This is an extract from the Tsunami Wave Strategy, you can download free here
How do we catch and surf those massive waves like Amazon, Google, Wal-Mart, Apple, early on? There is nothing else like them. What drives these massive waves over long periods of time, not only fundamentally, but externally?
Charlie Munger advised in a speech to focus on catching and riding a few massive waves over your investment career. But how can we, as individual investors, identify them early on?
There are specific external catalysts that help drive their share prices, in addition to the underlying business growth.
The most recommended catalyst is to follow the amount of Wall Street analyst coverage.
The story goes like this, Wall Street analysts will generally ignore small capitalization companies, until they became larger, and as more analysts cover a stock the more attention it gets with the general public too. And generally it is true, but it is too hard to measure with any sort of accuracy. It’s too inefficient to start searching and collecting the number of analyst recommendations, and just because one analyst covers the stock doesn’t imply all analysts will cover it, and finally most coverage is kept in house and not released to the public.
What causes a stock recommendation to increase dramatically and causes small cap analysts across the nation too say ‘I told you so!..?
We as humans have a tendency for overlooking the plain obvious in favor for the complex. When more complexity is added to a situation the harder it becomes to measure the results with accuracy.
And the catalyst you are about to learn about will produce an ‘everybody knows that’ response, because it is simple, but it is easily measurable, making it highly effective and efficient.
It is the type of catalyst that occurs right in front of your eyes on a regular occurrence. Every year new companies enter the S&P Small Cap 600 Index and every year new companies enter the S&P Mid Cap 400 Index and every year new companies enter the S&P 500 Index.
And once every few years, some young analyst says ‘I told you so!’ to their boss, in response to a small cap company becoming large enough to entering the S&P Mid Cap 400 Index.
This is Amazon’s rise through the ranks. The red line is the S&P 600 Small Cap Index, the yellow is the S&P 400 Mid-Size Index and the green is the S&P 500 Index.
What happens when a new company enters one the S&P indexes?
As mentioned earlier, analyst coverage from brokerage firms will mostly focus only on the Mid to Large Cap companies, and with a company entering either the Mid Cap or 500 Index it acts as a signal that this company is worth covering. It will also signal to large hedge funds who has position size mandates.
You will notice also that the company starts getting unusual non-financial press interest and maybe you hear about the company from a neighbor, who has never expressed interest about stocks before.
The S&P Index catalyst occurs in stages.
All the S&P 500 companies went through these stages, they first enter the S&P Small Cap 600 index, and as they continue to grow they then enter the S&P Mid Cap 400 Index, and finally if they continue to grow they will enter the elite S&P 500 index.
Keep in mind that it would be impossible for a company to go through these stages without sound fundamental growth, such as growth in sales revenue, growth in operating cash flows and growth in equity, but for this articles purpose we are only looking at the external factors that reflect the sound foundation growth.
You can download FREE the Tsunami Wave Strategy here to learn the valuation techniques and also the specific founder characteristics to look for in a founder.
Yours In Investing
Adam C. Parris