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7 Ways to Find Stock Ideas: Improving Your Search Strategy

Wednesday, Feb 15 2012 by
12
7 Ways to Find Stock Ideas Improving Your Search Strategy

Crucial to any successful investment process is having a good "search" or "origination" strategy, i.e. ensuring that you are constantly seeing a good "funnel" of investment targets. Part of that search process is having a well-through through set of investment checklists so that you can quickly  filter out the low probability time-wasters. But equally, it's important to think about the top of the funnel - how to find new ideas?

Are you getting enough good investment ideas coming in? Are you losing out because you don't have the right sources? Or are you missing out because you're not paying enough attention?

A famous example of this kind of "sin of omission" was given by Warren Buffet who said he committed a major mistake by not buying Wal-Mart at the right time - he suggests that this oversight may have cost his company, Berkshire Hathaway, more than US$8 billion!

Where can I find the good ideas?

That's the million dollar/pound/euro question and unfortunately, there is no one definitive answer. It just requires a lot of hard graft but, as ever, having a systematic approach helps. In no particular order, here are 7 search paths that may be worth building into your process, if you aren't already. Using others? Let us know in the comments below. 

The 7 Best Places to Look

  1. Your Own Backyard - Peter Lynch was famous for arguing that you should buy what you know, ensuring that you stay within a defined circle of competence. Lynch says he would rather invest in "pantyhose rather than communications satellites," and "motel chains rather than fiber optics". It's worth reflecting in your daily life experience to see if this throws up any ideas or opportunities. Note - this is not the same thing as accepting tips from your mates - see below. 
  2. Screening - It will come as no surprise that we are big advocates of quantitative screening as a way to generate ideas. This can come into three forms, all of which are worth considering: 
    1. Checking daily hotlists or a simple single criteria screens like the 52-week low list if you're a contrarian, or single metric value lists like Low P/E, P/FCF, P/B or relative strength lists if you're a momentum investor.
    2. Following Guru screens based on the approaches of investors you respect (like Benjamin Graham or Warren Buffett). We now run over 50 of these screens now on Stockopedia Premium. 
    3. Running your own screens, based on metrics you've found useful (and ideally back-tested).
  3. Stock Blogs & Social Investing Sites – There's also a growing number of high quality blogs with analysis that rivals the City at times. In the UK, the best stock-picking focused blogs include UK Value InvestorRichard Beddard of iii, Expecting ValueMark CarterValuehunterukValueStockInquisition and Wexboy. Bulletin boards can also be a useful source of ideas and ways to track "scuttlebutt", for example the Motley Fool in the UK or Seeking Alpha & The Corner of Berkshire & Fairfax Message Board in the US. On some sites, you must be careful given the potential for "pump and dump" scams, so never invest without doing your own research. It's also worth being aware of the herding instinct that can exist on social media sites - often, they are most useful as a way to test out your own thinking and seek out contrarian perspectives. Oh, and ignore your mates! It's possible that a tip from a friend might pay off, but usually it won't. Mixing investing with your socialising may be a recipe for disaster.
  4. Follow Trades - Although investing success is all about variant perception, that doesn't mean you can't draw inspiration from others. It's worth building a list of great investors whose process and philosophy you share. As discussed above, you may be able run screens based on their approaches, or alternatively, you can just look at their holdings! As seems to be the case with most things in investing (liquidity, choice of stocks, Reg FD), life is better in the States in this respect. Over there, any money manager with assets over $100 million is required to file a quarterly 13-F statement disclosing holdings (this data is then aggregated on sites like gurufocus.com or marketfolly.com). In the UK,  however, large shareholders are only required to flag long holdings above 3% of a company’s issued equity. This means that small funds often do not appear on the filing radar at all unless they invest in very small companies. Nevertheless, using sources like TrustNet, you can still get a reasonably good handle on what's happening. For example, let's say your investing style mirrored the Fidelity Special Situations Fund - you can easily see a list of its top 10 holdings here on TrustNet (although beware the index-tracking distortion).
  5. Fund & Hedge Fund Letters – Again, this is more a US phenomenon but there are some inspirational (and free!) letters by fund and hedge fund managers that articulate their investment theses. Amongst the UK letters, it's worth reading Tim Price, Niels Jensen & Hugh Hendry, while the best US letters include Warren Buffett (of course), Howard MarksSeth Klarman, the Sequioa Fund and the Pabrai Funds. Have a good look around HedgeFundLetters.com which just has some fantastic content. There are also some emerging UK fund management & broker blogs (e.g. MoneyMovesMarkets & the Share Centre), although the US is still way ahead in this area...
  6. Business Press – We're big believers in being informed and up to speed with world/market/macro-events (by reading the Financial Times & the Economist etc) but we would question how effective this is really for generating new ideas. It's likely to be arbitraged out, for the most part. Michael Price apparently emphasises reading with purpose, which makes sense, i.e looking for changes that could drive an opportunity such as new management, M&A, lawsuits & restructuring (as does Greenblatt). However, another ideas is to follow the trade press/sites. These publications can be a great source of differentiated insight since they are less often used by the average investor. 
  7. Brute Force: When asked how to find stocks, Buffett once remarked "begin with the letter A and work your way down". This refers to the fact that, when Buffett started his partnership, he allegedly went through 10,000 pages of a dry Moody's stock manual TWICE searching for stocks. Of course, there's no need for dusty manuals - you can look through our listings from A to Z looking for undervalued stories with little to no coverage (or you can screen and save yourself hours!). 

Tread Carefully...

  1. The Siren Song of Brokers - While broker reports can be very persuasive, we'd emphasise the importance of recognising that brokers tend to be institutionallly biased. A strategy based on following consensus broker buys has been shown to underperform. Nevertheless, that's not to say that broker reports aren't sometimes incredibly useful context for a potential investment. Furthermore, a strategy focused on investing in portfolios of stocks which see a significant change in the consensus recommendation has been shown to work (as the focus on the delta eliminates the bias).
  2. Tipsheets - We're also sceptical about the value-added of getting ideas from tipsheets, unless it's a seriously heavy-weight / educational newsletter backed by some quantitative muscle (e.g. the Manual of Ideas). There tends to be quite a lot of smoke and mirrors in this space and, when real money is at stake, few tipsters will be able to match their claimed ROI. After all, if someone genuinely had confidence in their ability to predict the future, why would they be willing to sell you that information? In fact, the record of even the professional analyst community is appalling with studies showing the average 1 year forecast having an error margin of 46%, and average 2 year forecasts having an error margin of 95%...

But Do Your Own Research (DYOR)

No matter how you find any idea, remember: this is only a starting point. You still need to do your own work, otherwise you won’t have the necessary belief to hold the stock through the inevitable periods of volatility for those big potential gains.

And Use a Watchlist

Finally, it's worth having a watchlist to help you to create discipline around your buying process. As Buffett has pointed out, compelling values are like fast moving elephants so you need to stay alert. A watchlist is essentially just a list of the most attractive companies you’ve found in your research. It's advisable to keep one (or more) religiously, including a valuation estimate and a target price at which you'd be willing to buy the stock. That way, you’ll spot when your stocks hits an attractive price point, rather than being distracted by market noise. On any given day, Mr Market won't necessarily be offering you a price that matches your watchlist valuation but don't let that discourage you (and don't lose the discipline of maintaining and checking it). A close eye on your watchlist will pay off in the fullness of time!

A more automated variant of a watchlist is to place ‘limit orders’ a broker at your "buy" prices - this enables you to automatically buy a share should it fall below your calculation of intrinsic value, regardless of whether you happen to be watching the market. The serious risk with this approach, however, is that the price could fall for a reason that impacts intrinsic value, e.g. company-specific news of a failed drill or flawed product launch, so you may live to regret that buy order going through, after all!

Got any other suggestions for how to find stock ideas? We'd love to hear them.

Further Reading


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9 Comments on this Article show/hide all

snickers 15th Feb '12 1 of 9
5

1. your own [literal] backyard: in the town i live in there are [at least] 2 listed firms. one is a small industrial, and therefore just about comprehensible to me, in terms of finance and technology: and if their car park was full on saturdays i'd surely have invested.

2. i spent yesterday plundering stockopedia beta's screens.. most interesting. heaping them all together threw up a name i'd have dismissed out of hand, which on a deeper look seems like quality; and they are full on saturdays.. [what's the smiley for coy..]. Often screens produce a lot of value traps, or expert accountancy crooks, but sieve the results though a few bulletin boards and all you have to do is wait for the next eurozone freakout etc..

3. one thing i just did - today - was sell something which had showed strongly in one of your [stockopedia] own screens - a momentum / fundamentals mix. since the company was at the top in terms of momentum [rel strength] i thought maybe it was a good signal.. time will tell. the idea of running your winners must surely have an end point.

4. contrarian idea: avoid anything you fully understand. it'll save you a lot of time following the minutiae of the management's decision-making. only pick things you vaguely understand, leave it to the experts and get on with your life.

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Elias Jones 12th Mar '12 2 of 9
2

Couldn’t find a stock sharing ideas and thoughts thread so posted on this one ‘7 Ways to Find Stock Ideas’. so sorry if on the wrong thread.

 

Mobile Streams (LON:MOS)

 

ANY thoughts about Mobile Streams as a business or the sector in general would be much appreciated.

 

I have had Mobile Streams on the watch list for a while but never held shares in the company.  I am toying with the idea of a small purchase as a potential LT hold.

 

MOS together with its subsidiaries provides technology and services for the publication of content on mobile phones.

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MadDutch 12th Mar '12 3 of 9
1

In reply to Elias Jones, post #2

Sharescope has almost no information of use to an investor; no P/E, no dividend, no company dates. It does give eps, earnings per share at minus 0.4. Most investors would think "not even at the end of a barge pole," so why are you interested? There are so many superb investments to chose from. You could follow Buffett into Tesco, take a risk on oil exploration with Soco or Tullow, or something with a lower risk profile like National Grid or SSE, Scottish and Southern Energy.

This is not advice; DOYR - do your own research!

MadDutch

If you reply, please copy it to me into an email, as Stockopedia have not got the internal navigation working well and I am unlikely to find it.

Snickers; nice one re the car park! Pity we dont all live next to our investments!

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Elias Jones 12th Mar '12 4 of 9
2

Mad Dutch, Thanks for the reply, I’m more for trying to identify a potential early stage growth story stocks and accepting the risks that go with the territory.

In my line of work I spend most of the day with young people and without doubt mobile products and services such as apps, games, music, videos are very popular and I can see huge potential in this sector going forward.

MOS with no debt at the HY stage reported revenue growth of 40% to c£7.4m (6 months ended 31 December 2010: £5.3m) with EBITDA being around breakeven. During December 2011 total revenues surpassed a new threshold level for MOS of £1.5m with Mobile Internet revenues exceeding £1m for the first time. With the largest catalogue of mobile apps in the world I think this growth could continue as for example Mobile Streams now has more than 1 million active subscribers in Argentina and 50,000 active subscribers in Mexico.

My big concern would be the ability to convert top line growth into bottom line profits in a fast moving competitive space where R&D, marketing and investment is a burden.

ANY other thoughts GOOD or BAD from fellow Stockopedia users about Mobile Streams as a business or the sector in general would be much appreciated.

 

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Edward Croft 12th Mar '12 5 of 9
2

As is reflected around the site these days we take a much more quantitative approach to stock picking. I've unlocked the Mobile Streams stock report today for anyone interested to have a look at this stock - http://j.mp/yUzVg2.

Basically, looking at the data, there are a few big red flags for me. Its a tiny microcap for which we can't find any broker details, no profit or cashflow in the last financial year and the Altman Z-Score is indicating a high level of distress risk.

As a general comment, investors here will need to be 'venture hardy' - some people love these kinds of microcap story stocks - if an investor can do the research necessary, then sometimes one can get an edge before the crowd - but there's also a big opportunity cost to spending time digging through very scarce information.

DYOR, of course, but Buffett has all the best quotes - you don't have to swing at every pitch - you can wait for the fat one.

Blog: Follow @edcroft on Twitter
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Elias Jones 12th Mar '12 6 of 9

Thanks for your thoughts Ed, appreciated and useful. Also, very good point about the opportunity cost involved.

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Elias Jones 14th Mar '12 7 of 9

In reply to Edward Croft, post #5

Ed, looks like the crowd has arrived with regards to MOS since Monday, the stock is now 3p more expensive to buy and up 25% today!
Thanks for opening the stock report on Monday, but with regards to the cash flow, why would the stock report system not show any figures when they pull in around £1m per month? Would the reason be because the last accounting period was for 18 months ending June 11?
Regards,
Elias

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Edward Croft 14th Mar '12 8 of 9

In reply to Elias Jones, post #7

Elias - free cashflow is a very different thing to revenues. According to our financials from Thomson Reuters, MOS may be pulling in a million or so a month in revenues but free cashflow has been negative for all but one of the last 6 years. Here's the CF statement for your own perusal http://j.mp/y8F2cB

Blog: Follow @edcroft on Twitter
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Elias Jones 14th Mar '12 9 of 9

In reply to Edward Croft, post #8

Thanks Ed, Sorry didn’t realise you meant no positive net flow of cash during the last financial year, when you mentioned no cash flow, I thought you meant the company did not have any inflow or outflow of cash.

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