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How I pick shares- Part 1 (Knowledge)

On the other hand, investing is a unique kind of casino — one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favour.” Benjamin GrahamThe Intelligent Investor

Each investor has their own approach and methodology as to how they pick shares. I thought it was time that I shared mine. I intend to write this over several weeks*.

I started my investment journey in the hills of the double-dip that took place back in 2011. We'd had the most horrible crash in the Stock Market in 2008-2009. I was very lucky as I went from a place professionally where I could have lost my job (the US business I worked for was planning to close down my office) to being part of a management buy-out that saw a premature promotion to a senior position and relative job security. However the rosy glow of the initial optimism of 2009-2010 was now in the rear view mirror. 2011was brutal as we nearly wobbled back into full recession and some stocks had taken a hammering. In retrospect it was the ideal time to get involved, as pessimism abounded and value existed.

What I learned back then still influence my thinking now. I wrote back in January how Fantasy Football taught me how to gain an edge in share investing. The principles from that are how I started.

Well I'm going to look at the following principle from that this week:


(1) Having a good understanding of players and analysing the players you pick is very helpful indeed in picking a winning team and reduces (without eliminating) the risk of picking dud players. So learning and analysis is important.

So how do this lesson help me?

There are plenty of professional investing types who will tell you that it is impossible to be consistently good at investing in individual shares, as the sheer level of information that you need in order to make an informed decision to invest is beyond the reach of most individuals. I've heard accountants don't typically make great investors as they can find red flags over any company!

Whilst I agree that there is information that is beyond the reach of individual investors, thanks to the global marketplace of the internet if you know how to use it, you can find out a lot more than you ever used to. Furthermore there are excellent research tools such as Stockopedia  and Sharepad that make your life much easier. If you'll pardon me, I think professional disdain for individual investors is rather old fashioned and harks back to an era when the professionals did have far more of an edge. 

The other truth is that the stocks which are going to make money are those with smaller market caps and  they tend to get far more ignored by the professionals. The result is that if you can concentrate your time and effort on really understanding these companies, you may well develop and edge that even most of the professionals can't match.

Now obviously this all comes with warning, as small caps can often get hammered more than most in times of crises. they are illiquid and AIM (which is where you often find them) is more lightly regulated than the Main Market. However if you want value (or certainly misprices), you are more likely to find it in these places.

Applying the analogy, why then do some people excel at Fantasy Football and many others perform in a ho-hum manner? Well these people tend to have an instinct as to which players are performing above their quoted value and buy them before others do. Once the players start to rise up the ranks, their value increases making it harder for other managers to import them in without compromising their finite budgets. So there is a distinct advantage in being an early mover. You will net the early points haul and be in  better place to move the player on when they have reached optimum value to sell, so you can move on to the next value play.

These players tend to come to the fore at the smaller "less fashionable" clubs (classic small caps by analogy) where knowledge about players is much more scant- unless you are dedicated. I remember a certain Andy Carroll who was a striker at newly promoted Newcastle United in 2010. You would have only known about him if you'd seen his performance in the Championship promotion run. He started that Premier League season like a train and scored a hatful of goals, despite having only a Fantasy Price-tag of £5 million (good strikers tend to be double that). He was snapped up by Liverpool FC in January 2011 for a record sum.

Equally "forgotten" players at bigger clubs who are in the rise can also be a fruitful hunting ground. Perhaps my favourite example was Gareth Bale who was a £5 million left back at Spurs. He had a rocky start to his career and was nearly sold. However the shrewder managers would have noticed that his assist rate for goals suddenly started to climb when he was moved into midfield. Spurs also kept more clean sheets. Bale scored goals too (notably free kicks) yet he was still classed as a defender meaning that goals scored provided 5 points rather than 3.

Those "in the know" profited because they took the time to study these special situations. Although Andy Carroll's career was beset by injury, he did go on to play for England. Gareth Bale became one of the best (and most expensive) footballers of the modern generation.

So what am I looking for as I expand my "knowledge" of the Market. In short I'm looking for companies that have a well managed, well financed (i.e. sensible debt) growth strategy in areas where demand for their good or services will hold up well and expand. I like to see some track record (i.e they need to producing a profit rather than the hope of one) and I like to see a capable and focused management. If I believe that what I am paying for them now is less than what I genuinely believe they will be worth in the future then I am interested. If a company has a competitive advantage (such as a patent or operate in a marketplace where there is a high bar to entry) then they make it on to my watchlist.

I am constantly reading and looking for listed companies who are growing and thriving. If I spot one, I look to build up my knowledge about them before considering buying their shares. I may miss out by not jumping in at the start, however if I am in it for the long haul I really don't mind missing out on those initial  price rises if it helps confirm or challenge my working hypothesis.

The truth is that there are a lot of listed companies out there which are not worth investing in. As a private investor however you have the luxury of being able to spend your time choosing the really good ones.

As ever, this blog is published subject to my disclaimer


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