You may be nodding your head in agreement. Think about those sorry souls whose birthdays fall on Christmas and how they will forever be gypped of presents! Yes, most of us feel it is best to spread out the cheer; however, when we invest, don’t we pray for Christmas and our birthday on the same day?   When we buy a stock, we want all the good news to happen immediately. Sure there is a real opportunity cost to money. We want to cash out quickly so we can move on to the next great investment. Can all the stars align and we make our 50% upside in 2 weeks instead of 2 years? Maybe. But more times than not, we’re waiting longer than we’d like for the stock to go up.

Worrying and waiting for the stock to pop upon purchase is like hoping for a two in one celebration. Most of us wouldn’t want this in our personal life and expecting this in our investing life makes it harder to look beyond the short-term noise. We end up selling and often times too soon.

Investing takes patience and expecting Christmas and your birthday rolled into one is what drives us batty. While we’re certainly not going to pray for snow to slow things down, if you’ve done your research on the stock you own, then Christmas and your birthday should come around, they just may not be on the same day.

The apple fell pretty far from the tree when it comes to gardening, green thumb I am not. But I like to think that investing for the long term is a lot like gardening. We plant our investments months, even years in advance expecting that come spring the bulb grows up to be that rich ruby red tulip advertised on the packaging. There’s the daily tending to the garden, making sure the soil is replenished and the plants are watered. Also, the pulling out of the inevitable weeds that mange to creep in (hey, no one’s perfect and when it comes to investing you just want more right calls than wrong ones) and if you’ve followed your process and the rules of gardening, you get to enjoy the best part – the harvesting of the goodies.

Unfortunately, nowadays it seems like investing has become like the US college basketball single elimination game – you lose one game, you go home. A team’s had a winning season but then one bad game? Sayonara. It’s an unforgiving system that makes a decision based on one data point instead of seeing the data point in a greater context. Truly this is madness.

Even the best of companies slip up for one reason or another, so as an investor it’s your job to determine if the slip up is due to temporary and identifiable reasons. Investing is about recognizing patterns across multiple events not making conclusions based on a single one. Though sudden death games make for exciting television viewing, when it comes to investing let’s keep the madness where it belongs – in a sports bar and not in your portfolio.

I think it’s like the feeling I get when I look at my to-do lists. There’s giddiness about the eventual gain despite the ongoing pain. Over the last few years, we’ve seen a “deleveraging” going on in the market (i.e., defaults). Whether it’s a never-to-be repaid credit card bill, mortgage payment or government bond, bad debt is making its way out of the system. A big reason for the market volatility. But for all its short-term outlook shortcomings, the market is a great discounter of already-known news. This is what investors mean when they say things like “Oh, that bad earnings report last quarter? It’s already baked into the stock”.

The great thing about the market is that it’s forward-looking; it’s not stuck living in the past. So as we work through this deleveraging process, risk is being taken out of the system, all else being equal. With less risk, investors are feeling less fearful of the future. Though I don’t think anyone really knows how much bad debt is out there, we have a few years’ worth of less bad debt on the books. And unlike my lists which have no system in place to limit the number of my to-dos, institutions and governments have been putting regulations in place so that, for example, people without income can no longer get six figure loans.

The credit crisis and subsequent deleveraging we’ve been seeing is helping take risk out of the market. With less chance of default, the market’s looking ahead to happier days. There’s still huge uncertainty out there and well beyond our borders – China’s economy slowing down or the Middle East’s political unrest, to name a few. But such temporary events serve up buying opportunities for the long term investor like me and other than checking things off my to-do list, nothing gives me more joy than buying high quality companies on sale.

Now this year has been brutal for the bottom-up stockpicker. The correlation among S&P 500 stocks is at a record high of almost 0.80 (1.0 being perfect correlation). Believe it or not, this is higher than during the 2008 market crash when everything went down en masse.

A high positive correlation means that stocks move in the same direction – so whether you’re a consistent dividend paying market-leader or a junky debt-laden losing-market-share business, the stocks of both companies move in the same direction. There’s no differentiating between quality and junk and in such an environment, you can blindfold yourself, pick any number of stocks and they would all pretty much perform the same way. Whatever you owned would trade in the same direction, a scary thought to those who claim they can pick stocks!

When does this happen you ask? When macroeconomic factors overshadow company fundamentals. This year the stock market has been driven by macroeconomic factors (government stimulus programs) and global economic news (Eurozone crisis). These past few months, news out of Europe have been calling the shots – the market plummeting on days when the European Union waffles on a bail out of Italy and Greece, and soaring when the EU suggests they will step in. So in such a market environment, what does a bottom-up stockpicker like myself have to be thankful for?

Well, I am thankful for quality management teams who despite large cash balances, aren’t making ego-driven bad acquisitions and squandering cash. Instead they are reinvesting it into the company or increasing their dividend payout. I am grateful for managements who continue to cut waste, search for lower cost suppliers and streamline unnecessary or overlapping expenses. And I am appreciative of all the company employees who are learning how to do things more efficiently with fewer dollars and resources.

As the CEO of one of our portfolio companies said, they’re not going to get any tailwind from the global economy so they have to figure out a way to create their own growth. This means coming up with new and innovative products so that people will buy or offering better customer service so that customers will stay. This is what good companies do – they stay on course of continuous improvement through hell or high water.

So as a bottom-up stockpicker, this is what I’m grateful for because fundamentals always matter. If you can hold on to a longer term outlook and look beyond short term volatility, you too will be thankful for what high quality companies are doing when it seems like stock picking doesn’t count.

When I ask this question, I’m often met with an “are you kidding me?” look – do you need a right reason? Just be happy your stocks are going up, thankyouverymuch. However knowing why your stocks are going up when the market takes off will protect you on the downside when the market turns south.

These “straight up” months are often called “junk rallies”. Yes junk as in lower quality and these riskier stocks tend to lead the charge. In October, investors (a moody bunch) decided that the world wasn’t going to end (Greece got bailed out – hooray!) and when investors feel better about the future, they take on more risk. So they went shopping for lower quality/riskier companies like ones with more debt or more cyclical sales because the probability of bankruptcy goes down when things look macroeconomically brighter, all else being equal.

If you find your portfolio outperforming for non stock specific reasons, be careful – you may be holding a handful of junk. This will feel great in a month like October, but hurt when sentiment reverses and lower quality stocks drop like a cinderblock as investors do the inevitable “flight to quality” dance.

At SAM, we manage a portfolio of high quality stocks and in these straight up months, we tend to underperform – we will be up, but up less than the market. I’m happy to report that the portfolio is behaving the way it should. When a portfolio manager loses money, she’s in the hot seat because everyone wants to know what went wrong. But equally important is understanding the reasons when she outperforms. This is a great check on your money manager – is she sticking to her strategy.

Successful investing requires a disciplined strategy so call me crazy but when it comes to investing I will look a gift horse in the mouth.

The Washington Post had compiled comments in recent weeks by executives of more than three dozen large companies to see what they’ve been saying about the economy and the plans for their businesses. Though the CEOs aren’t talking about a massive hiring spree, they’re not closing up shop either. Even in my small cap universe, I’m hearing the same thing – choppy economy prompts caution not retreat. There seems to be a definite disconnect between Wall Street and Main Street.

Now I’m not one to quote accounting books, but in accounting there’s a term called “going concern”, the idea being that the company is assumed to be around 1, 5, 10, etc. years from now. Depending on how much cash you need when, this “going concern” concept certainly applies to you when it comes to investing.

You see, owning stocks requires a CEO mindset – you don’t close up shop because of short term stock market setbacks. You need to see the bigger picture and have confidence that the stocks you own will be around for the long term. However, investors are often told to hang in there because of a vague and frankly outdated argument that stocks outperform in the long run. Don’t tell that to people who over the last 10 years find themselves in the same place where they started.

During July it was a fearful stock market that watched the Mexican standoff between the U.S. Democrats and the Republicans over raising the debt ceiling. For reasons plenty explained in the news & papers, a deal finally got done, all the while investors rushed to/from the exits with more ultimately leaving than staying.

Many argue that July’s poor stock market performance was self-inflicted (will the politicians stop bickering and just raise the debt ceiling – please?). It came down to the August 2nd-wire and though I won’t pretend to understand the horse-trading that goes on behind Washington’s doors, this seemed like a classic case of a person getting in her own way.

I’d like to think there’s a big difference between politicians and investors, but when it comes to investing, we too can be our own worst enemy. Filibuster debates on which stocks to sell; carpetbagger opinions on which stocks to buy; and gerrymandering of facts to support the position. All this going on in our heads and in a market sell off, it’s easy to lose sight of the broader picture and get mired down in the mud.

The greatest edge you can have as an investor is a longer term horizon to ride through the dips. Since it’s next-to-impossible to call the bottom of the market, spend your time going back to the basics. Do your reasons for buying this stock still hold up and does the valuation still make sense? After doing your homework, you should be buying more or getting out. Hemming and hawing may work in D.C., but it won’t in your portfolio.

“It was the best of times, it was the worst of times….” If Charles Dickens were an investor, you’d think he was writing about the market performance in June. For the first half of the month, the market sold off with the Russell 2500 benchmark index down almost 8% by mid-month. The second half of the month the market rallied and though the Russell 2500 ended the month down 2.20%, it had clawed its way out of a deep hole in just fifteen days.

As many of you know, the US government has been busy buying bonds from banks to jump start the economy. The idea is that banks use this money to lend out. This increases spending and as demand for things increase, prices go up and we have inflation. Now the problem is that when you have inflation, the real value of your dollar goes down and so the dollar “depreciates”, which takes me back to summertime travel and the J-Curve or what I call the “things will get worse, before they get better” curve.

The J-Curve is just that, a graphed curve in the shape of the letter J. In the world of economics, this curve refers to a country’s balance of trade (i.e., does it export more stuff than it imports). As the value of the dollar relative to other currencies falls, it costs more dollars to import that Italian Gucci handbag since the weaker dollar now buys fewer Euros. So in the short run, we find ourselves in the sloping down to the bottom of the J part of the curve. The dollar amount of our imports is higher than our exports and we have a trade deficit. We also can’t believe that the Canadian dollar is worth more than the US!

For US companies that import items to produce their goods, their costs go up. But they may not be able to raise their selling prices as fast, if at all and so profits fall. This is a strong and persistent theme among companies these days. With the dollar being as weak as it is, US companies are crying out in unison – we missed our bottom line because of rising input costs.

However there is hope at the end of the J-Curve tunnel because in the long run, companies should be able to find cheaper suppliers; they should be able to raise their selling prices; and more importantly, the weak dollar should encourage other countries to buy more cheap US goods. Once this happens, we’ll find ourselves on the upward slope of the J, heading higher.

During these down days of the dollar, I really get to see the high quality companies stand out. They are the ones who have “pricing power” – they’ve been able to raise their selling prices to cover rising costs because people still want to buy what they have to sell. I’ve also found great companies on sale because some of their inputs must be imported and in the short run, their profits are getting squeezed.

It’s hard to have faith in the J-Curve when you’re a short term investor. Maybe it feels better to sell now and go away for the summer. If you do and find yourself with fewer Euros than you’d like, just remember you could be making up the difference by investing in great companies that in the long term will ride the J-Curve to profitability once again.

Then it struck me how similar that show is to the stock market. As an investor, every day I experience a form of Idol, but instead of watching beautiful young people sing, I watch stocks sink or soar.

Benjamin Graham, the father of value investing, described it best when he said in the short run, the stock market is like a voting machine – tallying up which companies are popular or unpopular. Every day, investors cast their votes for what they “like” and the stock price reflects the actions of millions of people who buy or sell based on a feeling.

But Graham also noted that in the long run, the market is like a weighing machine – assessing the substance of a company. In the long run what counts is the firm’s actual underlying business performance, not the investing public’s fickle opinion about the company’s short term prospects.

What makes the market more exciting is that unlike Idol where Pia has now been “delisted”, in the stock market you can always find companies that aren’t getting enough votes right now for whatever reason – either company specific (new product launch off to a shaky start) or secular (who wants to own sleepy utility stocks in a bull market). As a long term value investor, my job is to figure out if a stock is unloved for identifiable and temporary reasons, and if it has what it takes to become the next American Idol.

knowing when to sell is the other side of the knowing when to buy coin. your job is to make sense of all the information out there to figure out which side of the coin you should be on. and here’s the secret – if you did your homework figuring out whether to buy, just repeat these steps to figure out if it’s time to sell. 

is the price right? what’s the valuation looking like relative to itself, its peers, the market. is it still a high quality company? are the fundamentals like earnings power and quality, cash flow, competitive position, debt levels, ROE, etc., still intact (if not getting better). what’s the quality of management? is it the same CEO running the show or have there been major changes in management. remember – being a successful investor is either buying an undiscovered gem or buying when the stock price is temporarily mispriced for identifiable reasons. 

during earnings season, you get to hear from the people running the business talking about the business – scripted and unscripted. i live for the unscripted moments because they provide insight that financial numbers can’t convey. for all the public to hear, company management will often tell you where the business is heading. of course you need to trust then verify with your own analysis. i try to look for disconfirming evidence but it’s a delicate balance – if you’re always listening for lies, you may miss the truth when it’s talking straight at you.

on a recent earnings call, i heard the company CEO say something that was music to my investor ears (the stock went up almost 20% that day) – he told us to ”hang on to our forks.” commenting on the future of the company, the CEO said as a kid growing up, after dinner whenever his mom would say “hang on to your fork”, he knew something good was around the corner. so folks, if you found a high quality company to invest in with still upside to your price target, there may be a short term lull between dinner and dessert – but hang on to your fork.

Beijing is littered with hotels that make the Wynn look like a Super 8. all the major international hotels are there and then the domestic ones with Chinese names but Western architecture. and like the Nevada desert, Beijing is sprawling with room to build these monster hotels. but unlike Vegas where the hope is that the economy rebounds and people once again return to frolic and play, it will take another Olympian feat to fill these Chinese hotels.

even with the recent 21% hike to the minimum monthly wage, earning USD175 a month ain’t going to cover the average hotel stay of USD50 per night. so the question isn’t who’s staying at these monster hotels, but who isn’t – and that’s the majority of the Chinese people. 

China’s hotel industry is a reflection of a real estate market (and government policy) gone awry. the rest of the world’s experience has debunked the “build it and they will come” policy yet construction continues because of the disconnect (i.e., manipulation) between supply and demand. and as i learned in Econ 101, any time there’s government intervention  to set supply or demand, deadweight loss is created.

as an investor, i try to make sense of how the things i see and read impact the stocks i own and the ones i hope to buy (or short). investing in emerging markets like China requires a long term perspective because you’re banking on the rise of the middle class - an inevitable but drawn out phenomenon. however it will take decades to get cash flow coming out of these hotels, if at all. since a lot of China’s real estate developers are state owned, private or only traded on Chinese exchanges which bar foreigners from owning stock, China’s doing us a favor by keeping their real estate investments local. so perhaps government regulation isn’t so bad after all.

regardless of whether you own ten, a hundred or a million shares, i’ve found that small cap company management will take your calls (and if they stop, that may clue you in to something too). as the CFO of a small cap tech company once told me, he was amazed by how few shareholders bothered to call. now as a bottom-up research investor, i love talking with management because behind every stock price is a hot-blooded company run by real people. they are dealing with real issues all the time not just four times a year when most investors tune in to listen to the quarterly conference calls.

stocks move based on expectations and when a stock goes up or down (crazy flash crashes aside), it’s because something unexpected happened. there are times when truly the unexpected occurs and there’s no way you would have know (or if you did, you’d go to jail for acting on inside information). other times, the “unexpected” was there to be expected had you just followed up with management about something already disclosed in a company press release, something their customer/competitor/supplier had disclosed or a development in their industry.

investing is both an art and a science and part of the art is discerning knowledge from conversations. remember, you’ve got to do some basic homework before you call, the company CFO isn’t your new bff so be prepared (would you want the CFO spending time running through the rudiments with you or busy managing expenses?). so make sure you’re somewhat prepared before you dial, but don’t be intimidated – as a shareholder, you own a piece of the company. on the website of every publicly traded company you’ll find an Investor Relations section with an email or telephone number. set up that call – though it may not be as enjoyable as speaking with your mom, more times than not, management will pick up and i guarantee you’ll get insight into your investment that staring at the financials won’t provide.

i’ve often read that diversification is the only free lunch when it comes to investing. put your money in a basket of stuff (stocks, bonds, real estate, etc.) and this will lower the risk of your portfolio without lowering your expected return. by spreading your savings in a variety of assets which, in theory should not move up or down together, you’re reducing your risk of losing it all. the thing is, as 2008 has shown us, in a bear market the only thing that goes up is correlation.

but what if you put your eggs in a basket of high quality companies that can grow earnings over time? then you may find yourself with a free lunch if you invest for the long term. remember – a stock price represents the discounted sum of all the future earnings of that company. so if you invest in a business that is going to be successful over many years, as the business becomes stronger and more profitable, its stock price will rise to reflect the increasing earnings.

knowing what you own is practicing risk management and if you have the patience to invest in high quality companies for the long term, you may find yourself with a free lunch.you may feel like losing your lunch as you ride out the stock market gyrations, but know that in the long term, investing in high quality businesses should lead to market outperformance. should you be looking for a quicker fix, then i suggest putting on a costume this halloween and start knocking on doors – it’s your one night a year to get something for nothing.

preppy, goth, hipster - there are countless colorful labels to describe fashion but when it comes to investing, there are really only three:  growth, value or core. now for most of us, we’ve only come across these “investing styles” when deciding where to put our 401k dollars. do you go with the Small-Cap Growth Fund, the Large-Cap Value Fund or the Mid-Cap Core Fund?

despite the widespread use of the growth, value and core labels, surprisingly there’s a lot of gray in their definitions. but typically, growth means looking for companies that are growing faster than the market (could be revenues, earnings, ROE). value means looking for stocks with PEs or other kinds of multiples lower than the market. and as for core, well, let’s just say it’s stuck in the middle – not too hot, not too cold. and these three “investing styles” can be applied to the individual as well, such as “i’m a value investor.”

and like fashion, certain “investing styles” are in vogue or not depending on where you think the economy is heading. now growth tends to do better when we’re heading into a recovery and value tends to outperform when heading into a recession. so the logical conclusion would be to load up on growth stocks when the good times are ready to roll. the thing is, if it were that simple to time the market, they’d be a whole lot more billionaires running around, and i for one, would be on a yacht somewhere warm and exotic, not at a computer banging out this blog.

think about it – right now, we have successful veteran investors living through the exact economy but with polar opposite views on where we are in the cycle (think warren buffet vs. bill gross). and if these studs of the investing world don’t agree, what is the poor layman investor supposed to think and do? unless you have access to information that the rest of the investing community doesn’t, you’ll always be late to the game if you’re always switching styles.

so go ahead, buy that leopard print dress if you must. it’ll be far less costly to change up your fashion than your investing style. just think, you can look forward to all the laughs you’ll get when you look back at that picture of you in the “latest” fashion trend.

well, it’s not about uncovering investing “secrets” as they are there to be found in books, literally in black & white. the real discovery is about knowing yourself and your emotional makeup. if paying full price for say, a suit, makes you cringe, why would you feel comfortable paying up for a stock that’s trading at say, 40x PE? or if you get queasy carrying a balance on your credit card, how could you sleep at night with your savings invested in a company with little cash and lots of debt on the balance sheet?

the thing is, when you invest in stocks that go against your own personal spending philosophy, you’ll run for the exits at the first sign of  noise. how could you have conviction in something that goes against your own spending style? for reasons that may not be company specific, your stock may toss and turn with market volatility. and in the small cap space, the swings are even wilder. so if you don’t have faith in your investing style, that’s when emotions take over and we end up making bad emotion-based not fact-based decisions.

of course, in life, there are times when we wish we were a little more daring or a little less frugal. but the stock market is already a place driven by human emotion and when it comes to your money, the less drama the better. investing in the stock market is an extension of how you spend money in your day-to-day life, so know thyself and make sure the person paying for the groceries is the same person buying that stock.

i once read that if you stand with one foot in the past and one foot in the future, you’re pissing on the present. i get it, appreciate the moment or as a Buddhist would say, be present. but what if the present isn’t as easy to appreciate as say, smelling a rose?

i mean, who enjoys following the daily stomach churning contortions of this volatile market? endless hours of meditation sitting cross legged on a cushion sound pretty compelling compared to a daily roller coast ride in the markets when what’s at stake is your metaphorical lunch. however when it comes to investing, longer term stocks do tend to outperform other asset classes. so thinking about the future may actually be what you need to focus on in these wild swinging market times.

this does not necessarily mean buy a stock and tuck away, out of sight and out of mind. instead it means know why you own a piece of this public company, set future milestones as part of your investment thesis, document what you will do when these milestones are achieved, and set target sell prices. in other words, be unBuddhist - think about the future and don’t let the present craziness of the markets lead to sorrowful decisions and suffering.

one action (or inaction) to pay close attention to are stock buybacks and insider buying. if the future’s so rosy, is the company buying back stock? are the executives adding to their stockpile? people buy stock for one reason and that’s to make money. for whatever reasons, they believe the stock price will be higher tomorrow than today. so when a company, particularly one flush with cash, is not buying back its stock, you need to ask why not?

now not all reasons are ominous. they could be preserving cash for a (smart) acquisition, they may have plans to pay down debt. there may be a number of legitimate reasons to hold on to the cash besides our sales are dropping and we need to run for the bunkers.

however one thing’s for certain, buybacks are signalling tools. meaning – the company is saying to the market that it thinks its stock is undervalued. and as value investors, we love finding those undervalued stocks.

like in those ancient Asian black and white ink paintings, in white space there is meaning. so when you listen to the ceos give their Q2 commentary, listen for what’s not being said.  when it comes to investing, and life in general, inaction can also speak louder than words.

granted, this year may be an anomoly year as the US soccer team advances far beyond most people’s expectations. and for this reason alone, more Americans may be tuning in. still it’s amazing to learn that billions – that’s billions – of people are watching the World Cup. soccer (ahem, football) is truly an international sport and in this interdependent, interconnected world we live in, investing must also be approached as an international activity.

but if you look at the portfolio of a typical American (including perhaps, your own investments), you’ll find at least 95%, if not 100% of it invested in the US. striking when you also consider that the US is less than 5% of the world’s population. yes, the US is the largest economy, almost 4x larger than that of China’s, but as the rest of the world grows, does it make sense to exclude this growth?

now if you’re reading this blog and have some interest in investing, then you’re probably familiar with the rule of thumb – own 60% stocks and 40% bonds, then tweak depending on your age. nowhere is there a domestic vs. international rule of thumb and this mindset needs to change.

when i talk about global investing, i’m not suggesting you run out and buy Angolan stocks (unless you’ve done your research and due diligence and found a diamond in the rough, not to be mistaken with a conflict diamond, of course). i’m talking about select international markets where there are 3 key charcteristics: economic growth, rule of law and regular financial reporting.

when it comes to stock picking, we want companies that are growing revenues and earnings. and the global markets are rich with undercovered and undervalued high quality companies that are growing faster than their US peers. and if you think the US small cap space is underfollowed, wait until you venture into global small caps where nobody knows their name (well, maybe not nobody but far fewer folks than in the US).

so even if you’re not quite ready to invest in global stocks, there are many other investment vehicles to choose from (mutual funds,  index funds, ETFs) that will give you global exposure. you may be tuning in to the World Cup only when the US team plays, but to exclude 95% of the world’s population when it comes to investing deserves a yellow, if not red card.

now if the tip is coming from a professional money manager who, in theory, has researched the company and done her homework, you may give the tip more cred. and that would make sense, right? you pay investment advisors to research and recommend stocks. but i’ve seen enough portfolio managers buy stocks based on a gut feel, not on research. and in this business, you just have to be right more than you’re wrong to have a “winning” track record.

but i assume you’re reading this blog because you want to learn how to invest for yourself. no more losing stock tips! and to that i respond first, you must develop a process, a checklist, some systematic way to weed out the losers. in other words, you’ve got to mind the process.

investing is all about funneling: taking a universe of thousands of stocks and narrowing it down to the handful you’d like to own. and the process is what you use to create that basket of high quality companies.

as a fundamental bottom-up investor, i’m all about the checklist: strong balance sheet? check. healthy cash flow? check. the business has a competitive advantage? check. high return on equity? check. my list goes on but really, it boils down to making sure i hit up those key traits that i believe are important.

just think – it’s like dating, you all have your own checklists, but in investing you don’t have to be so coy. there’s no shame in asking a ceo how much money he thinks the company will earn this year.

now equally important is to be mindful of the process. checklists are great to identify simple straightforward characteristics about a company. but investing is complex and that requires you to be flexibile and to exercise judgment.

at the end of the day, we all want to make money. if your aunt pam’s stock tip works out, all’s good with the world, right? wrong. for every stock tip that works is one that blew up. this isn’t investing, it’s gambling and you might as well go to vegas and play craps, your chances are just as good and you’ll probably have more fun.

mind the process and be mindful of the process – this will give you the confidence to make that buy or sell decision because you did your homework. whatever the outcome may be, you can’t be faulted if you followed a sound checklist.

during the bleakest days when the word “recovery” dare speak its name, the only positive thing companies could point to on these earnings calls was the draconian cost cuts being made - headcount reduced 40%, salaries reduced 10%, no more conference travel, etc. etc.  now with lots of “i think we’ve seen the bottom” comments by company ceos and subsequently, a rallying stock market, happy days are here again. and so now investors want to see profits grow for reasons other than because the company laid off a third of their staff. in other words, companies need to show me the money. i want to see the top line or revenues grow.

comments about more restructuring and cost cutting? oh so passe. investors are looking for top line growth or look out below. but before you write us investors off as a greedy bunch, let me explain and i’m going to rope in charles darwin in my defense.

as darwin would attest, only the strong, nimble and crafty survive. we see it in the animal kingdom and we can also see it among publicly traded companies (yes, a kind of animal kingdom in its own right). so during this downturn, when the weak went bankrupt or cut off unnecessary divisions to survive, the strong should have gotten stronger. they used their nice cash balances to innovate  and invest in research & development to create new and better products, or they took out their competitors by buying them and getting a larger piece of the pie.

and so coming out of a recession, the strong (if they were strong , nimble and crafty) should be showing better revenue growth either through people buying more of their products or being able to charge more for their goods. on top of the cost cutting, we should see profits slingshot higher. and if they don’t, then investors should be selling the weak and looking to buy the strong. and if darwin were an investor, i think he’d agree.

when a stock is added to an index like the Russell 2000, it needs to be labeled, or classified into a Russell sector (e.g., Technology) and Russell industry (e.g., Semiconductors).  now for the most part, logic reigns and a stock that sells computer software will most likely be put in the Technology sector.  however, life is full of surprises and sometimes, believe it or not, a stock gets misclassified (particularly in small cap land) and consequently, overlooked.

recently, while sifting through some companies that came up on my high quality screen, i found a name that had high ROE, revenue and earnings growth, strong balance sheet and was trading at a nice cheap valuation.  it was also classified in the Russell Producer Durables sector.

now when an investor hears Producer Durables, for the most part, she’s thinking equipment and machinery.  since the financial metrics of this particular company looked great, i dug deeper into the name.  i nearly fell out of my chair when i found out what this company actually did.  this “producer durables” company is actually in the health care business. and what’s more, it’s the leading health services provider to the US government.  yes folks, that health care reform legislation?  right up this company’s alley and it will hugely benefit from the flood of spending to occur over the next 2 to 3 years (and beyond).

misclassified and overlooked, folks.  and therein lies the investment opportunity. and once investors catch wind that this this company is actually in the health care services business, it will get a lot more attention.  as investors realize that the company’s revenue and earnings growth will be higher than its Producer Durables “peers”, it will get a higher multiple and trade more in line with the faster growing health care services companies.  the stock multiple will expand (e.g., instead of trading at a PE of 10x and an EPS number of $1.00, it will trade at 15x that same EPS number or a $15 stock price instead of $10).  so the stock price will go up and all because the stock was misclassified!

over the long run, information does disseminate and in that sense, the market is rather efficient.  the beauty of being a bottom up stock picker is that there are times (moments i live for) when there’s a disconnect.  and when you stumble upon one, it really is like finding that $100 bill on the sidewalk.

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particularly in small cap investing, these investor conferences are the only times when you get to hear about an unknown company. for the most part, small cap companies don’t have an army of investor relations or IR people who attend these events, or travel around the country to market the firm.

what you’ll find is that this IR duty falls on the CEO or CFO who should be running the business, not running off to Manhattan to market the firm.  so despite being a pain in the butt to attend, a small cap company will try to present at one big conference a year.

now you would think that with hundreds of investors, all listening to the same company presentation, what could you possibly hear that no one else hasn’t already heard?  and so isn’t this “good news” already priced into the stock?

well, believe it or not, people aren’t always the best listeners. or, people are just too darn skeptical.  or, other people may not be in the room.  yes, believe it or not, sometimes you may be the only person in the breakout session (these are smaller meetings after the presentation in which the company can drill down into the details and you can ask them questions).  this is the best feeling in the world – when you find yourself, by yourself, or with just a handful of other investors, talking to a company and learning about say, a process change that will cause revenues or profits to be higher than what most people expect.

as a small cap stock picker, i live for moments like these. so while these “dog and pony” shows may not always bear fruit, they’re not a complete waste of time either.  if nothing else, you’ll get a free lunch and meet other investors – another potential source of good ideas.  better yet, at lunch you may sit down next to the cfo of an HR payroll software company, unknown at the time, but not for long.  exactly how i found one of my best stock ideas.

so when you’re researching small cap companies, get to know the ceo. would you vote this person off the island?  now i’m not asking you to make the ceo your new best friend.  though we all want our company management teams to be likeable, that’s not always the case.  and you don’t necessarily need warm and fuzzy to be a great leader.  but you do want someone in charge who is above board.  let me explain.

recently i had to wrestle with this ceo issue when i discovered a small cap company that had all the characteristics that i love – financial strength (excellent cash flow generation!  great balance sheet! growing revenues and earnings!), high ROE and ROIC and if that weren’t enough, the stock was cheap.  boy, was i ready to pounce on this one.  thing is, as cliched as it sounds, if something’s too good to be true, it probably isn’t.

i researched the ceo and learned that just before joining this particular company, he was the cfo for a larger company.  and he somehow managed to quit (“for personal reasons”) just a few weeks before the SEC showed up on the company doorstep with accounting fraud charges – a whole laundry list of them.  the investigation lasted for years, the stock got killed and the company ended up restating revenues.  what a mess.

now i’d like to think that i’m open minded about some things and yes, people can change.  but when it comes to my money, i think not.  and until there’s massive overhaul to public company reporting, management teams get compensated on how much they can grow revenues and earnings (through legit means or not).

so that oh-so-wonderful stock that unfortunately had questionable management?  i passed on it.  it continues to go up.  a pang of regret?  not at all.  the great thing about being a small cap investor is that there are thousands of stocks from which to choose.  find ones without tainted leadership.

sure, life is full of surprises and that reputable ceo may turn out to be quite the opposite.  but like it or not, we look to people’s past as predictors of future behavior.  and as it is with your friends, once they’ve broken our trust, it’s hard to forgive and impossible to forget.

concentrated small cap stock picking is what i do and as a professional money manager, i’m paid to monitor, 24/7, the select number of eggs in the basket.  but if you’re like most folks who don’t have the time to stay on top of the goings-on of each stock you own, then buying an index fund with hundreds of stocks, or outsourcing the “dirty work” to people like me, makes sense.



the things is – when you’re trying to get better returns than the market (e.g., the S&P 500 Index), you can’t look like the market! simple as that.  and what’s one way to look different than the Index?  own a smaller basket of high conviction stocks.

these are stocks that you would lie down on the railroad tracks for.  managements that you can believe in and businesses that can grow and grow profitably.  why water down your portfolio’s returns with lukewarm stock ideas? like anything in life, why do something that you’re not fired up about? life’s too short for mediocre living.  and your savings are too important for mediocre stock picking.

sure, you may get safety in numbers and you may get market-like returns.  but if you want to beat the market, then you need to look different.  and one way to do so is to look nothing like it.

if you have time to manage your own money, create a concentrated portfolio of compelling ideas.  or outsource it to folks who follow this investing strategy.

perhaps the hardest part of this concentrated portfolio strategy is the mental and emotional wherewithal to ride the ups and downs.  there are a number of great investors out there who are open-kimono about their investing strategy.  yet how come more people can’t duplicate their successes?  because investing is not just about knowing the numbers.  it’s about knowing your emotional make-up.

know thyself is never more true than when it comes to investing.  concentrated small cap stock picking is one way to outperform the market.   it may not be a shoe that fits all, so find the shoe that fits for you.

one of the dangers of wading through streams hunched over is noticing too late that the clouds have rolled in, the sun’s blocked, and suddenly finding yourself scrambling for cover when the hailstorm starts.  so what’s a poor “bottom-up” stock picker supposed to do?  how do you know when to look up?

the answer – equip yourself with the safety of valuation. before you go jaunting off to turn over stones, know if going in that direction even makes sense.  does the stock look expensive (on say p/e or ev/ebitda or any other relevant metric) relative to itself over time?  how does it look relative to similar companies?  if the company is running at record profitability, is it because they’ve improved something fundamental about the business that can be sustained?  or is it a “cyclical” company (i.e., positive correlation to GDP, so when the economy grows, sales grow – think steel production).  and so when the clouds inevitably roll in (ah yes, even southern california has cloudy days), is this company sheltered by the umbrella of valuation?



yes, i know, i know, in a recession, the only thing that goes up is correlation.  in a year like 2008 when the Russell 2000 was down 34, there weren’t many areas to hide.  however, responsible investing is all about sizing the risk (not just the return).  and when you’re armed with the safety of valuation, you can more confidently venture off to particular areas, turning over stones, knowing that the sudden dark shadow on the water is only that of a passing plane.

same thing goes for stocks.  investors value stocks on a number of different metrics, the most popular one being the price to earnings (P/E) ratio.  when a stock is trading below a certain value, it’s like seeing that Prada handbag for 20 bucks.  and as a value investor, i’m constantly looking for Prada handbags priced below what i think they’re worth.

but one of the greatest fears of a value investor is to fall in that “value trap” (i.e., it’s cheap for a reason). to continue the analogy, it’s like saying that Prada bag, it’s 20 bucks for a reason because that color/design/brand is out of style.  so before you buy a stock that looks screamingly cheap,  make sure to ask yourself – what’s going to move the stock higher? or as we say in investment-speak, are there any upcoming catalysts?



trust me – catalysts, you know ‘em when you see ‘em.

let me give you some examples:

today i met with management of a small cap company and by the end of the meeting, i was jumping with joy -  chock full of wonderful catalysts!  new management took the helm in 2008.  they  sold off a bunch of unprofitable businesses that the previous management had acquired over the years.  they recapitalized the company to pay down debt.  they closed down a money losing facility, restructured and moved production to a lower cost site.  and back in ’08 before new management took over, their customer service was horrendous (less than 50% on time delivery rates).  the thing is – in their business, their components need to be designed into their customers’ lines.  but with such poor reliability, the company was shunned.  now, their rates are above 90% and with materially better customer service, the company is being invited to the party and winning contracts.

and if that’s not the best part, the stock is poorly followed by the street (i.e., not a lot of published research on the company) and so i bet that the revenues will come in higher than expected, expenses lower than expected and earnings will beat the street numbers.  and this “upside surprise” will get the stock hopping.

so stocks that are cheap – it may be the buying opportunity of a life time, or a one way ticket down a ditch.  before you buy, make sure you can identify the catalysts that will get investors excited. without some “thing” that will unlock value, you may find yourself waiting a long long time for payday.

right now, we’re at the tailend of earnings season (see previous post on what “earnings season” is all about).  and companies are reporting record earnings.  and why not?  they’ve taken a machete to costs.  but before you jump in to buy a company with a record X dollars in earnings, ask yourself this – how sustainable are those cost cuts?  trust me – these record earnings are not what we in the business call “normalized earnings”.

work furloughs, freezes in the 401k pension plan, teleconferences instead of air travel – folks, these costs will come back.  in the same way that you and i may have downgraded our cable package because of employment uncertainty, when the horizon looks brighter, i know i’ll be adding back that HBO subscription.



but consolidating underutilized manufacturing plants, finding cheaper supply sources, implementing software to replace human heads – these cost cuts are sustainable.  if management’s thinking right, when on the brink of the abyss, tough decisions are made that were postpone or never really considered because revenue growth was good enough.  so when revenues grow again, the company does have a leaner and lower cost structure which mean higher profit margins and higher, sustainable earnings.

hence - normalized earnings or what earnings really look like. some management teams may be forthright about what expenses come back.  others may genuinely not yet know.  either way, use your judgment.  first, ask yourself – why did the company post record earnings?  and second, what costs are coming back (or not coming back).

once you get your arms around what the real earnings power may be, then figure out if the stock looks cheap or not.  don’t be tricked into buying low P/E stocks because the E (or denominator) is unsustainably high.

for most folks, selling is hard to do. why? we anchor off the price we paid for the stock, and we humans are, for the most part, optimistic in nature. the stock will go up and as long as i don’t sell, i don’t have a loss. even the greatest investors admit to the cartwheels of rationalizations made to justify hanging on to a loser stock. kind of like the excuses we make for staying in a bad relationship for one anniversary too many.

to this i say - use this year’s market rally to turn all those wonderful “unrealized” gains into “realized” gains. and offset them with those stocks that you know were bad investments but for whatever reasons, couldn’t get yourself to sell. the april tax season will be here before you know it and so here’s your excuse for selling those lumps of coal in your portfolio.

now after the job interview torture ends, when you all gather round to compare candidate notes, my guess is it’s like the old parable of The (Six) Blind Men And The Elephant. each blind man gropes a part of the elephant (trunk, foot, ear, etc) and they all come to 6 different conclusions. now i’m not one to rewrite parables but had these men used my Research Questionnaire Template (RQT) perhaps there would have been a little less quarreling and a lot more insight.

whether you’re interviewing job candidates or the ceo of a stock you want to buy, the process is no different. you need to ask the same questions of all candidates, of all company management, to benchmark the quality of the team. now some people are better than others in interviews. but if you’re asking the same question of every management team you meet (for example, “where do you see the company in 3 years time?”), you’ll be surprised at how easy it is to rank order which ceos have a vision for the company and which ones don’t, based on the answers they give. now you may not agree with the ceo’s vision, but at least you’ll know the ceo is planning for the future and not merely reacting or living in the past.

having consistent interview questions for company management is key to categorizing and identifying high quality teams. sometimes the company’s product or service may be so great and the market position so enviable that a mediocre management team may not matter. but you won’t know this unless you develop your own version of an RQT. and in the small cap investing space, management teams can make a huge difference. why? because in small companies, decisions tend to flow through faster. there’s less bureaucratic red tape and so the quality of the ceo, cfo and other senior management members, can be the difference between a company that thrives or one that dies.

now if done properly (not to be a fundamentalist about it), a fundamental research approach is what i call a private equity approach to public investing. it means a lot of rolling up the sleeves hard work. you talk to the company’s customers, competitors and suppliers. you reach out to industry experts and specialists. you read relevant trade magazines. and ideally, you go to industry trade shows which are an amazing place to find strewn all about, gold nuggets of information. wandering the convention hall floor, checking out the expo booths, you’ll be running into either current or potential customers, suppliers, competitors and industry experts.

and you may get a little bit of something else that, when pieced together with the other nuggets you pick up, may lead to a compelling investment idea.  for e.g., last month i was at a tech trade show researching a particular company. this trade show was THE annual event for this industry. and this company, was THE leader in the field. so i was very puzzled when i combed the expo floor looking for this company’s booth and found nothing, not a trace. and then a few days later upon returning from the trade show, the company announces that it is getting bought out.

remember – when it comes to investing, common sense goes a long way. it just didn’t make sense, something was off and in this particular case, something really did not add up.

earnings season – what is that you ask?

in the US, all publicly traded companies announce/publish their earnings every quarter (so 4x a year).  most companies are on a calendar year end, so Q3 would be the 3 months ending september 30th.  hence – earnings season is the time when public companies publish their financial results.

thus each quarter is a super busy time for money managers as they anxiously await ceo comments on how the business did and what the future holds (i.e, the all important “guidance” for next quarter’s/next year’s revenues, profits, etc.).  some public companies will hold conference calls or webcasts to discuss the quarter and give guidance (though not all companies feel the need to look into the crystal ball and predict the future).

now what does earnings season mean for the average investor?  a lot.

this is the time when you see the most stock movement up or down.  remember – stocks move on expectations so when companies release their results, the street may be expecting something else. beat these expectations – the stock typically soars.  miss these expectations – look out below.  and don’t forget the company’s guidance which typically trumps the quarter’s results whether they missed or beat expectations.

for small cap companies, earnings season is the only time they really interact with the public.  small caps usually don’t have an army of investor relations people.  management is busy running the business, not traveling to investor conferences.

so for the average investor, earnings season presents a great buying or selling opportunity. why?  because the market reflects human emotions – greed and fear.  when good or bad news come out, the market overreacts.  stocks get irrationally pumped up or pummeled.  and for us patient investors who do research on companies before buying a stock, we live for moments like these to sell and make a profit, or scoop up great companies at bargain basement prices.

remember that small cap companies tend to be under followed by wall street.  in fact – 4 times more sell side analysts cover large cap companies (S&P 500) than small cap ones (Russell 2000). so taking a “bottom-up” approach can really lend itself to small cap investing.

that’s not to say we ignore big picture trends. i’ve found that some of my best investment ideas work because of the tailwind provided by “secular” trends.  some examples – telephony moving from circuit based (i.e., landline) to VOIP, or consumers wanting healthier vitamin-laden drinks.   so when thinking about small cap investing, and investing in general, take a step back and observe.

it’s not about racking the brain to find a cure for the common cold.  it’s about shutting out the noise – or rather those “buy-this-stock-that’s-about-to-go-up-1000%” spam emails – to think about the changing environment around you.  we all participate in these “changes” yet how many of us actually take the time to reflect on them?

the reflection can pay off because in that awareness lies a great investment idea.

so right off the bat – where will we NOT look for small cap investments?  penny stocks.

my goal (and hope) is to help you find compelling small cap stocks to buy without “the assumption of unusual business risk in hopes of obtaining commensurate gain” (merriam-webster dictionary’s definition for speculation).  “gain” we shall seek, but taking on “unusual” business risk” is not responsible investing, it’s gambling.

with your hard work (remember:   small cap = underfollowed = intensive research to get an edge) and the value i hope to add, the next stock you buy won’t be like a lottery ticket with you praying for the big payout, but an investment with a high probability of success because of your research.

it’s labor day weekend so i’m off and back on tuesday.  for all of you who share this long weekend – enjoy the holiday!

why?

management tends to be more accessible.  not that they’re sitting around waiting for the phone to ring, but believe it or not, some small cap ceos do pick up when you call.  imagine trying to get larry ellison on the phone!

and what does this mean for the small cap investor?  access to information but not of the illegal insider kind. you can hear first hand about industry trends, the competitive landscape, etc., etc.  a mosaic of information that you can crunch through your brain (or run through your model) to forecast how business will be.

also, there’s no stopping you from calling a company’s suppliers, customers, competitors to find out what’s going on.  and in an underfollowed company, the observations and insights you gain from just doing bottoms-up research can help you predict changes to sales, expenses, profitability, etc., before they are reflected in the reported financials.

need i say more?  3 compelling reasons why investing in small caps makes sense.

next up – how do you go about finding these uncovered stock gems.  stay tuned.

with small cap companies, change cycles through more quickly.  with fewer layers of people, rules, processes, etc., than larger companies, changes to say the sales force compensation structure or a manufacturing workflow process, should impact the business faster – for good or bad.

and what does this means for small cap stock investors?  change – whether in business operations or senior management (e.g., a new CEO) – typically floats to the surface faster in small companies.

being able to determine if the change is for better or for worse gives you an edge.  why?  because the impact of the change isn’t yet reflected in the company financials but it will cycle through – and on the sooner side.

small caps are underfollowed by wall street - even more so in this recession as the number of sell side analysts goes down (i.e., people who typically work for brokerage firms and publish company research for investors).  so  small companies lose analyst coverage, or get superficial coverage because with fewer sell side analysts, the more companies the analysts have to cover.  and we only  have so many hours in our day.

and underfollowed stocks can outperform.  why?  because stocks go higher when a company’s financial results beat wall street expectations. and that’s why investing in small makes sense.

i set up this site to help you make smart investments in small companies (i.e, market capitalization of less than $2 billion).

i’ve been investing in small cap companies for over  5 years.  i love what i do -  everything I read, see or hear has implications on small cap investing and the challenge is to figure out what.

this site is a way for us to learn together, find great investments and have fun, as i share my observations about, and insights into,  this “small” corner of stock market investing.