As I’ve mentioned before, I spend the vast majority of my time reading. My office is filled with piles of papers, notebooks, and annual reports. I have two computer monitors (yes, I know some value guys have no monitors on their desk… something I admire, but I find the internet’s resources too valuable to ignore… for example, I can access 15+ years’ worth of annual reports in seconds, that’s something Schloss, Graham, Buffett would have readily used if they grew up in the current era, but I digress…)
I generate many ideas by paging through Value Line, which provides me a continual look at 3500 or so companies each quarter. This database gives me ideas to research further, which I typically do by ordering hard copies of the annual reports from the companies themselves. Most of my time is spent reading about companies that I came across in Value Line at one point. I think of it as my modern day “1951 Moody’s Manual“ that Buffett paged through in his early years. Over time, it’s possible to absorb a significant amount of knowledge, as you can go through the database a few times each year. I typically just glance at most companies. The way the sheets are organized makes this very efficient. I glance at the 10 year data including returns on capital, the book value history, the sales progression, and then the company description. Often it only takes 5 seconds to move to the next company. The majority of these businesses are not ones that I’d typically get excited about owning.
My basic objective with paging through Value Line is to find businesses that are ones that I’d consider owning at a certain price. The objective is not necessarily to find ideas that are currently undervalued, although that is sometimes a byproduct of this process. But it starts with flipping pages and looking for ideas that I’d like to know more about. I add these ideas to a watchlist, which becomes the list of stocks that I end up reading about one at a time. So my watchlists end up providing me with most of my ideas, and I actually maintain a number of google spreadsheets, including lists such as buybacks, high ROIC companies, consistent historical free cash flow, and book value compounders among other things.
Nomad Investment Partnership: Keep An Eye On The Unseen Risks
There are many ways to define risk. Warren Buffett has said that "risk comes from not knowing what you're doing." Q3 2020 hedge fund letters, conferences and more His mentor, Benjamin Graham, believed that risk should be measured as the chance of a permanent capital impairment of an investment. Seth Klarman also holds this view. Read More
Most of these databases are based on good quality companies that I want to read about and potentially value, so that I’m prepared to buy them if they become the proverbial 50 cent dollar.
So most of my ideas start with Value Line, then proceed through to my manually updated spreadsheet-watchlists, where they get filtered one last time by reading 10-K’s. I think of this process as idea inventory. Value Line provides the raw materials, the google spreadsheets hold the goods-in-process, and finally–after reading the 10-K’s–the ideas that make the cut end up in my main stock database as finished goods–ready for sale (or purchase I should say, at a certain price).
I’ve recently spent some time really simplifying my efforts and my process. To sum it up, the process loop here is simply:
- Page through Value Line, one stock at at a time
- Add stocks that I would consider owning to one of my watchlists (maybe 1 out of 10 end up on one of my lists)
- Using the database of ideas, read the 10-K’s and attempt to value the business
If I can come up with a value (and a corresponding price I would pay), I add the stock to a master list of ideas that I would buy.
So this process of just flipping through pages, adding ideas to lists, and then reading the 10-K’s is really the foundation of my investment process.
But in addition to searching for good operating businesses to own, I am always on the hunt for special situations, cheap assets, and other undervalued situations. These “other” ideas often come from simply reading the paper and keeping the antennae up for things like spinoffs, tender offers, corporate restructurings, etc… the best way to find these ideas are simply to read the paper and to look at what other good special situation investors own. I often find ideas this way.
And the last thing I’ll mention: screens. I don’t spend a lot of time with screens, but every few months I go through a few screens. The idea is the same as Value Line… try to find companies that are worth spending time reading their 10-K’s. I wrote a two posts (here and here) on some quality screens I like to watch. Greenblatt’s screen is a good one, and sometimes I’ll check the cheap stock lists (low P/B and P/E, etc…), but usually I’m just looking for ideas to read more about.
10 Years of FCF with High ROIC
I’ll close the post with a quick glance at one such list I looked at today. I have a saved list of all the domestic non-financial stocks that have produced positive free cash flow for 10 consecutive years. This list alone would be a good list to go through A to Z. There are exactly 600 companies on this list currently. There are 5161 stocks overall in this database ($10 million market cap), so around 12% of the companies out there have produced 10 straight years of positive free cash flow. I sometimes run an additional filter on this list of stocks, and today I looked at how many companies on this FCF list were able to generate returns on assets above 20% in the last year. Only 25 companies passed this test. Most of them are far too expensive, but this might be a good list of companies to read about. Most of them are capital light businesses with high margins, high returns, and remember–they all belong to the exclusive club of companies that have produced 10 consecutive years of free cash flow:
Here is a look at them, sorted by ROA:
I own two companies on this list (Weight Watchers and Strayer Education), and a few others happen to be on my list of companies that I’m currently reading about. As you can see by the earnings and free cash flow yields, most of these are too expensive for my liking, but they are the kinds of businesses that have a higher than average probability of providing their owners with compounding intrinsic value over time, and thus might be good companies to read about.
So if you don’t have one, set up a process to generate ideas, and then spend time reading the 10-K’s, and over time, the knowledge compounds like interest, and as your database of ideas grows, so do your opportunities for potentially finding good values. Good luck!
Disclosure: I own shares in Weight Watchers and Strayer Education for myself and for clients. This is not a recommendation. Please conduct your own research.