Stocks that make progress
What is it that makes you want to buy a stock? What is it that makes you want to hold that stock? Does a nice 2, 3, or even 4% dividend get your attention? Or does a momentum boost, such as a positive increase in comps or same store sales, get you on the momentum bandwagon? Does it involve growth in earnings, dividends, or book equity?
Perhaps it’s a volume trigger or a technical breakout. Maybe it’s an upgrade from your favorite research organization or analyst (Dear God, I hope not). Does an attractive industry lure you in, regardless of the details of the specific stock (I remember a Motley Fool post titled “Any Gold Stock Will Do.”)?
Maybe something like high operating performance, such as ROA, ROE, or profit margins is your ticket to buy. Maybe you’re looking for that “cigar butt” or asset play, where you find a company trading near its working capital. Or maybe it’s the potential for future growth – a company with a market cap of $2B now, but with the potential to reach $20B in the next decade, is sure to the next 10-bagger, right?
Buffett and Munger have always claimed that they look at 4 criteria for owning a stock: “We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.” Berkshire has also grown a liking for companies with high returns on equity, and managers of their insurance investments (including Buffett) are willing to “pay up” slightly for companies with such returns.
So what do I look for when buying a stock? Well, it’s varied quite a bit over the years.
When I first got started, roughly 7 years ago investing, I really, really didn’t know what I was doing. I simply looked for stocks with high dividends, whose stock prices were trading well off the 52 week highs. If I remember correctly, my first purchase was GE in 2007, on a day it took a ~5% tumble. I employed this “method” of stock picking a lot longer than I wish to recollect.
I also got crazed in buying companies that were trading at dirt-cheap multiples, regardless of the business. I chased a lot of Chinese [fraudulent] small-cap companies down that rabbit hole. Ugh.
I started looking at companies from an enterprise perspective, selecting only companies trading with large net cash or net investment balances. (The markets are surely valuing their “operating assets” incorrectly, right?) This led to purchases like JOSB, MLR, SUP, and GLW. Well, it turns out that these aren’t the highest-performing companies from an operational perspective.
Quick note about enterprise investing, and the subsequent EV/XX multiples that go along with it: You’re not an enterprise investor. You’re a common stock investor. Invest accordingly.
And my most recent [realized] mistake with investing was reading that damn William O’Neil book a couple of years ago.
Buy more after a breakout, he said.
It would lead to great returns…he said.
Now I’m sitting on JMBA at an average buy-in price of $15/share and SODA with an average buy-in price of $55/share. I’m not proud.
I used to buy and sell stocks over periods of days and weeks, rather than months or years. Trading fees ate into my accounts like termites into a 2x4.
I’ve learned a lot. It’s been frustrating. It’s been educational.
So what do I look for now? What makes me want to buy?
Well, I have taken a few pages out of Buffett’s manual. I like to attempt to stay in my circle of competence, and I like companies that have high returns on equity (and returns on assets, even more so). And to take a page out of Munger’s book, I like cannibals - companies that do a really good job of reducing outstanding shares. I’m certainly not opposed to dividends, though I think too many investors favor dividends over buybacks. (If I hear that BP, Chevron, or Conoco’s dividend is bigger than Exxon’s one more time, I might throw my laptop out of the window.) I also still have a bit of that enterprise bug in me – I’d much rather invest in a company with little-to-no debt, than a company burdened with as much debt as market equity.
But ultimately, I want to see that a company is making progress - value-increasing progress that’s impactful and consistent. Are increases in earnings good progress? Sure, as long as the increases in earnings are proportionate to (or exceed) increases in invested capital. Are increases in book equity progress? Sure, as long as the company can maintain a stable ROE. Are increases in dividends progress? Yes, as long as the payout ratio as a % of cash flows remains stable and low. Are annual cash outlays issued toward buybacks good progress? Only if the outstanding share count is actually being reduced (not simply negating stock-based compensation).
Regardless of the itch that drives you to invest in a stock, becoming good at picking winners is something that takes practice, patience, dedication, and lots of stubbornness. Anyone that tells you they started investing last year, and they doubled their money in 6 months is either lucky or lying. It’s something that you’re gonna have to work at. I’ve been at it 7 years now, and I still have a long ways to go. But the ride has been fun and the future rewards will [hopefully] be satisfying.