By Alex of The Snowball Effect
Last week we went deep down to try and find out who we fundamentally are as investors (follow this link for the full post: Step #1: Find out who you are as an investor – IDS series). This is the first step and it is of utmost importance for any serious investor who wishes to successfully invest for the long run, whatever you wish to invest in. Never forget who you are as an investor. Now that this is done, we can focus on something much more concrete: sourcing investment ideas. We are not reinventing the wheel here, but for many inexperience investors, it can be challenging to get started and they might get stuck at this initial step of the process. For more experienced investors, this process can always be improved upon.
In the next few paragraphs, I’ll be exploring in detail the many ways I use to source ideas. But again, keep in mind that these different ways of sourcing investment ideas are tailored around my personal way of investing (and might not apply to you). However, it will hopefully give you a bit of inspiration and some ideas of where to look for for potential investment targets. The following list isn’t comprehensive and as it is the case for Investment Decision Systems (IDS) as a whole, these sources of ideas evolve over time. I divided the specific sources into more general categories, which will almost certainly include ways of finding targets whoever you are as an investor. Let’s get started!
1- Quantitative stock screens
Quantitative stock screens are a very common way of finding investment ideas. However, it’s worth spending some time discussing this way of sourcing ideas as it can be easy to apply incorrectly and miss out on potentially good investment targets.
Rule #1 when using stock screens: keep it simple. Stock screeners, even the best ones, can often make mistake in the way they process the financial information they gather and so, the more complex are your screens, the more chances you have that the screener used erroneous data somewhere, which will lead you to misleading outputs (garbage in, garbage out) and you’ll lose time looking at targets which are not worth it. This is also the reason why I don’t favour using screens for complex qualitative factors as qualitative information is even more complicated to process. So, unless you are a great programmer who has a lot of time to spend on developing very complex and accurate screens, just stick to the basics and use simple screening factors.
Don’t try to develop the best stock screen ever – it doesn’t exist. Otherwise, we would all be using the same screen and investing would be a piece of cake. Screens exist to generate ideas, not to give you answers. In my next post, next week, we will look at selecting primary fundamental factors to narrow down our list of potential investment targets. You’ll be able to use some of these primary fundamental factors to build better stock screens. Even though I’ve tried to order the IDS into ordered steps, it’s important to keep in mind that all steps are interconnected and can’t be considered independently. As one screen won’t be able to make it all, I suggest to use multiple screens (over time) with a combination of different factors and ranges, which will usually apply to financial performance and strength metrics and valuation data.
That being said, which stock screener should you use? Again, it depends. First, it depends what you have access to. I am lucky to have access to Capital IQ, which is a tool for finance professionals, but for which you need to pay a hefty subscription fee. So, to be honest, I have not had the need to use other platforms. But, I’ve come across other (mostly free) screeners which you can consider using. Here are a few:
– Simple and international: Google Finance Stock Screener
– Also simple and international: Financial Times Stock Screener
– Good but US only: Zacks
– Good and somewhat international: Uncle Stock Screener
– Interesting pre-set screens: Old School Value Screener
If none of these suits your needs, do a simple Google search and you’ll be able to find several others which you might like.
2- 52-week lows list
Considering my approach to investment, I do like to keep track of 52-week lows lists. This can be considered as a derivative of quantitative stock screens, but it’s worth reviewing as a factor by itself. 52-week lows lists have been around for decades and can easily be found in newspapers (online/offline), using screeners, etc. The appropriate way to review 52-week lows lists is to note which companies are NEW on the list. The reason behind this emphasis is that some firms can stay on that list for quite some time and might end up being value traps. So in order to save time, keep track of the list and focus on new additions.
Alright so this one is an obvious one. You simply need to be consistent and make it a habit of reading the news to see what comes up. It’s important as reading the news will provide you with very different targets compared to ideas generated from your stock screens. I use the news in two main ways. First, reading the news can allow you to uncover great companies, which you can keep track of. It’s also a good way to learn about different industries and keep up to date with what’s going on within these industries. Second, reading the news will allow you to find companies with valuations affected by different types of events. For example, spin-offs, M&As, geopolitical events, etc. I also like to look for events hurting a company’s valuation, but leaving its operations, financials and prospects intact.
A few basic sources which I enjoy reading:
– Google Newsalert: This one is a useful tool which allows you to set up news filters and which sends you all the related news daily (weekly, etc.) directly to your mailbox, whatever the source is.
Depending on what is your focus at a specific point in time, you might want to consider reading some industry specific publications (such as industry magazines, etc.) or more local news.
4- Blogs and other similar websites
As opposed to mainstream news publications, blogs are a good way to find less covered ideas and get a more personal and independent point of view from the author. Even top portfolio managers consult blogs (and similar websites) once in a while to generate ideas. Below are a few websites I like to consult.
5- Industry focus
Sometimes, it can be worth focusing some time on evaluating a particular industry and its players. At any point in time, there are some industries which seem to be abandoned by the investment community, which can lead to very depressed valuations and maybe offer interesting investment opportunities. This is especially true with cyclical industries. However, you want to be careful and avoid sunset industries which will never make a comeback. As always, it requires some thinking, but it’s one of the ways to uncover interesting targets. In addition, personally I stick to what I know and like to invest in. It’s the typical “circle of competence” theory (by Warren Buffett). If you can’t understand an industry and where it’s heading, even if it seems cheap, just forget it. There are plenty of other options.
There you have it! That should be enough to keep you busy for a while. But that’s certainly not the end of it. One extremely important last step in terms of sourcing investment ideas is to keep a log of the ideas you find. There is no way you can remember everything you come across on a daily basis and if you are like me, if you don’t use your idea within a short period of time, you’ll probably forget about it quite quickly. However, if you’ve spent time and energy identifying potential investment ideas, even though they might not be actionable ideas as of day 1, they might become very good opportunities in the future and if that’s the case you want to keep track of these ideas and make sure you’re ready to act when appropriate. Keeping a log of your ideas will also remind you that you need to keep learning more about a certain company or industry. If not, you’ll be starting from zero again and again and your progress will be very slow. Up to now, I’ve been using Google Portfolio to keep track of my ideas but now that Google is planning to kill Google Portfolio in mid-November, I still need to find an alternative. I am thinking of trying the equivalent offered by Yahoo Finance or simply create an Excel spreadsheet. You can use anything, the important is to do it!
Featured image: Your next idea… a needle in a haystack?
Next post, next week!
Keep growing your snowball!