Now that I have found some Potential Stocks to look at, how do I ‘process’ them through my Analysis System? (wow, that sounds really structured and impressive - it ain’t really….)
The first step is a very fast ‘Triage’ process. This probably just takes me a very small amount of time, and to some extent is a 3 minute Quick Judgement - although it does run the risk of ruling something good out - but I think I have had enough experience now to be aware of this possibility. Although of course, Cognitive Bias can creep in at this stage and mislead me - as it can at any time.
I have my Fone by me at all times and I have the ADVFN App on it. So, whenever I stumble over a new Stock, I am able to quickly Search for it on the App and look quickly at things like Market Cap, the Chart and whether or not it pays a divvy etc. If the Fone is not handy, then I will grab one of my Tablets and use that.
The other Key Tool I use is a good old fashioned notebook……..made out of Paper and Cardboard, believe it or not !! This year it is Black and purchased from my local Tesco round the corner for about a quid - expensive Trading Systems? My arse………
Last year the Book was Blue. I like variety.
During Triage, I look at the following factors very fast, sometimes with the use of ShareScope on my Laptop for Earnings Forecasts and Debt etc., but I tend to only turn my Laptop on in the Evenings so I sometimes have to make my initial judgements on limited information - but at this Stage it is not a great issue. If I am getting the idea from Investors Chronicle, there is usually enough information on the Page to run some basic checks. Many of these are the kind of things covered under the ‘WheelieBin‘ bullet points on that webpage (or perhaps, rather, the opposite !!):
- What Sector is it in? If Biotech, Small Pharma or Mining, it is pretty much discarded straightaway. If it is small Tech in a ‘hot’ Sector, then it might get chucked out fast - I tend to avoid ‘Story Stocks‘ that have got all the Bulletin Boards excited - recipe for losing money. Anything China or Malaysia or Old Soviet Stuff, is ruled straight out. I am increasingly wary about AIM stocks - they have to be real businesses to get me interested.
- I tend to rule out small Market Capitalisations - I want a minimum of £20m and preferably more like £40m or so. There is nothing wrong with Microcaps per se, but they are more prone to Operational Trading Problems and they lack potential share buyers as the vast majority of Fund Managers are not allowed to invest in them. So they can languish forever even if they are a Great Company at a cheap price. The movements in their Share Prices are hugely dependent upon the action of Retail Investors / Traders who can be very fickle and illogical at times - making the Stocks Volatile and unpredictable. If a Microcap has Trading problems, it’s Stock can get butchered - this is a Big Risk of these kind of Stocks. I tend to only get involved if I am close to the Company and therefore have an ‘edge’ - this rarely is the case.
- Is it a Sector that I am interested in? Would it possibly be a big Dividend Payer for my Income Portfolio? Is it in a Sector where I already have plenty of exposure? Would it perhaps be better than a Stock I already hold in a particular Sector - WheelieSwitch? Does it play into a particular ‘Big Picture’ theme that I want to play? For example, Agriculture seems a good bet with the World’s population growing fast - Stocks in this area may be very attractive.
- Is it something that is likely to do well on a Long Term basis? Can it keep growing for many years or does it have a Technology that is easily overtaken and unsustainable? For example, can Seeing Machines SEE manage to commercialise its ‘Tiredness Signalling’ devices for Machinery Operators before the World goes Robotic in a big way?
- Does the Company have an ‘Economic Moat’? Is what it does unique? Does it have Pricing Power? Does it have technology or processes etc. that are protected by Patents and / or Regulation? Is it serving a Niche Market in which it has a huge lead?
- Does the Company have a good record of achievement or has it had huge problems in the past? For example, Breedon Aggregates BREE is a Hot Stock at the moment getting tipped everywhere. However, this was the former Ennstone ENN - it went Bust - not for me, thank you very much. Things could well be better now, but why take the risk? There are millions of other great Stocks out there. Investors must avoid ‘Moth to a Flame’ syndrome, where we get attracted to Dangerous Junk just because it is jumping up and down and waving at us from the latest Tipsheets, Emails, Mags, Bulletin Boards, etc. Another Stock in a similar mould is Drax (DRX) - this one went Bust years ago and got resurrected as pretty much the same thing but with a daft ‘Environmental’ idea to ship in wood from Scandinavia or somewhere and to chop it up and burn it - Biomass. Sounds nuts to me and only exists because of EU and Government Subsidies - once they wake up to the fact that this is in no way good for the Environment, the Subsidies could be removed. Remember what Buffett says “when a Good Management Team meets a Bad Business, it is usually the reputation of the latter that remains intact….”
- Is it a Recovery Situation? I love stocks that have got beaten up (and are therefore probably cheap and oversold) because things have gone wrong but once they have changed management and got a new Strategy (usually to chop stuff) then they can recover very well and big gains can be made. Aviva AV. is a superb recent example - they had tough times and got a new CEO in, who is brilliant (Mark Wilson) - it is pretty ‘simple’ for him to chop 47 Business Units down to maybe 30 and improve things relatively easily. Moss Bros MOSB is undergoing a similar Turnaround, where a huge Cash Pile gives it space to do fairly straightforward ‘Self Help Measures’ to turn things around.
- Is it a Cyclical Business that is very dependant on Economic growth? For instance, Marketing Businesses are highly Cyclical - you do not want to be buying these going into a Downturn - even if they appear cheap - Sales and Profits can just collapse overnight. Recruitment Companies are similarly bad news at the end of the Cycle. In a similar way, it is great to buy things like Tool and Machinery Hire businesses in the early phase of Recovery - these things can give you fast earnings growth and p/e multiple expansion - big wins in a couple of ways - Double Whammy. Buying Cyclicals is not an issue if you do it at the right time, but far too often people buy them late in the Cycle.
- Has recent Trading been strong? Are they ahead of expectations? Has there been a Profit Warning? I tend to dislike stuff that has Warned - if so, it will probably do another couple of Warnings. No thanks. I want to buy things in an ‘Upward Virtuous Circle‘, not in a ‘Downward Death Spiral.’ If things have Warned a few times however, I am starting to get more interested - particularly if the Chart is starting to break the Downtrend and may be moving more to Sideways moves and perhaps even the start of an Uptrend. Turfing out the old Management is the best signal that things are going to change.
- Is the Outlook good? In my quick Triage process, I might just go by the text in whatever I am reading that has flagged up the Potential Candidate - a thorough read of the recent Trading Updates will come later.
- Is the Stock a New IPO that other Investors might not have woken up to yet? New Floats often take a long time to get on people’s radars - especially if they are dull old stuff - but remember, boring wins every time.
- Could Stock be a great Range Trader? Is the Range clear and wide enough to make it worthwhile? Remember, these things work brilliantly if you use Leverage - small moves (10%) can give big profits when geared up.
- Could Stock be a bid target? Is it fair value so could attract a bid? Has it been the subject of Bid Speculation before or even a failed takeover bid that might come up again? Is the sector one that is consolidating? For instance, at the time of writing this Blog, General Insurance Companies are dropping like flies to predatory bids (I ain’t complaining as my BRIT was one of them !!).
- Debt - has it got Debt? How much? What is the ratio of Debt to Profit? (any more than 3 and it is usually discarded now). There are exceptions to this, but they are rare. Balance Sheet strength is hugely desirable in terms of avoiding Risk. My current approach is to almost totally avoid any debt. I find that Companies with Net Cash have so many more options - not only does it make them ‘safer’ but they have firepower to undertake Bolt-on Acquisitions and raise Dividends. It strikes me that a lot of ‘Cashed up’ Companies are actually very good Cash generators - this is obviously a great thing and can drive the Stock Price upwards.
- What is the p/e ratio like? If 20 or over or maybe high teens, it might be discarded now. If a fast growth stock, in tech or similar, I might accept a higher p/e if the Growth Story is good enough - but it has to be pretty special. Sometimes you have to ‘pay up’ for Quality - I intend to do a separate Blog on this in the hopefully not too distant future.
- What is the forward p/e based on? Do Analyst Consensus Forecasts look sensible? This latter check might be something I do more thoroughly in the ‘Analysis’ Process rather than during the Quick Triage.
- What is the PEG (Price Earnings divided by % Growth Rate)? I want this to be below 1.0 ideally.
- Does it pay a Dividend? If so, what is the Divvy Yield? Does it appear to be rising over time? What is the Forecast Divvy likely to be? If this is a potential Income Portfolio Stock, then I probably want a Dividend Yield around 4% to 5%. For normal Stocks, I want 2% to 4% if possible. It depends really.
- Are the Revenues, Profits, EPS, Divvy all growing over the years? This is a big thing for me - I want to see actual real progress in the prior Results. The Investors Chronicle ‘Company Results’ Section is brilliant for this as they put the previous 4 years in each of their little tables at the bottom of each write up of a Company.
- At this stage I don’t get too concerned about the Cashflow and suchlike - that is for the next stage of Analysis if the Stock gets that far in my Processes. I never get overly concerned by ‘Book Value’ unless it is a Property Company or Investment Trust or something. I find Book Value pretty useless at helping me make money - if you obsess about such measures, you just get sucked into some possible ‘Value Traps’ - ok, a low Book Value might be nice, but it is low down my list of important elements to a Great Investment. To me, the Business itself matters most - metrics etc. are secondary. I try to think like an ‘Owner’ not a Trader in a Stock. I want to ‘Own’ part of a Great Business.
- If it is a Property Company (REIT) or an Investment Trust maybe, what is the Discount or Premium to NAV? Often if it is a high Premium (more than 1 or 2%), I will discard it now. I tend to want a decent Discount - 10% or more gets me excited (don’t worry, I have a Cold Shower if needed). In practice, I don’t recall ever buying a Stock like this on a Premium to NAV.
- What is the chart doing? Is it going up? Does it have momentum? Often I will use the brilliant ADVFN App on my Fone at this point, to get Charts ranging from 1 month to 3 years very fast. Has it dropped away from previous Highs and is basing now and finding Support? Is it looking like ‘Breaking Out’ and likely to move up? Does it look Topped Out? Is it coming up against huge resistance, where it will most likely struggle?
- Is there anything significant from a Strategic viewpoint taking place in the Company that might drive Sales, Profits and the Share Price? For example, with XP Power (XPP) they were doing a Strategic Shift from being a Distributor of Electronic Components to being a Manufacturer; or with Devro (DVO) they are opening 2 new Sausage Collagen Skin factories. Is there a New Product maybe? What is likely to drive the Share Price up?
- Something I really like is when I read that a Company has decided to commit to future Performance Measures. For instance, KCOM said a few years back that they were committed to raising the Divvy by 10% a year - the Market generally loves this sort of guidance - as long as it is not daft of course. Other examples can be “we will double Revenue over the next 4 years” or similar. Of course, when they miss such Guidance it can be very painful !!
- Is the Stock one of these - “it’s ok, worth a further investigation” or is it a “wow, I really like the look of this, that looks very cheap for the growth”? or maybe “I have been on the lookout for a stock in that Sector, this could be the kiddie !!” Obviously, if something really excites me then I will ‘Fastrack’ the processes and get it into the Analysis Stage straightaway - but it is still vital to use Chart Timing tricks to try to get a good Entry Price.
In the unlikely event that a Stock gets through my Triage Process, it is then popped into my ‘Little Black Book.’ I tend to write a very short description of what is going on and the Valuation aspects (p/e, divvy, PEG) as I see them and any Debt concerns. If I really, really, really, like the Stock, then I sort of put loads of Pen Scribbled asterisks around it or maybe draw a box around the entry. As a result, my Book is now full of great ideas that have been through the Triage. When I have some cash and feel a need to buy a Stock, I have a look through here first to see if anything leaps out for proper deep Analysis.
Obviously some Stocks don’t quite meet all the Criteria but still have a lot of appeal - in this case I will bend the rules a bit as I have still not made a decision to buy. Passing the Triage Process merely means that they earn the right to be popped into Wheelie’s Little Black Book - no more than that. Some honour hey?
Sometimes a new stock that I find will be able to ‘jump the queue’ and I ‘fast track’ it because it looks so good and it fits a particular need I have in my Portfolio. For example, I did not buy it, but XL Media (XLM) was exactly this kind of stock a few weeks back. It was (and still is) clearly very undervalued and a Screaming Buy - I did not buy as I am trying to be disciplined and reduce my Number of Holdings. However, once I had realised the Value on offer, I was shouting about it to everyone.
Quite often I decide on a particular niche that I want to play - for instance, I don’t really have much, if anything, in IT Security - this is not good as it is obviously a great place to be. If I am in this mood, then I will be on the lookout for a Stock or two in order to fill the gaping hole in my Portfolio. By the way, Accumuli (ACM) might be worth considering in this space.
In a similar way, I have two big Holes in my Income Portfolio that arise because I want to hold 12 Stocks (for adequate Diversification) and only have 11 and also because BRIT has received a Takeover Bid and I sold out of it this morning. So I have a need to fill these two ‘Slots’ and I am on the lookout - however, with my concerns over the General Election uncertainty, I will not be rushing to buy anything.
It is fair to say that this is a pretty meaty list and perhaps unrealistic (and a downright lie !!) to say that I do all of these checks prior to popping them in the Book. However, these kind of thought processes can happen pretty fast once you are used to working in this way and Experience helps enormously. In practice, I often find myself staring into space with a cup of PG’s Finest (ok, Asda Value), thinking about Moats, Competitors, Opportunities, Trends, etc. Obviously, when you are first starting out it is hard to have such Experience - but don’t worry, it comes with Experience !!
I will soon add a Section for ‘Wheelie’s Little Black Book’ onto the WheelieBin, WheelieWatchlist etc. webpage on WD2 www.wheeliedealer2.weebly.com The intention is to keep this updated and effectively enable Readers to see the Stocks that I have popped into the Book as possible Investments but which require Final Detailed Checks and lots of brain power.
Gotta dash, future gazing to do……WheelieD