that have been a total loss. If I’m doing a reasonable amount of research I won’t be investing in much that could be a total loss in my opinion, but for the sake of argument let’s say it was one helluva party when I did the research on two of those 15 companies and I woke one morning to a huge hangover and two stocks suspended and not coming back. I’d be 13% down on my portfolio in a worst case scenario. That wouldn’t be nice but it wouldn’t be unrecoverable. In reality the worst might be one company going bust or less. It may be one company halving in value. If you have a spread of stocks then this situation would likely be a much smaller if it was to happen. What is more, I tend to be more heavily invested in the stocks that I hold that are the safest and the smaller positions are the riskier stocks. On this basis, any stocks upsetting the apple cart would be way less than 15% damage, it would likely be 4-5% at worst.
On the other hand, my 13-14 other larger holdings that will nearly all have the potential to double quickly could make up any 4-5% fall in short order. For this reason I regard taking a hit from a stock going wrong as just part of plan. The whole point of holding a spread of stocks is to diversify risk. If I want high performance, high growth I know that I cannot eliminate risk. I take it on the chin and find somewhere else to make it up. I look at what went wrong, look at what I missed and try not to do it again, but always accept that there will be hits and not to beat myself up about them.
15 share holdings feels about right to me. You can eliminate a lot more risk by holding a larger amount of stocks but you dilute your gains too. Buy enough shares and you basically have a tracker fund. I think 15 shares is a reasonable balance.
Jim Slater’s first point on his list and mandatory is 5 years positive earnings growth. After Covid it is near impossible to find a stock that meets his demand. I currently look to find stocks that have sales higher than pre-Covid currently, or nearing that.
I have several added features I like to see where a recovery stock is going on. A chart is important and I rarely buy until I have seen the chart at least look like it is bottoming. I prefer charts to start making bowls too but will go into bowls on a separate page some time.
I also want to see board changes in any recovery play. Bad directors rarely become good directors so I need to see CEO, CFO, COO, Chairman ideally change, at least the CEO or CFO but the more the better. A less negative sounding statement from the board is usually a good sign to me, it doesn’t have to be positive, it just needs to be less negative. Another good indicator is to check the “sizzle”. When I used to be on ADVFN I always looked at a stock’s “thread” there. If there were loads chatting on there then often any news was pretty much priced in. I used to like dead “threads”
I have learned over years that it is better to target an area you understand rather than be a small fish in a bigger pond of knowledge. Tech, oilers, resource co’s pharmas, banks, nearly all of these are off my investment list. Mark Twain said “a goldmine was a hole in the ground with a liar at the top'“ I would extend that to nearly all mines. Oil co’s are similar in that it is impossible to verify claims until the the CEO is smothered in crude. When it comes to Tech, you can know books full of stuff about what a product can do, but what about the competition? How do you know whether someone has a great product or just a more popular one than what you are invested in? You might be investing in Betamax with VHS just around the corner. Pharmas are similar and to me better invested in late on into a product line than be an early investor in a product that fails. Personally I can’t make investing in pharmas look like a plan unless I invest in lots early on and catch the one or two winners that 100 bag or more. It’s a plan, but not for me. Banks are another I leave alone, who understands them other than another banker? All the complicated derivatives these days just means they are too mysterious for me. I have invested in this stuff in the pasts, and I’d never say I’d never trade one of these stocks but these days I avoid them as investments.
I prefer to invest in consumer stocks, engineering co’s, manufacturers, house builders and suppliers - these are easy stuff to understand. What’s easier than going into a retailer and seeing how busy they are or buying one of their products and using it as a basis of research? If I was trading then I wouldn’t let this bother me. When it comes to buying and holding a share I require something I have confidence in, where I can see whether the product or service is something I’d buy. Being able to do decent research means on the occasions when there is a seller in a stock, I have the confidence to hold or buy more if they hit the price.
I rarely short a stock, and haven’t done in years. I know I am an optimist, I always have been and have a positive outlook, even in the bearish markets. To be a good bear you need to be a pessimist imo. I’d far sooner spend my time looking for stocks to buy when they bounce than play short. You need to know your own psychological make-up and frailties as well as strengths in my opinion. I try to invest using psychology too - often it isn’t about what a certain stock will do, it’s about understanding what other investors will do - - the herd effect for example. If you can predict the herd and the timing of the herd you can time your investment decisions far better. Shorting has diminishing returns too. 100p shorted only returns half what your original investment would have returned once the share has halved. If you invest 100p long you investment is returning 50% more on your original investment when it has risen 50%. Basically the most you can make on a short is 100%, on a long the gains are potentially infinite. There are no 2 bagger shorts.
If there is one thing I try to do it is to keep it simple. I don’t want hedging strategies, I don’t want to be trading pairs, complication is distraction. I want to know a business and the guys/gals running it. Backing a good CEO or board who have done it before is a plan that usually works. It’s all just about timing, research and confidence in my view.
So there you have it, I think I have covered how I work and think and hope I haven’t given too much away, but hope I’ve have helped you think about having a methodology that maximises returns.
Good investing.
yes, will do something soon, might be a week or two
Great article Richard. I must re-read the Zulu principle. I agree with most of the sectors you avoid (certainly banks, junior miners & oilers and jam-tomorrow single product tech / bio techs although have held larger pharma over the years e.g. #AZN and $VRTX and some tech (e.g ARM back in the day). When I first started out and knew even less about investing than I do now, I lost about 80% of my investment in RBS. Thankfully I had only invested small sums but still the lesson was learned - I use stop losses now although it sometimes results in being kicked out of perfectly good shares it does avoid the catastrophic losses and helps me sleep at night, plus I can always buy back - do you use stops?
Have you always diversified with ~15 different co's or did you concentrate in to fewer when you started out? Do you limit or diversify across sectors (e.g. hold max of 5 retail stocks)?