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Snappy Decisions – The Art Of Finding, Analyzing And Researching Stocks Faster And Better

Snap. Make fast, decisive and good decisions when picking and analyzing stocks. Snap decisions. Isn’t that what we all want? But how? Ian Cassel’s article on indecision really got me thinking about the role of decision making. I’ve also been coming across more articles and books on decision making and lo and behold, I see a copy of Blink: The Power of Thinking without Thinking on my shelf. My wife is a Malcolm Gladwell fan and loves to buy books, instead of reading them… Anyways. If I call it gut reaction, you know what I’m talking about. It’s similar but not exact. By calling it a gut reaction, it hides the fact that it’s an area that can be improved. You could call it an instinct or intuition, and you’re either born with it or not, but even instincts are learned and developed. But gut reactions are really subconscious signals from the amount of data that you’ve accumulated throughout your life that comes out in different forms. You’ll see how this all fits in because I’m going to show you specific examples that will help you with your decision making. I’m sure you’ve experienced things where: You get an uncomfortable feeling just when you’re about to sign a big deal Your hands get sweaty during a conversation When you see a no-brainer deal, it’s like a light bulb literally lights up Or maybe your gut really does have a reaction Are these natural tendencies? Yes, but it’s also a result of having picked up signals and clues that you haven’t realized. I’m going to use the term “snap decision” because it’s the term used in Blink, and I prefer it much more. The Power of Snap Decisions and Processing There are some things that we just cannot verbalize or explain. Here’s an example. Think of a person you love and try to verbalize what that person looks like. It’s impossible. I would never be able to figure out who you are talking about. “Shoulder length hair, small roundish nose, big round eyes, egg shape face.” That’s my wife. You’ll never find her in a crowd with that description, but in my mind, I have the power to easily create an image of her and pick out a scarf that will suit her, or imagine the expression on her face when she gets her favorite cup of coffee. Being a value investor and too much of a fundamentalist, it’s too easy for me to ignore this part of how I think and process information. There are too many times where I find myself forcing an explanation that really can’t be explained. Or not selling a position when my gut is giving me signals, but because I’m unable to verbalize or explain it logically, I ignore it – and lose money. Checklists Are NOT Fool Proof To avoid mistakes and bad decisions, you’d think that checklists are the answer. But it’s not. I sound like a hypocrite because I’ve written a lot about checklists already. These four are the ones that get read the most on Old School Value: 15-point Phil Fisher checklist analysis My investment scorecard Package of checklists to download My old flowchart checklist viewed over 27k times I strongly advocate using checklists, just not 100-page versions or ones that require you to write an essay. If a checklist takes you a whole day or more, you’re drowning yourself with information or you’re looking at the wrong things. A checklist will not make you a better decision maker. A checklist is there to prevent you from blowing yourself up. Blink starts with a simple story of a museum who bought an ancient statue after months of due diligence. They brought in geological experts to verify that the marble the statue was made from came from the correct time period. Other scientists ran all sorts of tests to verify that it was in fact an original. They did some crazy in-depth due diligence. The museum finalized the deal, and it was a proud moment. Until one day, an expert in statues and art comes to check out what the news was all about. In one glance, he was taken aback. He didn’t know what it was, but he felt it looked too “fresh” for something that is supposed to be centuries old. He couldn’t put his finger on it. Then, another expert comes by, and for some reason, she feels “disgusted” and starts to analyze the fingertips of the statue. Long story short, the statue was a fake. Now, the question posed in the book is, how were these outside experts able to understand that the statue was a fake the minute they saw it? Why and how did the scientists and the museum curator miss the signs, that now look so obvious in hindsight? This brings it back to why I don’t like looooong checklists. Checklists are good to narrow down a basket of stocks or to use as a last line of defense. It’s not a good idea to base your entire thesis on a checklist as it could easily box you in. Focus on the Important Facts. Everything Else is Noise The people that realized the statue was fake didn’t have a 50-page lab test report to base their decision off. They recognized just one important area (“fresh” and the finger nails) to tell them everything they needed to know about the status of the statue. Instead of being knee deep in documents approving the test results, these people were able to come to a fast and decisive snap decision. The problem nowadays is that we are literally flooded with information, and we think that more information and quick information is good. No. Focusing on the right information is all that’s needed. When Bill Ackman hosts a four-hour call defending his position in Valeant Pharmaceuticals (NYSE: VRX ), which can be summarized in five points – there’s an issue. He’s drowning himself in data and doing what all those scientists did with the statue. The more information you have must mean you know more. Right? Well, the short seller Andrew Left is the perfect example of simply looking at the important facts (the fingernails) to smell something foul with Valeant. Click to enlarge The market is the verdict so far with Valeant down 67% YTD and -83% in one year. Knowing what to ignore is just as important. Focusing on the Important Things with Apple My decision to continue holding Apple (NASDAQ: AAPL ) is still strong, and my thesis and reasoning is simple. With Apple, I don’t bother with trying to keep up with the trend of tech and what it is doing with motion detection for TVs, cars, or the next-generation iPhone. I don’t care how many pixels the camera has or what size screen it will be. What I see is a strong brand with a rabid fan base begging the company to take their cash anytime something new comes out. The company milks profits, and its free cash flow generation and balance sheet are out of this world. The valuation is simple, and my advantage is time. There are literally hundreds of things I ignore, but these simple facts are my fingernails. If these things change, then the whole story changes, and it’s time to sell. Until then, Apple is a position that I didn’t need to think much about. Once it hit a nice entry price, I was all in. On the flip side, haven’t you missed out on some no-brainers because you were really slow to make a decision despite the fact that you may already know the sector well and have prior experience with the company? How to Improve Your Snap Decisions The first requirement is that you have to know what you don’t like in a company. It makes the process so much easier. Everyone is different in what they like and don’t like, but you have to know your own list. I have a short list based on past money-losing mistakes that irks me. Excessively paid management – the IRS defines the term broadly as “suitable” salary, but is a $65m salary really comparable to the position or suitable? C’mon. Self serving management – it’s all about it. Talks without walking the walk – promises don’t translate to the financials. Significant related-party transactions – paying kids, cousins and grandma. Chinese companies – Sorry. Trust is hard to build back. Excessive short-term debt. Companies constantly raising money or diluting shares. Needlessly long financials and reports designed to confuse and hide info from investors. I also have a list of things that I always like. Frugal management. Management that understands that the business is bigger than it is. Simple accounting. Strong brands that have real value – Circuit City isn’t a brand. And examples of 10 of my favorite numbers I look at that provide an insane amount of insight into the business performance. Throughout my investment journey, I’ve been subconsciously checking off things on these lists when identifying and finalizing my decisions. When I focus on the areas that are important for me to be comfortable, it makes the hard work in making an investment – enjoyable. When I get away from this, it is a mental struggle, and I get frustrated and irritated because I’m all over the place and it feels like I’m going nowhere. Instead of trying to know everything about a company or management from A to Z, my decisions are more accurate when I focus on the points above. Create Your Decision-Making Base Just like a cake where you have a base and then you build on top of it and decorate it, I’ve rebuilt my base to focus around Quality, Value and Growth. By creating the Action Score, Quality Score, Value Score and Growth Score , I’ve streamlined my fundamental analysis process even further, and it’s now become my four horsemen. I identify Quality with: CROIC FCF/Sales Piotroski Score Value is based on: Growth is scored with: TTM sales percentage change Five-year sales CAGR Gross profit to assets Action Score is the best of Quality, Value and Growth. So… What is your quality criteria? What is your value criteria? What is your growth criteria? Try to keep each to three to five criteria. No more. Force yourself to focus on what is really important to you and what has worked and helped you. Just because I’ve listed 10 of my favorite ratios, don’t try to use it all. Just because you read about a new valuation method, don’t treat it like a shiny new tool where you ignore everything else. Take a look at the table below. I got this from Adib Motiwala , a friend and value focused money manager. It was in one of his letters from a few years back and explains the 2,000+ words in this article. Analysis, Decision and Reasoning Table By creating a very simple table like this, it immediately increases your ability to recognize what you like and dislike. Update something like this once a quarter and you’ll be able to recognize the good from the bad. You don’t need a 200-slide presentation to make your case. It’s obvious. With a table like above, instead of analysis paralysis, you are presented with a list of highly actionable stocks. I shared a story about a new OSV member who took my list of the best Action Score stocks from early in the year when I gave it away for free. He noticed a company on the list that he had seen around town, understood it from his personal experience and invested in it. He was able to leverage his subconscious knowledge, and with the supporting focused fundamental evidence from the Action Score list, made a decisive bet that he is enjoying right now. Create an Industry Handbook and Use it Like a Map or Guide One project that I haven’t been able to finish is to create my own industry handbook. Investopedia has an industry analysis handbook which is a good start. You get an overview of the industry and what the important metrics are. What you’ll do is: List all the industries you are interested in. Fidelity has a good resource . For each industry, write down 3-5 of the key criteria and metrics that have to be analyzed. Use it to quickly check whether an investment qualifies to be looked at. If you’re looking at retail, then you want to see how same-store sales have been over the years whereas SSS is useless for an insurance company. You may dislike debt, but it’s needed in capex-heavy companies like utilities and oil drillers. So it’s important that you are using the correct ruler to measure with. The scientists who analyzed the statue were using the wrong ruler. Final Thoughts The goal isn’t to make fast decisions. The goal is to acknowledge that our decision making can clearly be improved systematically. Also that decisive actions can be taken with a limited amount of focused and relevant information. It’s not something you have to be born with. Sure, deliberate practice is required for this to become second nature. But remember that it’s just as easy to make slow and bad decisions with a ton of data. Ask Valeant and Ackman. To make good snap decisions, start thinking about using decision trees, decision tables, noise eliminating tools, industry analysis handbooks, and anything else that will feed you good and proper information and guide you to faster and accurate decisions. I have basic systems in place that tell me which valuation method I should use for which stock. I use my Stock Analyzer to quickly decide which stocks are worth investigating and then running several “what if” scenarios to test my assumptions and theories. I don’t read news, I don’t watch news, I don’t listen to news because it’s too hard for me to filter out the useful 10-20%. Once you start diving in, you’ll realize there is a lot of strategic thinking that goes on without you realizing, and these are just some of the ways to strengthen your decision muscle and apply it to your investing. Next book on my reading list? Thinking, Fast and Slow . Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Un-Expectedly High Expected Return Of Global Equities

It seems just about everyone I talk to these days is underwhelmed by the long-term expected return of the global stock market. I too am more worried than normal about owning equities. However, my defensiveness arises from their negative momentum, not their valuation, which I see as surprisingly attractive. The valuation picture is blurred by the dramatic divergence between US and non-US equities. For the past four and half years, the US equity market has outpaced non-US equities by more than 10% a year. After that relative outperformance, US equities do appear overvalued, but the attractive valuation of non-US markets more than compensates in a global portfolio. The table below shows the cyclically adjusted earnings yields (using the past 10 years of earnings) of each regional equity market. The Baseline regional weights I’m using fall in between the weights published by MSCI and those calculated by Bloomberg using their WCAP function. 1 Click to enlarge The earnings yield of the global equity market is 6.6%. To get to an estimate of the long-term expected real return, I assume that 60% of earnings can be paid out in dividends (besides sounding like a reasonable assumption, it also happens to be the average payout ratio from 1915 to 2015 in the US), which will grow at about 1.5% above inflation in the long term. Many observers prefer the even simpler estimate of just using the earnings yield itself, which is 6.6%, but I prefer basing the estimate on cash flow to investors, which is generally more conservative. This results in 5.5% for the long-term expected real return for global equities (6.6% * 0.6 + 1.5%). 2 So how attractive is a 5.5% expected return above inflation? Here are four perspectives to consider: US equities returned 5.4% after inflation in the 50 years from 1965 to 2015, which many people view as having been a good time to be an equity investor (although not nearly as good as the 8.2% from 1915 to 1965). The chart below shows that 5.5% is well above the average expected return of 4.5%. It is in the top decile of expected returns calculated this way since 1985, a period of time longer than the careers of 80% of the people currently employed in the finance industry. 3 By contrast, other assets, such as fixed income and real estate, are currently offering low expected real returns in the bottom decile of expected returns over the past 30 years. It is difficult to come up with a simple prospective measure of expected real returns for alternatives such as hedge funds, but they certainly have been struggling recently to generate the attractive returns they produced in the ’80s and ’90s. Caution: Equities can get a lot cheaper, quickly. Just a month ago, global equities were more than 10% lower than they are now, in case we need any reminder. While 5.5% appears attractive as a long-term expected real return, we need to keep in mind that we may see much higher expected returns than that in the future. Bottom line: Global equities are pretty attractively valued, and when they enter a period of positive momentum, we’ll probably see very healthy returns. Click to enlarge Footnotes: MSCI bases its weights on strict investible market cap data while Bloomberg bases theirs on unrestricted market cap. The Baseline weights used here go beyond market cap, using other economically relevant data to compute weights. See this note for details, and here for a further comparison of weighting schemes. Based on the belief that earnings and dividends will grow at less than the rate of real GDP growth due to various slippages. For a more detailed discussion, watch this video , and read this short note . Furthermore, if we think of this as the central case in the return distribution, and if we believe the long-term return is distributed relative symmetrically around this value, then there is a convexity adjustment that makes investing in equities even more attractive. A back-of-the-envelope illustration is to note that if we thought there were two equally likely long-term (say 30 year) outcomes for the real return, of say 5.5% + 2% and 5.5% – 2%, we would see that the return associated with the expected value of equities would be 6.02%, or 0.52% higher than the 5.5% base case. From US BLS data, here . Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The V20 Portfolio Week #24: A Change Of Heart

The V20 portfolio is an actively managed portfolio that seeks to achieve an annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here . Always do your own research before making an investment. Read the last update here . Note: Current allocation and planned transactions are only available to premium subscribers . Existing holdings: CONN , SAVE , I , CALL , OTCPK:DXMM , ACCO While volatility is not something to which we should pay too much attention, it is nevertheless a possible indicator of material fundamental changes in our holdings. Over the past week, the V20 Portfolio declined by 0.9% while SPY (NYSEARCA: SPY ) rose by 0.8%. Conn’s (NASDAQ: CONN ) will be reporting earnings in a little under two weeks, meaning that the portfolio will likely experience higher than normal volatility. As investors, we look forward to earnings for guidance, to verify if our initial assumptions are correct. For Conn’s, much of the market’s concern revolves around the company’s credit operation. Despite a sound retail division, the market is still quite apprehensive about lending money to Conn’s. While improvements in the credit division has been foreshadowed by falling delinquency rates, earnings will shed more light on the details, hopefully providing more assurance to the market. Over the long term, whether the market recognizes the company’s value today or tomorrow is irrelevant, assuming that the management allocates capital correctly (i.e., seize growth opportunities, repurchase shares when conditions are favorable, etc.). Thus far, the management has been committed to their plan by buying back shares and expanding the store count. More on MagicJack Ultimately management’s actions will directly influence the company’s financial results. In MagicJack’s (NASDAQ: CALL ) case, capital allocation policy took a drastic turn (see my premium article here ). The gist of it is that the management decided to use half of the $80 million cash pile to acquire a company at 8-10x cash flow, when MagicJack itself was only trading at 2x cash flow. In previous quarters, the management did the right thing and created a lot of value by buying back these discounted shares. Unfortunately, as this acquisition has shown, the management has failed to choose the optimal method of capital allocation. Because the original investment thesis depended very much so on what the management has chosen to do with the cash (in a sense all investment thesis revolves around cash, but in this case it is particularly important as much of the value is tied to the cash at hand), it is unfortunate that things turned out the way it did. While the company itself is still extremely cheap, it is critical that we identify material fundamental changes in our holdings (such as changes in capital allocation policies) and evaluate them accordingly. As John Maynard Keynes is rumored to have said: “When the facts change, I change my mind. What do you do, sir?” As with anything in life, there is a certain degree of risk in investing. Financial results will fluctuate, but people’s thought process changes as well. While one can make an effort to understand the financials, there is no foolproof way to understand human psychology. This is why Buffett values a good management team so highly. As outsiders, the best way to analyze the quality of the management is by looking at their past actions, not their words. But as MagicJack has demonstrated, even that may not be enough. Many investors tend to focus on the result, not the process, of an investment decision. Unfortunately (and sometimes fortunately), the right decision can lead to a bad outcome, just as how a bad decision can lead to a good outcome, simply as the result of luck. Nothing frustrates a poker player more than a bad beat, yet professional players recognize that it is just a part of the game, and it is the initial decision that matters. Performance Since Inception Click to enlarge Disclosure: I am/we are long CONN, CALL, SAVE, ACCO, I, DXMM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.