A few weeks back I read the book called “The Motley Fool investment guide” written by two charismatic brothers, David, and Tom Gardner. They are also co-founders of the Motley Fool, which offers financial investment and planning services.
Each of them has their own style of investing and they differ quite a bit from each other. Tom’s style leans more towards “traditional” approach, like large caps, companies with a long history which have survived multiple business cycles. Whereas David’s style is more tuned towards growth stocks which have small market caps.
Here are some key take aways and checklists from the book:
Foolish investment process (Tom’s investment style):
Tom looks at the company’s Culture, Business Strategy, Financials, Safety and Valuation (in that order).
Culture :
Following are some ways to understand company’s culture:
- Company’s rank in Fortune best companies to work for list
- Ehisphere most ethical companies list
- Glass-door reviews
- The founder is the CEO
- Employee retention rate
Strategy:
- Are you(the investor) using the product? Will you pay more for the same product/service? (Pricing power)
- Recurring revenue. Products that consumers will have to buy every 30 days
- Growing total addressable market
- Capital allocation: growing gross margins
Financials:
- Sales growth
- Higher profit margins
- Healthy return on equity ( around 15-20%)
- Healthy balance of cash and long term debt
- Acceleration in owner earnings
Safety:
- Founder-led company and if there is a plan of succession in place
- The company is aware of disruptive threats and reinvesting to make sure they neutralize it
- Diversification in clients – one client should not be more than 10% of revenue source
- The company is not getting too big to grow – law of large numbers
Valuation:
- A high growth rate of owners earnings
- Expected growth rate higher than market
- Expected long term growth rate should match historic growth rates
- 5 year minimum holding period
The following is David’s investment style. He calls it “Rule Breaker Investing”. He even has a weekly podcast with the same name.
6 sign of a rule breaker:
- Top dog and first mover: dominant market share, highest market cap, first mover, creates its own niche
- Sustainable advantage: business momentum, patent protection, visionary leadership, inept competitors
- Past price appreciation: market recognizes the winner, Newton’s law of inertia
- Good management: listen to conference calls and interviews, are they smart? visionary? Inspiring? Look at their track record
- Strong consumer appeal: strong brand, rarely needs to advertise, their brand is associated with “experience”, a consumer doesn’t need to know what to buy or when to buy, the company can increase prices by 5-10% without losing market share
- Overvalued , according to media
Great stock takes not two minutes, but one sentence to explain
Companies usually go through a hype cycle. hype cycle can be described as the following phases:
- Technology trigger
- Peak of inflated expectation
- Trough of disillusionment
- Slope of enlightenment
- Plateau of productivity
We need to identify companies that are between 1 and 2.
Following the the screener that can be used to narrow down the universe of companies. Foolish Eight:
- Company sales: 500 million or less (to avoid big stable companies)
- Average daily dollar volume(average daily volume * stock price): from $1 million to $25 million (for liquidity purposes)
- A minimum share price of $7 (less than that falls into illiquid junk)
- Net profit margin of at least 7% (net margin relates to the quality of company)
- Earnings and sales growth of 25% or greater YoY
- Insider holdings 10% or more
- Cash flow from operations is a positive number
- Relative strength: strong price appreciation
Some misc points
Things to look in income statement:
- Margin rise at best and stay steady at worst
- Make sure the company is continuing to invest in R&D
- Make sure the company is paying full income taxes
- Shares count not increasing a lot
Things to look in balance sheet:
- High cash and cash equivalents
- Avoid too much debt
- Make sure growth in accounts receivable and inventory approximates sales growth