I divide my time into two main areas: business development (this includes networking, meetings, discussing ideas with prospective investors, etc… basically everything it takes to run my business) and investing. In the latter category, the majority of my time is spent doing two things: idea generation (building watchlists, reading, screening, etc…) and researching (going through items I’ve placed on my watchlist in greater detail). So investing is a never ending interplay between getting ideas and researching ideas. I think of this general concept as “idea inventory”.
What I mean by this is that my watchlists naturally get larger as I find more ideas that might be potential investment opportunities. As the watchlist grows, I need to spend more time researching these ideas to determine if any of them should be placed into my portfolio. As I spend more time researching, the idea watchlists get smaller as some stocks either get placed into the portfolio or get removed (some stay on the lists if I think I might buy them at lower prices).
Balance Idea Inventory with Research
Just like an operating business, you need inventory in order to eventually sell goods and make profits. But you don’t want your inventory to pile up too high, or you’ll end up with too much product on your shelves that will need to get marked down (i.e. JC Penney). With idea inventory, you need to balance your time between finding ideas and researching ideas in order to efficiently make conclusions about which stocks you should buy.
I recall Buffett mentioning in his early partnership years that his “idea inventory” was always at least 10% ahead of his available capital to invest, which meant he was nearly always 100% invested. This is something to think about… I think that just about every individual investor, and the majority of small to medium sized professional fund managers would probably improve their results if they focused more on managing their idea inventory and less on trying to analyze the security markets, business cycles, and the macro picture.
I don’t have any problem with holding cash, but as I look through my idea lists, I’m finding lots of opportunities to invest in small undervalued companies that on balance, should provide safety of principal with adequate returns.
Where Might Some Bargains Be?
I’ll mention a few specific ideas as I find them interesting enough to post. But a few areas of the market worth looking at are:
- For Profit Education (historically very good businesses… low fixed costs, high returns on capital, currently offered very cheap relative to cash flow)
- Industrial Metals (high costs, capital intensive businesses, but many are cheap relative to net assets)
- Gold/Silver Miners (same)
- Small Community Banks (there are still plenty of small banks selling for 70% of their tangible book values)
- Insurance (there are parts of the insurance sector where numerous stocks are selling at 50-70% of tangible book despite experiencing consistent 10% annual growth of book values)
These are just a few small cheap pockets within the larger market (which is what I would call fairly to moderately overvalued). But even with the broader market looking somewhat expensive, there are still these parts of the market that look cheap. I just mentioned a few areas that look cheap. There are plenty of other random cheap stocks in other industries that may or may not be undervalued.
Notice how the list might make you feel when you look at it. Many investors hate these areas of the market. Even value investors might hate them…. i.e. for-profit education has all kinds of business problems and regulatory hurdles, metals are high cost businesses selling a commodity, ditto for the precious metal miners, community banks low ceilings for growth and are often very mediocre operating businesses, insurance stocks can’t seem to consistently produce underwriting profits and might be vulnerable to rising rates, etc…
There are all kinds of reasons to not like cheap stocks. But as I heard Steven Romick say in a recent interview “Good things happen to cheap stocks“. Walter Schloss made 21% a year for 47 years… looking at his list of stocks he owned, he bought a lot of low margin, high cost, ugly businesses that were backed by significant assets. He also owned a few compounders and a few great businesses, but on balance, he owned cheap stocks.
There are still cheap stocks in this market. One thing to always keep in mind is to “think differently“. Happy hunting…