Stock Selection

Stock Selection

I gravitate to the Mid and Small cap sector as I find it a more inefficient area of the market where you’re more liable to come across stocks that trade at a discount to their intrinsic value. I also prefer companies that are growing revenues, cash flows and earnings. Make sure the company has a reasonable amount of debt.  I like to see the people who run the company (CEO, CFO, Directors) own a good portion of their own stock, if the CEO is also the founder of the company, even better. In Canada where I invest, small to mid cap company size would be anywhere from 100 million to 2 or 3 billion dollar market cap. In the states these numbers would be larger as it is a much bigger market.

I have some scans setup in my TD Waterhouse account where I sometimes find some interesting ideas but most of the time I steal my ideas from the professionals. I listen to Market Call on BNN (Canada’s version of CNBC) which is a phone in show featuring fund managers in Canada. Some of them are quite good while others are not so hot. Since I have a preference for the Mid and Small Cap sector I have found the following guests very good at providing me with information and stock ideas.

Stephen Takacsy
Michael Smedley
Jason Donville
Peter Hodson
Jerome Hass
Peter Imhof

Andy Nasr is good if you like dividend paying stocks while Norman Levine does a good job in the larger cap area. And John Zechner is an old hand who is worth listening too as well. And they are going to be wrong sometimes. Don't get hung up on that. Even the best stock pickers can be wrong 33 percent of the time. This isn't a game for perfectionists. And by the way this isn't meant to be the last word on who to listen to on Market Call. Everybody has different tastes and preferences. Listen to the show for awhile and decide for yourself who you would prefer to listen to.

A lot of people get hung up on the top picks of these analysts but I think it’s more important to focus on some enlightening piece of information or thought process about a particular stock they discuss on the show. Their top picks can be random as they are all on the show several times a year. Focus on all their buy recommendations and especially on why they like them.

I also borrow ideas from fund managers who report their holdings on www.sedar.com.

One thing to keep in mind, don’t just steal ideas from anybody. You want to focus on mutual fund managers that have less than 300 million dollars of assets under management. It’s important to stay small if you want to outperform the market in the mutual fund world. You also want to follow someone who runs a concentrated portfolio and who has a low portfolio turnover in his fund. Be sure to read about the mandate of the fund so you will be familiar with the investing philosophy of the fund manager. Take time to read about what the fund manager has to say about his holdings as sometimes you can stumble on some interesting piece of hidden information.The downside of doing all this is when a stock you own plunges in price. Because you took the idea from somebody else you may not have the courage of your convictions to hold your position. Therefore it would be a good idea to learn something about the stocks your holding to learn further insight. Knowledge is power. I may even do this myself.

Apart from this, one thing I have learned from hard experience is to buy cheap. That often means buying something that sold off, because they missed their quarterly numbers. If their return on invested capital (ROIC) has been good over the years it can indicate a good quality company that has gone on sale.

The market is filled with people who grew up in the eighties on the instant gratification of video games. They have no patience. If you can extend your time frames and holding periods to three years or more you can often take advantage of this market inefficiency.

A great site to visit for analyzing companies is this one from Morningstar...

http://quote.morningstar.ca/quicktakes/Stock/s_ca.aspx?t=TIH&culture=en-CA&region=CAN 

You can get most of your research done there. You can also input a companies metrics into a spreadsheet and track them yourself. I've done this and use TD Waterhouse to get the inputs I need from the financial statements they provide on their website.

Remember this is how I do it, in time everybody develops their own style and approach, once your information base expands to a certain point you may want to start using your intuitive side more (right side of your brain) as it can work in lockstep with what you already have learned about the markets so far.

One more thing don’t get hung up on the precision of the numbers, they are only there to put you in the ballpark. Remember they are based on a lot estimates and assumptions on the Income Statement and the Balance Sheet.  The numbers should be your servant not your master. Following the trend in metrics like operating income, operating margin, operating cash flow, book value per share and return on invested capital can tell you a lot about the growth prospects of a company.

And I know it’s a lot to ask but don’t be afraid to go to Sedar and look up an annual report of a company your interested in even if it is to only read management’s discussion about their companies business prospects. Hey, maybe I should do that too.

If you would like to learn how to read financial statements a good introductory book would be

Warren Buffett and the Interpretation of Financial Statements by Mary Buffett

My personal favorite in this area is

The Guide to Understanding Financial statements by S.B. Costales and Geza Szurovy

After that you might also want to try

The Five Rules for Successful Stock Investing by Pat Dorsey

Take your time and enjoy the journey. Learning how to invest in the Stock Market should be an empowering experience.