What's your due diligence process?

[Happy]

And Buffett is famous for making investment decisions in mere minutes. 

 

Buffett explained at an annual meeting that he has looked at every company in the US big enough that he could possibly invest in it to the point that he either won't understand it well enough or has done so much work on it that he won't really get any further with more research (only on a superficial level). So he can now make a decision on most of them in a few minutes because he immediately knows he doesn't understand them well enough or has already spent many hours researching it. 

[peter1234]

How much value do you guys place on equity research reports?

 

I occasionally find them helpful in learning about a business I'm unfamiliar with. Sometimes weird metrics, legal analysis, or commentary can help me think about the business in a good way. And sometimes it helps for me to check my work against when I disagree. Nothing is as much fun as a report coming out that knocks down a core holding ~10% which, upon closer analysis, is severely flawed in one way or another.

 

I find them useful to find industry and competitor info quickly. Some company info and the metrics the analysts look at are helpful as well.

 

Helps you to understand where they are coming from and what your variant perception is.

[Spekulatius]

I am more of a Graham type investor. I keep a watchlist of a few hundred stocks (in yahoo) sorted by industry lists, countries etc. Those are all stocks that. I found to be interesting at some point. Once something becomes cheap and looks overly depressed I do a bit research and find the underlying cause for the price decline /depressed stock price.

 

i look for low valuation metrics and reasonably solid balance sheet and a management that does not seem to screw over shareholders. I do accept low liquidity and in some cases low profitability, if I think the assets are worth way more than the current EV. i look for stocks that trade at less than 80% of their value, as determined by easily discernible metrics (RE valuations based on rent multiplier, cash and current assets,P/Book EV/EBIT metrics in some cases).

 

My favorite areas are real estate, E&P's, banks, insurance and manufacturing. I avoid retail and tech (in most cases). I own a diversified portfolio with typically 30-40 positions at all times. I think of investing like farming, I seed some, grow some and harvest some at all times. My desired holding period is 1-3 years, similar to Grahams 2 years, but I do hold some shares longer and don't mind opportunistic short term trades either.

 

 

[no_free_lunch]

Spekulatius,

 

With such a diversified portfolio, how have you done versus the indexes?

[Spekulatius]

Spekulatius,

 

With such a diversified portfolio, how have you done versus the indexes?

 

I have not done detailed calculations with the inflows/outflows recently, but I beat the SP500 most years. The biggest outperformance was during bear markets, in bull markets I generally perform more inline with the market. In my last detailed calculation in 2012, the IRR in my IRA started in 1998 was around 18%

 

I believe the outperformance in bear markets is due to the fact that many stocks are "multiple pillar" stocks, backed by earnings and assets, with little correlation to the general market direction. I have also used volatility to my advantage with short term trades in my IRA. This works best in bear markets when volatility is very high, but not that well recently.

 

I think a Graham like approach works, because one avoids doing stupid investments, where the risk of permanent impairments is very high. I acknowledge that a concentrated approach can yield better results, but there is also a higher tail risk  and many will blow up over time. That said, I have been following a more concentrated approach in the last few years as well (via position weighting).

[Spekulatius]

As far as the process if selecting/eliminating is concerned, I have over time gained a basic feel what to look for in various industries, like banks (FDIC records), insurance companies (book value growth, loss triangles), E&P's (reserves), which saves a lot of time. Once I research a company, In not only look at the financial records of the companies itself, I equally spent time to look at the records  and presentations of direct competitors as well. This has proved very valuable to me, to get a different perpective, and often a liked a competitors stock more than the one ai initially was researching.

 

I also like to read the shareholders letters and look at what metrics management looks at and how consistent the message is over the years. 10k's are valuable to look at somewhat hidden timebombs like pension or asbestos expenses or other liabilities that analysts often spent very little effort on, despite the fact that they can be a significant part of the EV and is not shown in any screener.

 

All those things work well in situations where reversal to the mean is more likely, not so much in trend business like retail or tech (unless it is very mature in nature).

[SharperDingaan]

We look at the index 52 week high/low to identify the depressed sectors. It should capture the cyclical & company specific crashes.

Look at just the top 5 sector names. Drop if there are not marginable or there is no option market.

High level research on sector events over the last 3 years.

Research relevant commodity cycles.

Global index scans.

Drill downs.

 

The expectation is that whoever you buy, you will be there for 1-2 full cycles, & only involved in name-brand companies. Almost always you will be buying in pessimism, using options to control risk, & margin to cover any unexpected need you may encounter. Top down approach. Commodity/industry knowledge & quality matters.

 

SD

 

 

 

 

 

 

 

 

[peter1234]

We look at the index 52 week high/low to identify the depressed sectors. It should capture the cyclical & company specific crashes.

Look at just the top 5 sector names. Drop if there are not marginable or there is no option market.

High level research on sector events over the last 3 years.

Research relevant commodity cycles.

Global index scans.

Drill downs.

 

The expectation is that whoever you buy, you will be there for 1-2 full cycles, & only involved in name-brand companies. Almost always you will be buying in pessimism, using options to control risk, & margin to cover any unexpected need you may encounter. Top down approach. Commodity/industry knowledge & quality matters.

 

SD

 

What do you mean by 1-2 full cycles? I thought business cycles were around 5-7 years, which would mean you expect to hold 10-14 years or very close to 'forever'... TIA.

;)

[SharperDingaan]

What do you mean by 1-2 full cycles?

 

Commodity cycles. Most of the time these will be commodity businesses, where that commodity market crashed during the year.

Quality is your MOS that the coy will not BK, & that ultimately it will be worth the time investment.

If you bought a cigar butt, you failed.

 

SD

[Mephistopheles]

My question for the experts on the board is this. Is it always necessary to read the 10-k/q cover to cover, no matter what? Or can it be dependent on the situation. For example, I'm invested in the GSEs. I've read hundreds of pages of court filings and transcripts. I feel like it's not necessary to tear up two 300 pg. 10ks in this case because everything depends on the court rulings, but I feel guilty for not doing so. Am I wrong to approach it like this?

[tede02]

I definitely wouldn't call myself an expert but will offer my own experience.  I believe the short answer to your question is no.  With 10Qs in particular, how much really changes quarter to quarter?  I'm not suggesting one disregards them but reading everything line by line is a waste of time.  Let's put some context around this.

 

Say you're completely new to the investment game.  You've never read an SEC filing.  At that point in one's investment career, I think it is important to look at all of the filings in detail.  This is the process of gaining experience and learning what information in these reports is really relevant.  Over-time your efficiency in cruising through a 10Q or 10K rises exponentially. 

 

Then there is the learning curve for each individual company you're researching.  The first 10Q or 10k will probably take you double the time it takes to read the second one and so on.  Again, once you determine the key factors that are worth reviewing, you probably can review a new filing in minutes for material information (or disregard select filings entirely). 

 

That has been my experience.  This is an issue I struggled with particularly in my mid twenties when I was really studying guys like Buffett.  I think its easy to get this false impression that you need to memorize every little detail about the companies your investing in.  That was a mistake I made.  I still struggle with paralysis by analysis at times but I try to remind myself that investing is really all about high probably bets.  As Buffett has said, look for investments that are obvious.  I always try to remind myself that I'll never have perfect information which is why that margin of safety is so critical.  Now I just need to practice what I preach! ;D

[ItsAValueTrap]

My question for the experts on the board is this. Is it always necessary to read the 10-k/q cover to cover, no matter what? Or can it be dependent on the situation. For example, I'm invested in the GSEs. I've read hundreds of pages of court filings and transcripts. I feel like it's not necessary to tear up two 300 pg. 10ks in this case because everything depends on the court rulings, but I feel guilty for not doing so. Am I wrong to approach it like this?

 

I think you should.  Buffett probably sold his position (a long time ago) in part because he didn't like what management was doing.

 

Certainly if you read their 10-K you might discover that they are doing something that's not obvious.  There might be something funky going on in how they value their securities, the risks they are taking, the derivatives they are using to hedge, etc. etc.  The Level 2 and Level 3 assets have the potential for shenanigans.

 

*I do not understand Fannie and Freddie.  Nor have I read their 10-Ks.

[peter1234]

My question for the experts on the board is this. Is it always necessary to read the 10-k/q cover to cover, no matter what? Or can it be dependent on the situation. For example, I'm invested in the GSEs. I've read hundreds of pages of court filings and transcripts. I feel like it's not necessary to tear up two 300 pg. 10ks in this case because everything depends on the court rulings, but I feel guilty for not doing so. Am I wrong to approach it like this?

 

This is a very interesting question.

 

Since you probably got interested in this idea by Berkowitz/Ackman and know their thesis, it makes sense to focus on the few variables that will determine the outcome here.

 

Uncovering information that helps you quantify the odds should be your focus. Learning about the business and financials is less relevant here.

 

Skimming the filings quickly might be helpful. After reading all the court filings, you probably know more details than are disclosed in the filings. Still, filings might give you a quick high level overview from the company's perspective.

 

[SharperDingaan]

If you have to read the 10-K cover-to-cover every time out, you are trying to substitute numbers for confidence/intuition.

Most everyone would use the tede02 approach.

 

A 10-K is no different to a text-book. Read/scan it once to understand & apply the content, then it is reference only. Nobody would re-read version 2, version 3, etc. of the textbook as it came out - at best they would scan for just the changes, & use an app to do it.

 

SD

[tede02]

 

A 10-K is no different to a text-book. Read/scan it once to understand & apply the content, then it is reference only. Nobody would re-read version 2, version 3, etc. of the textbook as it came out - at best they would scan for just the changes, & use an app to do it.

 

 

This is an excellent metaphor!