I’ve achieved a 15% compound annual return in my personal stock investing portfolio over my 12-year investment career. Outlined below are My 70 Rules on Investing in Stocks which will…hopefully prove to be valuable information for budding investors in the stock market and, for the experienced investor, maybe there’s something new there to think about or, at least, to validate how you’re already investing in the market. Enjoy.
The comments above & below are edited ([ ]) and abridged (…) excerpts from the original article written by Robin Speziale
This article gives you access to my investment thought process as to how I invest in stocks, my thoughts on the market, which types of stocks I pick, and why. I learned about top investors’ investing strategies and their frameworks in the process of writing the best-selling book, Market Masters… and I upgraded my own investment approach as a result. [Check out https://goo.gl/T2fnWj – Register for chance to win an iPad Pro!]
My 70 Rules on Investing in Stocks: See Rules 1 to 35 here
- A company’s stock price performance needs to match its underlying fundamentals over time. My favourite companies have stock charts that rise steadily over time, in line with their intrinsic growth, with very little volatility in their stock prices. Just an almost perfect upward trend line…
- When I first learn about a new company, I add it to my “watch list,” conduct further research, and follow it for some time before I decide to initiate a positon. I give myself a ‘cool-off’ period to avoid buying any stocks on emotions.
- Management of those companies on my watch list must all demonstrate operational excellence, combined with superb capital allocation, intelligence, and a strong drive to compete. Further, management needs to have an achievable vision for the company, with the ability to execute and realize that vision.
- Management needs to have integrity. Why integrity? If management is caught with having committed a fraud, or breaking any laws, your investment in a company can quickly go to zero.
- It’s usually best when management has a stake in the company and/or is an owner/operator because they’re shareholders too. They want the stock price to go up as much as you do.
- …I like to invest in companies that serve a need/want that can’t be easily disrupted by technology in the next 10 years. Food, and drinks, for example. Everyone will still be eating burgers, and drinking coffee, the same way they do today, in 10 years’ time. Technology won’t change that basic human behaviour.
- If I don’t think a stock can become an “x-bagger,” I won’t invest in the company. For example, a 3-bagger means that a stock goes up 3 times from its initial investment. $100 invested would turn into $300. That’s why I like to invest in companies that are sized $100 million to $10 billion in market cap, more so on the smaller-end, because if a company “makes it,” I can potentially earn many times my investment. Because of the law of large numbers, once my stock grows into a large-cap, I’ll usually sell, and allocate capital into the new emerging opportunities on the stock market.
- I favour stocks that have strong tailwinds, like demographic trends, de-regulation, or shifts in consumer taste, driving profits in certain companies that are already selling those ‘beneficiary’ products or services.
- I don’t invest in companies that will just be ‘one-hit-wonders’. Growth companies can only maintain their high growth by investing in research and development, expanding their business into new product lines, services, and markets, and/or evolving with their customers, over time. Innovate or die.
- As soon as any management blames their problems on external reasons, like bad weather (seriously, I’ve heard this… as if customers can’t shop online), media, consumer taste, etc. I will usually quickly sell the stock. Management needs to adapt to change and accept their issues before they become BIG problems…
- I closely watch a company’s gross margin over time. Declining gross margins are a sign that competition is driving down prices and I only want to invest in businesses that have strong pricing power, which is a result of their competitive advantage.
- Even great companies have minor setbacks but the difficult part is separating the minor setbacks from the big problems. I always sell when there’s a big problem that will continually hurt the business going forward. In other words, I sell when my initial thesis to invest in the company is broken. I don’t wait and see.
- Because I invest in more illiquid small-cap and mid-cap stocks, I can stomach volatility; in other words, the ups and down in their stock prices – but that’s as long as the intrinsic growth trajectory of those businesses is up over time. Amazon didn’t go straight up. Successful investors had to have the wherewithal and confidence to withstand the ups and downs in its stock price.
- I mostly focus on Canadian equities, which comprise 80% of my portfolio. I feel I have an edge as Canada is my home country. However, 20% of my portfolio is in U.S. equities. I was buying U.S. stocks when the Canadian dollar was at-parity and also above-parity but I’ll buy U.S. stocks again once the CAD reaches 90 cents. I don’t invest in European or Asian equities, as I don’t believe many companies in those regions are controlled by strong shareholder-oriented managers. Plus, the North American companies that I invest in sell products and services into those regions. It’s a win/win.
- It isn’t enough that my fundamental research checks out on each stock. Stock price momentum needs to also be in an upward trend line over time.
- I verify net accumulation in a stock by checking its accumulation/distribution on StockCharts.com. If accumulation/distribution is rising, especially in a stock that’s consolidating (trading flat), than that’s a good sign. I want other people buying, and accumulating the stocks that I invest in too.
- I do a new scan of North American stock markets – TSX, Venture, NYSE, and NASDAQ – every three months for new issues. Also, some stocks appear on my filter for the very first time because they’ve finally surpassed a metric benchmark, like return on capital. That way I’m always on top of the market.
- I’ll use leverage/margin in my portfolio, but won’t surpass 20% of my portfolio’s total dollar value.
- When I sell a declining stock, on the basis that my original investment thesis has been invalidated, I’ll invest the proceeds into one of my winners. The winners can make up for the losses and then some.
- There’s no such thing as passive investing if you’re a stock picker. I’m checking my portfolio on a daily basis. If I wanted to ‘buy and forget’, I’d cash out and put all of my money into an Index Fund but that also means accepting those returns.
- …I study other people’s mistakes. It’s cheaper. That includes mistakes by hedge fund managers, and other “smart money.” Nobody’s right all the time. As James Altucher says, the investors and hedge fund managers who are successful all of the time are probably criminals (i.e. insider trading) or about to lose everything.
- Think about all the assets (intangible and tangible) that a company owns, and not only each assets’ cash flow generating ability now, but its ability to generate cash flow in the future. Having a lot of assets on the balance sheet doesn’t mean anything if the company can’t generate a high return on those assets for its shareholders. I love companies with wonderful assets, like Disney. The worst management teams buy bad assets through acquisitions, at too high a price, and then write off their mistakes later. Management needs to be good stewards of capital.
- I go to StockChase.com on a daily basis, and check the “Predefined Scans” section, to see the stocks hitting new 52 week-highs. If I see companies hitting new 52 week highs, I conduct further research and buy based on my aforementioned criteria. Why? Because that break-through price momentum is being fuelled by high demand (i.e., investors and institutions buying the shares). Similarly, stocks that have finally broken out of a consolidation phase (flat-line) are interesting to consider.
- I never say, “I missed out on that stock,” if I see it’s gone up 500% in 5 years, for example, especially if it’s still a small-cap or mid-cap company, because I know that those great companies can compound many times more. They’re still small. I also never say, “It’s too expensive so I won’t buy the stock”, after simply looking at the P/E and nothing more.
- I don’t quickly overlook companies that aren’t generating a profit. They may be the next winners on the market. Amazon, for example. By the time Amazon started to generate a profit, it had already become a $400+ billion dollar company, compounding many times over, and making their loyal shareholders incredibly wealthy.
- When I hear that there’s a change of management in a company, it makes me take a second look, especially if I skipped over the company in the past.
- I avoid companies that only grow through inorganic growth, i.e. acquisitions, fueled by debt, because once the debt, or acquisition opportunities, dry up (and often it’s both), the stock will fall straight to the ground for value investors to scoop up. Acquiring companies, and doing just that, isn’t a business strategy.
- I like to learn about how successful investors think. Their framework on why and how they pick stocks. You can read…The Money Train, Market Wizards, and One Up On Wall Street, to get into the minds of top investors.
- There’s little spread to be made in merger-arbitrage these days, because of high frequency trading, and easily accessible information and, when there is a juicy spread, the takeover could very well fall through…so I’d rather invest in small cap companies that could soon be taken over. They’re my “speculative takeovers.”…
- I’ve come to realize that the market is largely psychologically-driven. John Maynard Keynes described the stock market as a Keynesian Beauty Contest, where “it is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.” This can be demonstrated in what I’ll coin, in an homage to “the Nifty Fifty,” “The Sexy Six:” Facebook, Apple, Alphabet, Netflix, Tesla, and Amazon.
- I compare my long ideas (stocks I want to buy) with current short positions (as a % of float), and the analysis by any prominent short sellers. I always look to see the reasons why others would want to short a stock…
- Usually the media headlines…are most depressing exactly before the market starts to turn up again after a recession or bear market. Great buying opportunity…[That’s] why I keep cash on-hand (and still read news headlines).
- If I’m buying stocks, and I see that other small-cap funds or hedge funds are buying too, that gives me some validation but it doesn’t mean it’ll work out…
- There’s always tail risk. Someday, some event will rock the stock market but I’ll only know about it after-the-fact. Because of that fact (I’m not ALL-knowing after all), I don’t worry about things that I can’t control. I control risk by holding great stocks and controlling what I can in my portfolio.
- The stock market exists to help companies raise capital, grow, and be successful. Why would I invest in bad companies that don’t grow? That’s what value investors do (or at least, try) but that’s not why the market exists…
In summary, if I’m not beating the market’s long term return, (TSX ~10%), or beating it the majority of the time, then I should stop investing in individual equites and instead be putting my money into an index fund.
It’s been 12 years (2005 – 2017) and I’m still actively picking stocks, with a 15% compound annual return. Hopefully I can keep it up because, at 15% compound annual returns, I can double my money about every 5 years, without taking on too much risk.
I hope you enjoyed my 70 Investing Rules (Part 1 & Part 2). If you did then I encourage you to also read my talk on “Capital Compounders,” which is from the Fairfax Financial Shareholders Dinner (2017).
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