I think investing is simple, and the reason I say that is because it doesn't need to be complicated so why make it complicated.
There is a lot of overthinking you can do when making choices, whether it be, ordering dinner, debating whether you should go out, or choosing a share. So in a way this blog seems to follow from the last, a good starting point is believing in your choice. Second thing I want you to take from this is notice what's happening around you.
Easy enough to say, but that does require you to have a clear idea of what you are looking for, else how do you make that choice. So lets start with the obvious. You want a share that is undervalued, growing and makes lots of cash.
This is where I think theory is misleading. Theory tells us diversification reduces risk, and you should have a diversified portfolio. What theory does not tell you (and unit trusts hide from you) is diversification means basically you'll never outperform (maybe in the short term, but not longer term).
Fundamental principle: What reduces risks is only buying good solid businesses for a reasonable price, and not buying bad companies. Simple. (see future blog on risk.)
That said: If you not doing your homework properly, you going to make mistakes so diversify. If you do your homework and are certain concentration is the way. Even Warren Buffett agrees (actually he said it first, I just also did before I knew that he said it).
One of the most common questions I get asked is, "how do I chose shares?". Very hard question to answer. So over time that has evolved for me. In the beginning when learning, I was an industry person.
What you need to take from the following are things to look for. They should NOT be the only things, but its a start. Investing is not something you become good at overnight. Think about anything you do in life, riding a bike, playing music anything... just because you can ride a bike doesn't mean you can win the tour de France. Anyone can invest but unless you put some time in you're likely not going to win. You need to learn to think about many simple things, and here are a few..
Predicting industries - Not as hard as you would think!
You look around, you listen, and you think. Most people just go through life noticing things and then poof they go off into never never land. This is where you need to be Alice and follow the rabbit down the hole.
Just note I am not saying apply any one of these anymore, I have moved beyond just these, but these are still things you use to build you argument to buy.
Some theory: Simple thing you learn in finance. People over-react, so when everyone is selling might be a good time to buy.
BEWARE: Be careful with this, as you don't want to catch a falling knife. If you speak to any decent hedge fund manager they will tell you, "you wait for it to turn around, rather lose 5% on the upside than lose 20% on the way down."
Also just notice what's happening around you. Like your friends all start drinking craft beer or using an iPhone or Samsung. People start using things, or you start using something, might be a good time to buy shares.
Application: I want you to think when reading this, could I have thought about this? The answer is yes! So next time do!
- So 2009, mid year after financial crises. Note financial, to me this implies financials would be the hardest hit companies. Might not have been the worst off, but it you looked they had taken a beating from the market. So I bought some banks. No rocket science. (In another lesson in the future, we'll look at how you chose what bank).
- Now come beginning of 2010, we realized the world is not ending, people have taken all their money out the market, started being conservative, and now they sitting with some cash. Interest rates drop, money is cheap, people are scared of the market still, so what do they do? Governments around the world are trying to solve the crises by encouraging spending, so guess what people do: They shop! Retail boom, you can even see it when you go to a shopping centre, never mind the number of shopping centres.
Another strategy I was onto early on was "cash is king".
Theory: In finance, value is derived from future cash flow. Later on you learn about excess cash and adding it on to the value at the end of the DCF (discounted cash flow).
Cash earnings is still fundamental in my decision making. However even though most people know the theory they just don't seem notice. So in 2009, I heard about this company called ARB holdings (hard to believe but it is real). They basically are hardware shops, mainly cabling, wire lights etc. So on the market side. P/E like 8, market cap like R400m, paying a solid dividend. So I look at the financials, balance sheet R200m in cash. Look at cash flow making R80m a year.
When you are buying a business you are buying the operations of the business, any excess cash (R200m) is basically a bonus.
They were also growing. So being a sharing man I tell everyone I am buying this share, so one friend Erns (legend and now Vice president at an Canadian private equity company that he can't leave because they just give him more money to stay) says "should I tell my dad to like throw the house at it?" Bare in mind I have 3 months experience at the time, so I am like listen I am not sure about that, but he and another friend Pat partake in this opportunity at this point. Not even a month later like 10% down. Now I am getting heat, but still saying, "look it is fine the market goes up and down". Before you know it 20% down. So Pat sells obviously giving me flack for days. So I look at this (remember my first blog, if not go read it) and I just can't see how I am wrong. So while it was down I took all the money I could get my hands on and bought more.
Something to understand: Most people buy high and sell low, and most people lose money. To be honest if you aren't sure of yourself, and I have done this before you bail when the market moves negatively. Having stop losses is not a bad idea, but if you do your homework and you know what you doing, who cares if it goes down 20% for a while.
Similar story with Onelogix, and more recently Petmin (been bought out now). If a company has a decent amount of cash on hand, and is making lots every year, pretty hard to go wrong.
BEWARE: Accountants! Please note profits are not and may never become cash. Earnings are a "reasonable and fair" estimates of reality (at best). At this point remember Enron as the shining example of how the humble accountant can fool millions.
Earnings Growth
Then I moved to a more fundamental approach. (Obviously finally learning something). I started thinking about future earnings, and growth of earning! Two shares that illustrate this perfectly for me are NEPI and Cartrack.
NEPI - Is new european property investments, soon to be merging with rockcastle, but not the point. So Nepi was quite new in 2011, so one set of financials and a good story. After Pallinghurst, I must admit the inner accountant came out, and I wanted to make sure I wasn't watching the girl in the red dress (matrix reference). So I read the full story, news, financials, and I waited for another announcement. So basically this is what I saw, a company on a 18-20 PE, (everyone goes "yip, no thanks, too expensive!") that was borrowing cash at +-5%, and buying property yielding 8%-10%. On the side they were doing a lot of building and they gave you timelines, size and yields (pre-let so real yields). Firstly buying property at 5% and making 10% is winning, but basically they had doubled there lettable area, but it only happened just before results. So here you were on an 18 PE with half your earnings, and growing rapidly, they also pay a solid dividend or 3-4% (in euro's). For me I was like you buy in a year earnings are double, people then go "wow" and pile in, and then it keeps rolling. This happened over and over again for years. Still hold and still love it. (Remember this when you read the blog on PE ratio, coming soon).
Cartrack. So Kyle tells me about it. Also looks a little expensive (if you look at PE) for a smallish company. He actually gave me very little information to work with, so figure lets have a look. Key here is I READ!
Side note: So when Kyle was at Coronation, being under worked and over paid, I interviewed him to make short video's to show at university! This was my dream of sharing stuff with students that was useful in the real world, it was shut down. Anyways he said that they spend 80% of time reading and modelling (in excel, not the catwalk). If you know anything about modelling, you realise at first, it takes a lot of time after a while, takes like a few minutes a day, leaving you all day to enjoy coffee and read.) So might seem like a lot of work now, but is quick later.
So Cartrack is expanding into Asia, Africa and American, put down a lot of investment, and have a market leading product. In South Africa which is about half their business and they have discovery promoting them, so base cash flow solid and investing heavily in growth.
I can't believe I am going to sound like Joel Stern (extremely smart guy, but a challenge. Have had a week of him, 3 hours a day): Joel: "Accountants don't understand what assets are, so basically everyone is wrong, but I knew this from the beginning, my first accounting lecture I told the lecturer he was wrong, and that we should think of discretionary costs (things I mentioned below) as assets not expenses." I agree with Joel on his principle.
When a company is investing heavily in product development, capacity, staff and training, expanding etc. They are bound to be incurring large expenditure, which makes profits look depressed. (**continue by double stars below or enjoy an interesting Cape Town story of "Deluxe and the Dogs Bollocks")
Interlude (Do not be too concerned if you are not Capetonian, if you know what a hipster is you'll understand): Local example. Let's stay you start a coffee shop, like Deluxe. Day 1, need a barista, coffee machine, stock, pay rent and the first day you maybe have 7 people (who are friends - theory tells us you only really have 7 friends - again another lesson), because you think it is cool to put a coffee shop in a dark alley with no visibility, but I'll give it to them they were cheap.
Fortunately they know hipsters better than I did, because for a hipster it is much more hip to spend too much on pants to tight and short for you, so it is crucial to save R10 on your coffee, and there is the added bonus of telling your friends you went to this cool coffee shop, but I can't really tell you were it is, but it's like around the back of this biker dude's garage where he serves burgers, but only like 50 burgers, so if you aren't there 4 hours early you aint gonna get a burger. Then you go into this room with no sign.......
**So basically no customers for a while, then after a while, people know where you are, what you do, and you start making money. For Cartrack even if you didn't understand the principle above, there were constant notifications on SENS; basically they had like 400 000 subscribers in the last financial results, but half way through the year was 500 000, then 550 000 then 600 000, and share price didn't move much. So in the current earning there is basically no earnings from those new subscribers. Next year without any growth in subscribers you have an extra 100 000 people's subscriptions for half a year, another 50 000 for 3/4 of a year and 50 000 for basically a whole year. So I bought some Cartrack!
Last word of advice: Be conservative! To quote Justin a friend and investor, "Unlike base ball, when you step up to the pitch you don't have to swing at every ball because you can't go out. But when you do swing you better make sure you hit!"