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Recently I was asked on Twitter how I pick growth stocks. The answer is through a very thorough process, which I describe below in a fun military-style format. Thank you for the question! Please keep them coming by submitting a question here.
My mission is to analyze the investing terrain, select the best targets, and train the audience on how I target… growth stocks.
The US military uses a well-refined targeting process. This process has longstanding proven success in harsh conditions, times of great friction, and the fog of war.
Likewise, I use an analogous well-refined targeting process. On this mission however my targets are stocks.
The US Military Targeting Process:
1. Find (identify a target):
I read and talk about far and wide topics. I love sports, culture, entertainment, the arts, science, geospatial information systems and data analysis, the electromagnetic spectrum, space, space, and space, education, industry, military, aviation, adventure, leisure, luxury and quality goods and services, policy, leadership, ingenuity, big ideas, and business.
These things give me the broadest possible reach for catching useful investing information. I cast a really wide net, and I enjoy it! I have subscriptions to few investing resources and many non-investing resources. I read investing books of successful investors only (Buffett, Lynch, etc), and I follow today’s best investing minds. I am not after volume I am after quality when it comes to investing information.
I find that most investing resources are noticeably slanted towards selling or professional services, and are often craftily disguised nonsense designing group think. I see over-exposure to group think as a way to develop tunnel vision, which I consider a great risk!
As I read and talk with people throughout the day, I am doing so with investing in mind even if I never include those investing thoughts in the conversation. I naturally love learning, and naturally love earning, so this combination has become easier and easier for me over time. You can do this too.
The long and short of it:
I am constantly in learning mode. Constantly in receive mode.
2. Fix (discern the target’s location):
I want to assess where a company fits within the market. What is the company’s “location” in the marketplace.
To do this I add stocks to a boring, commonplace, free app (Yahoo Finance) all day long. As I jump in and out of reading and conversing with people, I drop into the app, find the ticker of something that relates directly to what I just discovered, or could be a derivative play of what I just uncovered. The app is good because it is easy to use.
I don’t do anything else on this app besides fill it with “potential targets.”
3. Track (monitor the target’s movement):
During my day, I go back into the app and pull tickers out. I also pull out associated tickers that are tagged in the included news articles below the ticker. This could be at 6am or 9pm. The time of day doesn’t matter here.
I am serious about the process, but not in a rush; this is a deliberate targeting process. I add them to my stock analysis software of choice (i.e. Y Charts, Sentieo, Koyfin, etc.). But you can also just use a free option like Yahoo Finance, or a relatively cheap service like Morningstar if you’re just getting started. Remember, your decisions are only as good as your intel. “Garbage in, garbage out” as they say.
Note: Morningstar does not cover a lot of smaller companies, but what it provides for bigger companies is excellent. I want to be able to target both big and small companies so I use Koyfin, which is currently free, and Morningstar. Likely, I will add Sentieo, but let’s see how Koyfin is first.
So what am I looking for?
I want The Trifecta of:
1. a great company, measured by their Fundamentals, People, and TAM (total addressable market)
2. great growth, measured by their revenue increases and customer increases
3. and a moat
Note: great growth is not 15%, but rather 50%, 100%, 200%, etc.
Note: a moat is that protective water around a castle. In investing a moat is the company’s distinct advantage. Often times that means they are doing something so well that others can’t do it too. The wider the moat the better! You’d be amazed at how many companies are not built for quality. It is often an intrinsic byproduct of their culture and leadership.
I begin to dig in with analysis. When I get started I look at the stock’s current price compared to its price history. If the price has not increased much (target location), I consider that a plus.
If it has moved it’s okay because at the end of the day I want great companies. Many great companies will keep adding value and increasing stock price. Some reach a stasis and are not growing much or adding much additional value but offer a dividend. These are often mature Industrial Revolution-borne business models such as GE/General Electric and F/Ford. A company like this often only has 2 of the 3 trifecta criteria.
Note: if you are going to spend money on a stock, you want to decide not just which stock/s are right, but which stocks are most-right. That depends on your goals, risk tolerance, and other factors. Investment advisors help with due diligence and suitability if you do not do it yourself.
I don’t allow myself to feel “late to the party” is a stock has already moved up in price. Since I only buy companies that I believe will be great for 10-plus years I never have buyer’s remorse or fear of mission out (FOMO). Great companies will outperform average companies over that time whether you bought them at $10 or at $100, so it works well.
That being said I am vigilant so targets aren’t slipping right past me! Clearly I want that great company at $10 instead of $100. But a great company is a great company. Don’t be stubborn about it. Just assess if the current stock price is fairly valued, or over- or under-valued. Finding great companies is excellent. Finding under-valued companies is excellent. And finding companies that are both great and undervalued is best. Don’t buy a company that is over-valued though. And the motherload is if you find a company that is great, undervalued, and also has a large moat.
Note: a lot of group think says that a stock is either a growth stock or a value stock or an income stock. I think that is crap, and I emphasize that growth is value. I don’t think the growth vs value vs income divisions make sense for a lot of reasons. I don’t get hung up on that. I do however measure and mitigate risk.
I will assign myself a new mission to train you on Fundamentals, People, and TAM in an upcoming brief. But for know just digest this targeting process.
4. Target (assess the value of the target and resources available to use on it):
Once I like a stock I put it on the target list! Now it is only a matter of time before I strike that target. I was able to find, fix, and track and opportunity! A lot of people rush in at this point and buy. I differential myself in this regard.
Sometimes I buy and sometimes I wait. If the stock has not popped yet, then I am more likely to buy (strike the target before it moves). If it has moved, then I am more likely to watch it and wait for a mistake. The mistake I look for is when the market unfairly punishes a great company for an unjust reason (often it is for emotional reasons that I do not suffer from).
Note: This is like your target getting stopped because the military unit in front of them got stuck in the mud. Like shooting fish in a barrel!
When the market punishes unjustly, I buy! This almost always nets me 5-10% quickly, as 3-10% dips in stock price in one day with a subsequent recovery the next day happen every day.
However, when I see the company on the target list took a price dip I look into why. Almost always it was the result of market emotions (more on Sentiment and Technical on a different mission).
I would not buy that company off my target list if I saw certain red flags such as:
1. significant changes in Fundamentals (income statement, balance sheet, cash flows, etc.)
2. significant leadership or management changes or concerns
3. significant changes in TAM (total addressable market, aka potential customers) or growth.
Note: Moats do not typically change quickly by their very nature. More often the above three things start changing first.
So that target list of pre-screened stocks is always built and I strike when the time is right.
5. Engage (apply resources to the target):
At this point you’re in excellent shape. Your mission is on track. You have built your target list, and now the market has unfairly punished some of your great companies.
But if 5 stocks are down which one do you buy?
Well I designed an investing method to help with this, and I call it Target List Averaging.
Simply put: you buy the stock that is down the most!
Remember, you already vetted and like all of the stocks on your target list. You want to buy the one that has been foolishly discounted the most. So buy it! You are buying with conviction at this point because you have done all the leg-work to bring you to this moment. Strike and enjoy it!
Then what? Target List Averaging means you buy and hold. You are “long the position.” This means you are not selling it an hour later, or a day or week later. The target list was built of companies that will be great during the next 10 years. Reap the rewards (and tax benefits) of holding onto it!
Note: how much you spend when you buy each stock depends on each investor’s financial situation. If I had $25,000 to invest on the year then I would buy $100 worth of stock each trading day (there are about 250 trading days each year). If I had $5000 to invest then I would likely buy $100 of stock once per week (1/5 of the $25k schedule). It can be modulated to fit your financial situation. I personally keep it at a fixed amount each day as that helps the “averaging” work best.
Next, you buy another stock off your target list. Buy the one that is down the most again! The stock is on sale, and you are enjoying discounts now.
Repeat this until you have struck (purchased) all the stocks on your target list. Some days you may buy a stock you’ve already bought. You don’t want just 1 share of each stock in your portfolio though; you want to build up your positions (the number of shares you own in each company). But you are in this for the long haul, so you’ve got the time to build up these positions.
Note: if you have a lot of shares of one company (say it is getting hammered on the week by the market), just buy the second hardest hit stock off your list. In this way you fill out your portfolio with all the stocks off your target list!
I designed this method after 20-25 years of reading, investing, and analyzing what works. It mashes together a few key investing concepts that are proven to work by legendary investors over time.
Note: this is just one of my investing strategies, but I like it the most when sharing investing information with people, especially those learning or just getting started.
Every quarter, review your portfolio and ensure The Trifecta items are still in place. Likely, you won’t have to remove a stock from your portfolio for years! You just keep adding to the positions you’ve built. In investing this is called averaging. Mathematically it is extremely sound.
Note: averaging is good while the market is climbing and very good when the market is declining. This means you’re either happy your purchases are rising, or happy your favorite companies are discounted! It’s a psychological, and actual, win-win scenario. You don’t have to worry like all the others who invest without a strategy. In fact, I get excited when the market drops because I get to add to my favorite positions for cheap!
6. Assess (evaluate the effects of the strike): Now you have a portfolio with positions that are building. Many investors do okay “picking winners” (a term I can’t stand). But they screw it up by mangling their portfolios. You have done the hard work already. Now it is time to relax and supervise. In fact, you need to take a step back from your investments to properly supervise them. If you are too attached to them you may become blind to problems or opportunities developing.
Note: building a deliberate Target List and assessing over time also helps drive-out any of that “get rich quick” crap-ola from an investor’s mind. Be thorough and deliberate, not hasty and panicked.
“He will win who, prepared himself, waits to take the stock market unprepared.”
~ not quite Sun Tzu
The investing intervals (how often you invest) you use to look at your portfolio will vary for each investor with the Target List Averaging strategy because if you are buying every day you see your portfolio every day. If you buy once per week, then you need to look at it less.
Periodically, look at your portfolio and see how each stock is performing, read some of the headlines associated with each stock you own to gauge the atmosphere around it and leave it alone. Let the portfolio do its work. (Understood that you are still adding to your portfolio at your set intervals.)
So when do I do something with a stock I own?
The only things I do are:
4. manage risk
I spend most of my time buying, as you could tell from the Target List Averaging strategy.
Second to buying, I am trimming. This is a rare occurrence though. Trimming is when you sell some of your position but not all of it (which is “selling” or “exiting”). If a stock goes up a lot I will trim. When I trim my goal is two-fold:
1. take back my initial investment (If I have spent $1000 buying the stock, then I take out $1000), plus
Note: Decide if you want profits (gains) because you will get taxed on them. I take profits because I treat investing as part of my income. Also, if I redeploy that money into a successful growth stock then those gains will far exceed the cost of the tax I pay.
Holding is holding. It means you aren’t adding to a position and you aren’t selling any portion of a position.
Managing risk is for another day. I will give that its own mission.
Selling. I exit a position only when I feel the company has lost its way. GE lost its way. It just did. (I actually like the new CEO and direction of the company, but frankly, it lost its way).
What does “lost its way mean?”
Go back to the beginning. What did you establish as criteria for your target list?
1. great Fundamentals, People, and TAM
2. great growth
3. a moat
If a company loses one of these items I likely sell it to be honest. Think about it: you only want the best in your portfolio and you probably have another great company lined up that has The Trifecta. So don’t settle. Losing the Trifecta doesn’t happen over night, but it happens. Sell it. It is your money, put it to work in the best company possible!
FRAG-Os: Upcoming Periods of Instruction from me for you:
(i) Defining A Great Company: Fundamentals, People, & TAM
(ii) Defining Great Growth
(iii) Defining A Moat
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