The Ten Doubles Challenge
Last year I gave myself a pretty lofty challenge: turn a paltry $1,000 investment into $1 million. Sounds ridiculous, I know, but hear me out. That initial $1,000, if doubled ten times, can turn into $1m. Do the math yourself. It works.
With my first successful investment in the bag (more on that later), I'm ready to share this with the Fool community. Maybe you'll want to challenge yourself! I'd love for you to do just that, which is another reason for starting this challenge with just $1,000. Everyone reading this blog can start with that amount if they have the patience to see it through to the end.
Each time an investment plays out, the entire amount is rolled over into the next investment. That's a requirement, or else it doesn't work. This isn't a big deal while the dollar amounts are small. This rule is here to force a specific risk-averse investing disciple that I'll discuss below.
It's ok to sit on cash while researching the next idea. Patience and thorough due diligence is encouraged.
No "adding money" to the project. I start with $1,000 and accumulate gains. If one idea doesn't pan out and there's a 20% loss, well that's how it goes. That deficit will need to be made up through subsequent investment. Though this rule certainly doesn't prevent investing other money into the great idea I've researched. If my "challenge money" is enough to buy 100 shares, I can choose to buy another 500 shares in my account if I wish for example. However, those gains and lossses will not count towards the challenge objective.
That's it! Pretty simple right?
This is not some 3am "get rich quick" infomercial promising riches. This can, and should, take a long time from start to finish. Most successful value investments will take 12 to 24 months to play out. That's if everything goes well. If I get stuck in a value trap or a good idea sours, it will take longer. Multiplying that time by the ten doubles needed to turn $1k into $1m and you can see that this will take some time. Good investing requires time and discipline so don't be scared off that this challenge could last 10 to 20 years.
Investment Approach & Philosophy
The most important thing with this challenge is to avoid taking losses. Especially big losses. A losing investment is like repeating a grade. No one wants to do that. If I work hard and get my first five doubles right, bringing me up to the $32k level I don't want to get cut in half and go back to $16k. Not only do I have to find another good idea, which is hard, even worse is the lost time to compound the money.
The need to avoid losses at all costs frames the types of investments that will be made. I need to focus on risk first and situations that have little downside. These are going to be deep value investments where I have a real margin of safety in stocks trading at a discount to tangible book value. I'm looking for cheap stocks where I know why the stock is cheap and what the catalyst is for full value to be recognized in a timely manner.
I view this as a balance sheet, and not a cash flow, approach to investing. Every single line item on the balance sheet must be fully understood, and adjusted if necessary. If the situation is too complicated, I move on. I am interested only in companies that are cheap today. I am not interested in companies that are cheap only if projections about future growth come to pass.
More importantly are situations that will be avoided. No growth stocks at lofty multiples. No options trades where time can run out and you never want to expose your entire bankroll into a potential 100% loss situation anyways. No highly speculative situations like some of the biotech companies I like. I may do all those things in my overall portfolio where I can manage risk through position sizing, but they don't fit into this challenge because the entire amount is always at risk and losses have to be avoided.
Notice that the title is "The Ten Doubles Challenge" and not "The Ten Trades Challenge". There's an important distinction. It's an admission from the outset that not all investments will work. Inevitably there will be some investments that don't work and hopefully the losses are limited to small amounts like 5%. Other times there will be investments that are only small gainers that don't move the needle much. It takes ten doubles to turn $1k into $1m, but it may take 15 trades.
Value investors are notorious for stealing each others ideas. For good reason: truly great ideas are hard to come by. So if you see solid work and a compelling thesis from a source you've come to respect, it often pays off to research it yourself to see if you agree with the conclusion. Never buy blind though, always do your own homework.
Credit where credit is due though and my first idea I came across on one of my favorite blogs here: http://valueinvestingworld.blogspot.com/2009/05/clear-choice.html
Clear Choice was a tiny health insurer, which is an industry I do know a bit about with my history recommending biotech, med device, and insurance companies. After reading the 10-K, particularly the footnotes, I agreed with the original author's thesis that the stock was cheap and supported by real assets and a history of profitable operations. This was a company trading at 0.4x tangible book with its assets being an investment portfolio and a corporate HQ. I was pretty excited about that.
This first trade was wildly successful. Since the challenge dictates starting with $1,000 I bought 100 shares at $9.85 on 8/20/2009 which after commission worked out to $995 invested.
I'll spare the details but the company was recently acquired for $26 cash per share. I had $2,600 deposted in my account on 5/25/2010.There was a $20 fee against that by my brokerage though so that leaves $2,580.
Not bad! Now only if they all work out that well and that fast!
Per the challenge rules I have to roll that entire $2,580 into the next investment. Not a big amount of money by any stretch, but that's ok. It's the journey and the process that's important right now and the money will come. No matter how big or small your portfolio fellow Fool, I want you to feel like you too can do this.
I have two strong candidates that I am researching. One is a company trading slightly above cash with generally cash flow positive operations. The other is a company trading at a steep discount to tangible book that is also profitable. Tough problem to have right?
My personal rule is not to write about companies with a market cap under $100 million. We have a lot of readers at the Fool and I don't want to be seen as trying to influence the stock prices of small companies. This is why I didn't write about this challenge or Clear Choice with its $20m market cap until after the investment came to a conclusion.
The two companies I'm looking at are right near that $100m level. I haven't decided yet if I'll post my thesis to this blog when the trade is made. I may again wait until the thesis plays out. We'll see. We also have trading compliance rules limiting when we can buy stocks we write about, so it's a lot easier just to not write about a company if I want to invest in it. In either case at some future point I'll give the key points as to why I went with the company I did at some point in case anyone finds that educational. We are here to teach people after all.
For this style of investing I'll give you three books to read. All are excelent:
You Can be a Stock Market Genius - Joel Greenblatt
Margin of Safety - Seth Klarman
Security Analysis 6th Edition - Graham & Dodd. The section introductions by contemporary investing masters are excellent.
If you want to challenge yourself...
You can't just buy any company and hope for the best. You need to be able to do real research and uncover true values. The good news is that you too can do this. Read those three books and you'll be well on your way. If you're not strong at financial statement analysis get some basic knowledge there too.
Get comfortable reading footnotes in the 10-K. That's the most important part of the filing. You'll want to focus particularly on the sections going into detail on the line items in the balance sheet. Stick with companies you understand. If it's too complicated, that's ok. Just set it aside and move to the next idea. We all have to know our limits. Over time your limits will expand.