Somewhere deep in the electronic storage vaults of Forager, we have a slide that explains it. Every fund manager does. And for good reason. Fully cognisant that past performance is more likely to be luck than replicable skill, prospective investors want to understanding how we generate our investment ideas.
The problem is that our slide is not that different from everyone else’s. Gareth and I saw many of them at a recent value investing conference in Madrid. We’re all running roughly the same filters, reading mostly the same media and checking each other’s portfolios out on a regular basis.
My belief is that the best ideas require something different. A unique insight. A different way of looking at a business or an insight into value that isn’t immediately obvious on the balance sheet. That might make them hard to find by conventional methods, but that’s the whole point. The best ideas are the ones no one else is looking at.
With that in mind, here are my four fundamentals for finding that hidden gem.
- Know what you are looking for
It sounds basic but you can’t find something if you don’t know what it is you are looking for. At Forager, the three criteria are unloved, under-appreciated, and valuable. We’ll come to the first criteria as we run through the list below, but stocks can only be cheap for one of those two reasons. Either there is negative sentiment towards a particular business or sector, or there is a lack of appreciation for how fast a company can grow or how valuable some of its assets are.
The last criteria, valuable, applies to both unloved and underappreciated. We need to be able to value some or all of the business. The business needs to have some identifiable worth and we need enough experience and skills to be able to value it. No matter how unloved the biotech sector becomes, we don’t have the skills to value an early-stage biotech company, so aren’t likely to go looking there for bargains (unless they start turning up as discounts to net cash, of course).
- Scour widely
An old friend of mine was at another investing conference recently when the speaker asked the more than one hundred attendees to put their hands up if they read The Economist. By his estimate, some 80% of the room raised their hands. Half of them were probably lying but still, it, the Financial Times and the Wall Street Journal are widely read in the sector.
Next the speaker asked how many people read Wired, and two people put their hands up. The speaker’s contention was that firstly, technology is changing the world and you can’t afford to be late realising the changes taking place and, probably more importantly, you are more likely to find unique insights reading things that other investors aren’t reading.
This latter point is crucial for mine. Spread your wings and develop areas of expertise that are relatively unique. Read widely and think laterally, sometimes the knowledge you gain can be applied to completely different industries.
- Always have the radar on
A key ingredient in idea generation is to have the radar turned on every waking hour of your life. We met directly with six companies prior to the Madrid conference and saw presentations on roughly 15 more, but I came back to Sydney with a list of 40-odd ideas to follow up.
Aesop, the brand of soap in the bathroom of my London hotel, reminded me to take another look at its owner, Brazilian company Natura. The CFO of shipping broker Clarksons mentioned how distressed the dry bulk shipping companies are: “there is no light at the end of the tunnel, but you can buy a bulker for 20% of replacement costs”. And the most beautiful airport I have ever been through, Adolfo Suárez airport in Madrid, looks like it doesn’t need another cent spent on it for the next 20 years. Time for another look at its owner, Aena, although a share price up 50% in the past 12 months means that one might be short.
Talks to friends, try new products and observe everything going on around you. Ideas pop up all over the place if you keep the “unloved, underappreciated” radar on.
- Don’t get stuck down rabbit holes
I have a theory. I’m not sure it is backed up with facts but it is my theory nonetheless: You don’t ever research yourself into an idea, you only research yourself out.
Within the first few hours of looking at something, you should have a clear model as to why you think the prospective idea is attractive, and you should be able to enunciate it in a few simple points.
Disprove the thesis is the part that requires hard work and due diligence, a process that can range from a couple of weeks to a month or so for us.
The key is not to spend too many months researching dud ideas. It’s easy to get deep into researching a company or even a whole industry and want to keep going for interest’s sake. Every hour you spend down that rabbit hole is an hour you are not looking for a more prospective idea.
I know it’s probably not as numeric as most people would like. And, while we’ve done a very good job developing a replicable, organisational Forager research process, I’m the first to admit we have been less successful producing a replicable idea generation process for the company. At the moment, it is still dependent on the individual. But those are my thoughts on idea generation. As you can see, it is the creative part of the job. As much art as science.
excellent thinking process, that are reflective whilst at the same time disciplined, vigilant and focused… it is this emotional fitness that enables timely executive functioning of Forager funds…
steve, whilst management of self and others with such emotional controls, Forager has our full confidence and long term commitment…
j&t, woof
I have, for many years, believed that finding good investment ideas is like finding good moves in a chess game. There are indeed hundreds (if not thousands) of axiomatic principles, that, if applied rigorously, can result in expert-strength play. However, to attain mastery one needs to take a more nuanced approach to the positions on the board and a more personalised approach to the inner dialogue that precedes move selection.
There isn’t much agreement in chess circles about how exactly grandmasters identify candidate moves, but I found GM Jacob Aagard’s take on it to be more insightful than most:
“During the last six or seven years I have been convinced that chess is built on dynamic rules, in the same way as physics and biology. I believe that most tournament games are not won by superior calculation or imaginary power, as I used to think, but rather due to superior understanding of the very basics of the game… Grandmasters calculate less than amateurs. Basically, they do not need to because they know what to calculate, or so [the] argument goes… In my teens, when my calculation powers were superior to my opponents’, I often impressed my higher rated opponents with numerous fancy lines, yet this did not lead to winning many points. And in Jonathan Rowson’s interesting recent work, The Seven Deadly Chess Sins, the author talks about his six game match against Michael Adams, the Homer Simpson of chess (a positive comparison). After the games it always turned out that Adams had seen only a fraction of the lines addressed by Rowson but, somehow, these were the relevant lines! Adams won the match 5-1.”
In other words, whether in chess or investing, understand the essence of a situation and you won’t get it too wrong.
Hi SG. You might find this interview of interest by Tim Ferriss with Josh Waitzkin (child chess prodigy, author and Brazilian Jiu-Jitsu blackbelt). The whole interview is great but if you don’t want to listen to it all, skip to 17 minutes and 15 seconds through to 18 mins 40 seconds where he is talking about “transitions”.
Regards,
Greg
Listened to it. Interesting stuff. Thanks Greg.
Thanks Greg, interesting listening
Not hard to spot ugly ducks right?
The trick is to work out which one’s will become swans.
Most of the ducks I pick just get uglier.
Tough market at the moment- just ask Apple. But it’s these conditions that test the skill of the fund manager.
Keen to see the Int. Share Fund line cut through the MSCI line soon, but Forager has done pretty well of late in the face of vacillating markets and a resurgent $Au.
Appreciate the effort.
Thanks, Ron
Jump onto livewire and scroll down the headlines. It is evident that everyone has the same ideas wrapped up in corporate speak… dividend trap, commodities bottomed, China bear, China boom, the case for a rate cut etc…. and you also have original posts from forager.
Interesting – everyone wants an edge, and everyone is actually playing in the same monoculture. Same daily reading, same booklist, same buzzwords…
I like your point about looking around you – some of my better ideas have popped up in completely unexpected places. Sometimes its just looking through the lists in the newspaper and seeing a company name and wondering what they do. Sometimes it’s been seeing an advertisement in the London Underground, or an airport. Sometimes its a case of ending up in a tourist trap in a foreign country and thinking “this place is a license to print money”.
Then the research starts – and it’s often pretty easy to knock ideas out – the thing that looks like a license to print money has a subsidiary thats a dog bleeding cash, the business is too expensive, and so on. Lots of ideas bite the dust in an hour or 2. Every now and again, I’ve found one or two worth buying. Of those some have done exceptionally well, and one went bust 🙁
The idea of keeping your eyes open and thinking “I wonder who owns this” is a great one. The world is full of possibilities.
I would be interested to find out how to go about validating an idea I read about on lithium producing stocks.
At the moment several stocks in the lithium sector have doubled.
How would you go about doing due diligence on these small cap stocks which I won’t mention…