For many beginners, the process of finding investment ideas can be confusing and overwhelming, especially in the stock market. Everyone wants to pick stocks of successful companies, or companies that will become successful. But there are just so many choices and a lot of information out there. Many investors don’t know where to start looking, or how to sort through the vast amount of companies listed on the exchanges. There are also many types of investments other than stocks as well.
Most investors generate investment ideas by starting with:
• names of companies that are recommended by analysts or industry professionals.
• names of companies that are involved in “hot trends”.
• using mathematical models to find stocks whose predicted price will move upwards.
• quantitative metrics to find low valuations or strong growth.
• qualitative aspects, such as competitive advantage, etc.
I will describe an approach that has worked successfully for me throughout the years, when searching for potential investments. The process has been divided into baby steps, with examples, so that investors can complete one task at a time without being overwhelmed. I perform these steps even before thinking about analysis (financial/qualitative evaluation, intrinsic value) of the investment candidate. It is more of a top down approach to generating investment ideas, but from the perspective of your priorities & goals .
This approach as the following advantages:
• Investment ideas are not limited solely to one type of investment or asset.
• Prioritizes and focuses on your plan & goals.
• Avoids chasing hot trends or popular investments.
• Reduces risks.
• Does not unnecessarily rule out good future opportunities.
• Allows for the possibility that investments may one day become serious candidates as situations may change.
• Does not automatically eliminate investments that do not currently meet qualitative or quantitative metrics.
• Ideas that play on your strengths.
• Prevents an investor from blindly flocking to investments or stocks mentioned by the media, analysts, or other investors.
• Also generates a list of suitable investment replacements.
It is important to note that this stage (just finding companies to do research) requires very little investment knowledge. Anyone can do this. Performing the research, evaluating them, and calculating their intrinsic value, requires more knowledge. But such analysis would come after this process, and is also area for more learning. Separate idea generation from analysis. Think of this stage as brainstorming for ideas only.
Think Like A Businessman :
From now on you are [your name here], businessman/person & investor.
At the end of the day, an investor is a business person, and must think in a businesslike way when investing. It definitely helps with selecting & thinking of ideas.
Benjamin Graham said that “investing is most intelligent when it is most businesslike”. Warren Buffett believes it is the single most important investing lesson he was ever taught by his mentor.
Refer To Your Long Term Plan :
Because investing is highly customized, investments should fit with your overall plan and individual goals. If you haven’t made one already, draft one first (even if it is a rough one). It is always one of the first steps I recommend beginners to take, because it is the easiest part and requires no specific investing knowledge. Its is goal setting and planning for the future. Mind you, everyone should spend a fair amount of time drafting their initial overall plan. When a draft is complete, work backwards and start thinking about intermediate goals/milestones that you need to reach between now and the final goal.
That process does require quite a bit of time, but is extremely important because it acts as an overall guide, directing the investor at each stage of the plan. Most investors skip this first step and do not have anything to guide their decisions. Often they find themselves flopping to different strategies, asset allocations, sectors, styles, etc. without getting consistent long term results. Years of hard earned money is usually wasted.
You need to set goals first, before being able to take baby steps to get there.
What Do You Want To Own? :
At this step don’t even think about stocks (why limit yourself?). Ask yourself the following questions:
Examples: Keeping it very general
• Operations (types businesses – production, leasing, lending, services, etc).
• Assets (real estate, bonds, loans, mortgages, licenses, royalties, patents, physical bullion, etc).
Jot down some very general notes. This step is just to get your brain thinking in line with your overall plan, so don’t expect to come up with much yet.
Where To Look? :
Again, at this step don’t think about stocks. Ask yourself the following question:
”If I had a few billion dollars on hand (and every dollar counts), as a business person, what kind of operations or assets would I buy and take private or hold in my private corporation?” in order to fulfill the function/purpose in the strategy that fits in the plan.
In answering this question, try to be more specific about the operating industry and assets. One of the best ways to help generate ideas for this step is to start with :
Operations which you may have in-depth knowledge:
•how they make money, marketing aspects, demand/supply, customers, suppliers, production, etc.
Assets where you have an understand of the underlying economics influencing it:
• conditions, laws, government policies, economy, etc.
Ideas can be drawn from your knowledge & experiences. This includes formal education, previous/current jobs, informal education, other experiences, your spouse’s experiences/education, your family experiences, etc.
Think of everyday things you are familiar with. Think of things you use, do, need/want, places you go, etc. Or they can simply be subjects that you are interested in knowing more about.
Reading business & industry trade magazines are also one of the best sources finding ideas. Sometimes a certain topic or event is discussed, and some companies are mentioned (involved, affected, interviewed, example, etc.) .
Start there and then expand outwards. Your list may be quite large at the end of this step. But don’t disqualify any ideas yet, as its just brainstorming for now. Below I have listed a variety of examples.
Note: Industries/sub-sectors I have listed may not be using official or “proper” names. The intention is to help stimulate some ideas.
Examples: Being more specific about industry/asset – there are tonnes!
• Retail restaurants, Oil, Gas, Mall leasing/development, Office lease/dev, Residential dev, Retailer, Clothing, Mining, Electronics (semiconductors, PC, control systems, appliances), Industrial (chemical, materials, machinery, services), Energy services, IT solutions (data, software, storage), Entertainment, Leisure (products, vacations, etc), Food production, Agriculture, Pharmaceuticals (human, animal, vaccines, diversified, generics), Medical (services, devices), Health care (elderly, critical care), Contract manufacturing (semiconductors, plastics, etc), Transportation (rail, air, sea), Services (delivery, maintenance, drilling), Banking (investment, retail), Financial (investment, hedge fund/private equity, services), Insurance (reinsurance, home/auto, life-co), Telecommunications (cable, phone, cell, etc), Broadcasting (TV, radio, film, etc), etc.
• Office real estate in a major city, Big box retail plazas in Canada, Mortgage securities, Corporate bonds from motorcycle companies, Corporate notes, Preferred shares, Licensing agreements for movies, Royalties agreement from restaurants, Gold bars, Silver coins, Futures contracts….
Examples: Whats around you, what is familiar – things/brands/places/names/etc
• Things that you buy a lot of.
• Things you use.
• Places you visit often.
• Activities that you are involved in.
• Things or services you need.
• Services you use frequently.
• Things, services,places, activities, that people you know ….like, do, use, need, etc…..
• … that your workplace or profession …. likes, uses, need, etc…..
• ….that people in your city….likes, uses, needs, etc….
Think About Specific Brands/Companies/Assets :
At this step, expand your list and drill deeper by thinking of the name of brands (and the associated companies that owns the brands), companies, and actual assets. This part helps you figure out what you think is the best within each operation or asset you selected. At this step, don’t limit yourself to companies that have public stocks. Don’t worry about what is actually available or not (some that aren’t available today may one day become available).
Examples: Companies that run specific operations, or owns a particular brand
• Lululemon (clothing retailer & manufacturer)
• Apotex (pharmaceuticals – generics)
• Aveeno -> Johnson & Johnson (pharmaceuticals,health care, medical – diversified health)
• Sands (entertainment – casinos)
• Paramount -> Viacom (entertainment – TV, film, theme parks)
• ADP (IT/finance – data / paycheck processing)
• KKR (financial – hedge fund)
• VeriFone (financial – mobile transactions)
• Moody’s (financial – rating services)
• SNC Lavalin (infrastructure – engineering services)
• Corning (manufacturing – ceramic materials)
• Precision Drilling (services – contract drilling & rigs)
• Monsanto (agriculture/bio-science – seeds)
• Starbucks (food – retail restaurant/roaster/producer)
• Lindt (food – chocolatier)
• 407ETR (transportation – highways)
• GTAA (transportation – airport)
• TetraPak (manufacturing – packaging)
• Hines (mall/office/residential real estate – lease/dev)
• YKK Group (manufacturer – zippers/diversified)
• Fairmont Hotels (real estate / leisure – hotel / real estate development)
• Smiths Detection (manufacturer- security devices)
• SoftBank (telecom – Japanese cellular)
• Ace Bakery (food –producer)
• BBC (broadcasting – TV, radio, film, etc)
• Mozilla (IT – software)
Examples: Specific assets, names, or companies that own them
• Private real estate offices located in New York
• Vornado Realty
• Farming properties in Canada
• Canadian mortgages from TD Bank
• US government treasuries 10yr
• Harley Davidson corporate bond
• Royalties from the Canadian chain restaurant Jack Astor
• Patents related to cell phone devices
• Silver coins from Australia
• Cotton futures contracts
• Gold index/ETFs
Determine What Is Obtainable :
Now that you have a pretty comprehensive list. Search and determine if you can acquire them and how:
• public companies traded on stock exchanges (local or global)
• owned by private corporations
• obtainable via private transaction (i.e. with company directly or through certain institutions)
• available in the futures markets
• requires minimum investments of $25,000
• qualified investors only
• closed to new investors
This step will filter out what is unavailable to you at the moment, from your list of ideas.
Note: Keep ones that are filtered during this step in a separate list. The situation may change in the future in which they may become obtainable.
•Lindt is traded on Luxembourg exchange.
From the previous list, names listed from 407ETR down to Mozilla, are unavailable directly or as separate tradeable securities:
• 407ETR corporation is owned jointly by SNC Lavalin, Cintra Infraestructuras SA, Ferrovial SA, pension plans, mutual funds, etc. SNC and Ferrovial are public companies. SNC is traded on the Toronto Stock Exchange, while Ferrovial is traded on the Spanish exchanges.
• Hines real estate funds are available through private transactions, while the Hines REIT is no longer accepting investors.
• Ace Bakery once private, has been bought by Loblaws. Loblaws is public.
• Smiths Detection once private, now part of General Electric. GE is public.
• BBC is owned by British government.
• Mozilla is not a corporate entity, nonprofit.
• Office in New York are available, but not quality you like, and still over $1million. Private transaction not possible at current platform level. (One day might be at a different level).
• SmartCentres brand is licensed by Calloway REIT, which owns, operates, and develops the big box shopping centres. Calloway is public.
• Limited partnerships are available for purchasing portions of farming properties in Saskatchewan. Various companies out there to invest with privately. Some need min $25k invest.
• Jack Astor royalties are under SIR Corp. SIR corp is public trust.
• Silver coins from Australia purchasable off Internet from a number of reputable retailers such as Kitco, or directly from The Perth Mint’s online store.
• Cotton futures contracts avail – with different time periods from months to a year etc.
• Several gold ETFs exist – some hold actual gold bullion, other buy/sell futures contracts.
Filter Out Businesses & Assets You Don’t Understand :
Many times a large portion of investment risk comes directly from the investor. You need to understand the operations/asset a bit more in-depth to identify the inherent business risks, as well as other associated risks. Then you could determine how they actually impact the business/asset.
Taking a page from Buffett, it is wise to stay within your circle of competence. Not only does it reduce unnecessary risks, but doing so gives you an advantage, as you would have an understanding & knowledge of the subject. Such competence mainly comes from your education (formal/informal), experiences, occupation, business partners, etc. It also helps you to avoid certain businesses/assets that may not be good candidates, because you understand how the risk impacts them.
Note: Filtering out ideas at this stage doesn’t mean you will never come back to them. Keep them in a separate list. That list will also highlight areas that you may wish to learn about in a more in-depth manner (in order to invest in it).
All investors should understand the general finances of any business. But not all investors will understand the operational aspect of every business, or the economic conditions impacting every type of asset. There may be many areas that you wish to learn in-depth, but you’ll have to pick and choose as time & resources are always limited.
Ask yourself the question:
“Of these businesses, if I were to take over as CEO and take the company private, how much of the financial, strategic, & operational aspects would I be able to understand?” or “If which of these businesses would I be able to start up?”
Stick with the ones you understand, or first learn up to a point where you would be able to understand much more than the average person. This step should narrow down your list of potential candidates to a comfortable & manageable level.
Examples: Some areas I would own
• Mining (metals) – My dad worked in the industry, which eventually lead to my own accumulation of knowledge in this area..
• General retail – Knowledge through personal experience and from my wife. I run any considerations by my wife who worked in different levels of retail. She knows operational aspects from the store shift level, up to management level. Even corporate executives who never worked on the floor make huge mistakes because they didn’t understand the actual operations!! An example was Starbucks’ initial hot food roll out in Canada.
• Commercial real estate – Personal experiences.
Examples: Some areas I would filtered out
• Oil or gas companies. I don’t know if LNG or Shale gas operations are better. I don’t know the actual operational differences of extracting oil from the oil sands compared to traditional or off shore oil, etc.
• Software – I work in the field. However, there are almost none that I would like to own.
• Technology – In general, there are a lot of new technologies that I don’t have a good enough understanding of.
• Fashion / clothing
One Final Check – After Filtering Out :
After filtering out the businesses & assets you do not yet understand, go through one last check before performing analysis on them. Ask yourself the following question:
”If I had a few billion dollars on hand (every dollar counts), I as a business person, is XYZ the kind of operation or asset I would buy and take private or hold in my private corporation?” (in order to fulfill the function/purpose at the current stage of the the plan).
The answer should be an easy “Yes”. Any significant hesitation indicates that it may not be the most suitable potential investment idea at the moment. Reasons may be that you either need to know more, or it simply isn’t a good fit at this particular stage, etc. Don’t throw out the idea, just keep it in another list.
Now that you have completed all the baby steps, you should have a short list of potential investments to perform further research on. You should also have a list of ones that were filtered out, which could be potential subject areas for learning. Beginners may have actually filtered out all the potential investments. If that is the case, it is time to choose one of the potential subject area to learn more about so that you can invest in them.
Advantages Of Starting With This Approach :
There are a number of reasons why I prefer starting with this approach, over other ones, for finding investment ideas. Some of the differentiating reasons include:
• It creates a list of investments that are not limited solely to one type of investment or asset, such as stocks. Investments are simply tools, and some tools are better suited for certain purposes than others. In this approach your investing landscape is not limited only to returns from stocks. There will be conditions that arise, in which stocks will be less suitable. For example, an investor would not feel compelled to invest in stocks (as their only choice) prior to the financial crisis with this approach. This is true for all investment types & assets, not just stocks.
• This process prioritizes and focuses on your plan & goals. It identifies what you need at a particular stage in your overall plan, rather than chasing hot trends or popular investments. Every single investment candidate would fulfill a particular purpose or function in your plan, that is geared towards helping you reach your goals. Most investors become lost & unfocused because they have one loosely defined goal, which is just to make the largest possible returns on each investment.
• It creates a comprehensive set of potential investments and does not unnecessarily rule out good future opportunities. Opportunities can be identified even if they are not yet suitable. Reasons why they would not be suitable yet may include not possessing the knowledge to assess them fully yet, not available, industry not mature enough, economic conditions not advantageous yet, do not possess large enough funds, etc. It allows for the possibility that investments may one day become serious candidates as situations may change. Ones that aren’t yet serious candidates for further research & evaluation are simply put on the back-burner, rather than eliminated completely.
• It does not automatically eliminate investments that do not not meet qualitative or quantitative metrics. The importance of this can be illustrated with an example. Many investors use quantitative metrics based on valuation or relative cheapness. With my preferred approach, an investment that may not be cheap enough would not be automatically eliminated. It would remain on the list, and then be put through the next process (analysis), which at that point would be filtered out based on its price. Subsequently, it could then be put on a watch list, until the price became attractive. However, starting with quantitative metrics first, it may never have been a potential investment idea at all. It may have been filtered out at the beginning, and never be fully researched and analyzed. It is likely that it would not make it onto a list to be watched.
• It selects investment ideas that play on your strengths (knowledge, readiness, experience, interest, etc) rather than your weaknesses. Other methods may generate ideas and point towards them as serious candidates, even if you know nothing about the related industry. That would increase the risk of investment loss.
• It prevents an investor from blindly flocking to investments or stocks mentioned by the media, analysts, or other investors. This approach helps to create a list of potential investment ideas, where you have your own reasons as to why they should be considered for further analysis. This is important as it allows an investor to start thinking for themselves, separating them from the herd mentality at the beginning.
• It helps to create a list of suitable replacements. For a number of reasons, specific investments may outlive their usefulness. Reasons may include change of influencing conditions, reaching their intrinsic value, unexpected negative events, deterioration, etc. In such cases, you will need to find suitable replacements that fulfill the same purpose/function within your overall plan. This approach allows you to think of investments that could be possible replacements, which may share very similar (but not necessarily identical) aspects. For operations, they may be related to operational flow, market, industry, etc.. For assets, they may be related to economic influences, conditions, terms, etc.
Beyond Finding Investments [Research, Evaluation, Valuation] :
After generating ideas of some potential companies/assets, the next process would be to analyze and determine their investment worthiness. It involves:
– Everything about the company (industry/segments, size, suppliers, customers, distribution, products/services, competitors, strategy, vision, problems, successes, laws, risks, etc.).
– Everything about the asset (industry/segment, demand/supply, sources, liquidity, policies, rules, covenants, risks, etc).
– Determine finances & accounting statements of business (revenue, income, health, ratios, debt, performance, efficiency, costs, margins, cash flow, other metrics).
– Determine qualitative aspects of business (quality of management, strengths of business, market dominance, etc).
– Determine the underlying economics affecting the asset and its impact.
– Calculate the intrinsic value of the company/asset (put a dollar value to it).
– Calculate probable return.
After completing analysis, you would be able to make a sound investment decision given the current market price of the company/asset. But evaluation & valuating are entire topics on their own, best left for another article.
DISCLOSURE: I hold shares of Johnson & Johnson, Calloway REIT
Thanks & Happy Investing! — The Investment Blogger © 2011