A Few Miscellaneous Thoughts on Investment Process

Posted on Posted in General Thoughts

As I’ve mentioned before, I spend the vast majority of my time reading. My office is filled with piles of papers, notebooks, and annual reports. I have two computer monitors (yes, I know some value guys have no monitors on their desk… something I admire, but I find the internet’s resources too valuable to ignore… for example, I can access 15+ years’ worth of annual reports in seconds, that’s something Schloss, Graham, Buffett would have readily used if they grew up in the current era, but I digress…)

Idea Generation

I generate many ideas by paging through Value Line, which provides me a continual look at 3500 or so companies each quarter. This database gives me ideas to research further, which I typically do by ordering hard copies of the annual reports from the companies themselves. Most of my time is spent reading about companies that I came across in Value Line at one point. I think of it as my modern day “1951 Moody’s Manual” that Buffett paged through in his early years. Over time, it’s possible to absorb a significant amount of knowledge, as you can go through the database a few times each year. I typically just glance at most companies. The way the sheets are organized makes this very efficient. I glance at the 10 year data including returns on capital, the book value history, the sales progression, and then the company description. Often it only takes 5 seconds to move to the next company. The majority of these businesses are not ones that I’d typically get excited about owning.

My basic objective with paging through Value Line is to find businesses that are ones that I’d consider owning at a certain price. The objective is not necessarily to find ideas that are currently undervalued, although that is sometimes a byproduct of this process. But it starts with flipping pages and looking for ideas that I’d like to know more about. I add these ideas to a watchlist, which becomes the list of stocks that I end up reading about one at a time. So my watchlists end up providing me with most of my ideas, and I actually maintain a number of google spreadsheets, including lists such as buybacks, high ROIC companies, consistent historical free cash flow, and book value compounders among other things.

Most of these databases are based on good quality companies that I want to read about and potentially value, so that I’m prepared to buy them if they become the proverbial 50 cent dollar.

Idea Inventory

So most of my ideas start with Value Line, then proceed through to my manually updated spreadsheet-watchlists, where they get filtered one last time by reading 10-K’s. I think of this process as idea inventory. Value Line provides the raw materials, the google spreadsheets hold the goods-in-process, and finally–after reading the 10-K’s–the ideas that make the cut end up in my main stock database as finished goods–ready for sale (or purchase I should say, at a certain price).

I’ve recently spent some time really simplifying my efforts and my process. To sum it up, the process loop here is simply:

  • Page through Value Line, one stock at at a time
  • Add stocks that I would consider owning to one of my watchlists (maybe 1 out of 10 end up on one of my lists)
  • Using the database of ideas, read the 10-K’s and attempt to value the business

If I can come up with a value (and a corresponding price I would pay), I add the stock to a master list of ideas that I would buy.

So this process of just flipping through pages, adding ideas to lists, and then reading the 10-K’s is really the foundation of my investment process.

But in addition to searching for good operating businesses to own, I am always on the hunt for special situations, cheap assets, and other undervalued situations. These “other” ideas often come from simply reading the paper and keeping the antennae up for things like spinoffs, tender offers, corporate restructurings, etc… the best way to find these ideas are simply to read the paper and to look at what other good special situation investors own. I often find ideas this way.

And the last thing I’ll mention: screens. I don’t spend a lot of time with screens, but every few months I go through a few screens. The idea is the same as Value Line… try to find companies that are worth spending time reading their 10-K’s. I wrote a two posts (here and here) on some quality screens I like to watch. Greenblatt’s screen is a good one, and sometimes I’ll check the cheap stock lists (low P/B and P/E, etc…), but usually I’m just looking for ideas to read more about.

10 Years of FCF with High ROIC

I’ll close the post with a quick glance at one such list I looked at today. I have a saved list of all the domestic non-financial stocks that have produced positive free cash flow for 10 consecutive years. This list alone would be a good list to go through A to Z. There are exactly 600 companies on this list currently. There are 5161 stocks overall in this database ($10 million market cap), so around 12% of the companies out there have produced 10 straight years of positive free cash flow. I sometimes run an additional filter on this list of stocks, and today I looked at how many companies on this FCF list were able to generate returns on assets above 20% in the last year. Only 25 companies passed this test. Most of them are far too expensive, but this might be a good list of companies to read about. Most of them are capital light businesses with high margins, high returns, and remember–they all belong to the exclusive club of companies that have produced 10 consecutive years of free cash flow:

Here is a look at them, sorted by ROA:

Quality Screen

(Source: Morningstar)

I own two companies on this list (Weight Watchers and Strayer Education), and a few others happen to be on my list of companies that I’m currently reading about. As you can see by the earnings and free cash flow yields, most of these are too expensive for my liking, but they are the kinds of businesses that have a higher than average probability of providing their owners with compounding intrinsic value over time, and thus might be good companies to read about.

So if you don’t have one, set up a process to generate ideas, and then spend time reading the 10-K’s, and over time, the knowledge compounds like interest, and as your database of ideas grows, so do your opportunities for potentially finding good values. Good luck!

Disclosure: I own shares in Weight Watchers and Strayer Education for myself and for clients. This is not a recommendation. Please conduct your own research. 

21 thoughts on “A Few Miscellaneous Thoughts on Investment Process

    1. Thanks Jonas. I think I’ll probably post an overview of WTW at some point soon. I just need to organize the notes into a post format. It actually is quite simple, so the post might be short and sweet. The crux of the idea is that it is a company with a strong brand name and large market share that produces high ROIC and stable free cash flow and has a majority owner committed to returning that cash flow to shareholders, all for a single digit multiple.

      I’ll probably post some notes sometime in the next week or so.

  1. Hi John – how were you able to cull the list of stocks with positive FCF for 10 yrs? What’s the source of the list, in other words?

    1. Hi Aly, I use Morningstar… thanks for the reminder. I should have credited them with the info on that screen, and I’ll update the post now. Morningstar is great because of the ability they give you to look back and screen for 10 years worth of historical financial data.

  2. Thanks for the post!

    Any chance you might be willing to share the names of some of the investors you follow on the special situations side? I have been trying to add these types of opportunities to my portfolio but am sometimes frustrated by my inability to source promising situations to investigate further.

    1. Sure Mike… there are lots of portfolios I look at. I have a list of about 50 that I breeze through once a quarter to look… it’s just one way to find ideas. I think reading the paper and just staying in tune with corporate events (set up Google keywords for “spinoffs” “restructuring” “tender offers”, etc…) is the best way.

      I glance at the portfolios of most of the big guys… Price, Loeb, Einhorn, Icahn, Buffett… I also like to look at the guys who concentrate heavily (Glenn Greenberg, John Shapiro, Alexander Roepers, Lampert, Pabrai, Allan Mecham, David Abrams, Gifford Combs, MSD Capital (Michael Dell’s management firm), Robert Karr, among others…

      Mario Gabelli has a portfolio manager that runs a fund he calls something like “Top 5 focus fund”. It’s based on 5 concentrated stocks with catalysts.

      James Crichton is a concentrated manager who likes special situation. Mick McGuire is an up and coming manager who invests in a lot of asset based special situation.

      Joseph Stilwell specializes in financials, MHC’s and small community bank investments.

      There are a number of other 13-F’s I glance at. I usually go through 50 or so portfolios once a quarter and keep a watchlist of 15 or 20 new ideas that I haven’t seen. I occasionally find an idea interesting enough to pursue.

      Hopefully that gives you a start. If you set up an automatic process loop, it only takes a couple hours each quarter to glance at their updated holdings, and you might find a few ideas that you can dig into.

  3. Great article! I have considered using Value Line as other investors have recommended that such a tool is power and simple. Based on your article, I may have to do just that.

    You might find John Mihaljevic’s book , “Manual of Ideas: The Proven Framework for Finding the Best Value Investment Ideas,” useful. He provides many different frameworks to find value investment ideas. I read it to see if there was any way to improve my ways of finding ideas and I must admit the book was fantastic! He did a great job in revealed their simple and clear ways of find different types of investment ideas. Their online resource is spoken highly by Guy Spier, among other individuals. I also must admit I emailed the author about his book as I wanted to thank him as well as receive clarification on a particular section. He responded in less than 24 hours.

    Anyways, Cheers!

  4. Hi John,

    Thanks for being generous with your process – really appreciate it.

    Could you take a look at the link to quality screens part 1? It seems to be down.

    Also, are there any immediate red flags that you look out for when reading Value Line and deciding whether to move on to the next stock or not?

    Cheers 🙂

    1. Hi Sam, thanks for the nice words.

      The link appears to work: http://basehitinvesting.com/quality-screens-part-1/ if that’s what you’re looking for.

      As for Value Line, I usually page through from stock to stock, glancing at the valuations as well as the fundamentals. Depending on the industry, I like looking at the 10 year historical record for returns on capital, growth of book value, and sales growth. I might spend more time when I see something interesting, but I’m usually just flipping pages glancing at the numbers. I keep a list of the 200 or so best businesses out of the 3500 that Value Line covers, and I update that periodically.

      Going through the pages helps build up and reinforce knowledge of each business over time, as well as keep you updated on valuations.

      As for warning signs, I don’t know if there is a specific sign, but I look at the capital structure to make sure the business isn’t overleveraged. I also try to stay away from businesses with deteriorating fundamentals (opposite of what I like such as steadily decreasing sales, negative earnings, and shrinking returns on capital).

      Hope that helps.

    1. Hi Henry, I haven’t posted on WTW yet. I plan to put up a post at some point. The short answer is I like the business a lot. I’ll share some more thoughts soon…

  5. Hi John – thanks for a great post. It’s helpful to learn about your investment process – quite similar to mine in nature, although we use different investment databases. I’m curious to know a bit more about your use of Value Line. Which Value Line paid subscription do you use? I notice there are a variety of different subscriptions/products available.

    Thanks.

    1. Hi Clay. I just use the old school Value Line hard copies. It comes once a week and features 13 issues altogether covering about 3500 stocks. I page through it weekly…

  6. John – thanks for the post. Very helpful to read about your investment process. I am curious as to which specific Value Line resources you use in your process. There are a number of paid subscription products available on Value Line’s website. To which of them do you subscribe and find most useful? Thanks.

  7. Do you know if there is there any way to bulk download the S&P or Morningstar tearsheets for each company in a screen (or even simply in the S&P 500) to be able to print and flip through them one by one?

    1. I don’t think so, although I’m not sure. I looked into that a few years back, but discovered Value Line was the best product out there if you’re looking for hard copies of tear sheets.

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