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.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.