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How to improve your investment research process

“Data! Data! Data! I can’t make bricks without clay.”
– Sherlock Holmes, The Adventure of the Copper Beeches

A regular Monevator reader, G., recently wrote in with a question about how to properly organise the deluge of information he comes across in his investment research.

Indeed, all of the information available can easily produce, as G. called it, “paralysis by analysis” – that is, being so overwhelmed by data that you decide no decision is the best decision.

G. noted that this issue was starting to frustrate his active investing:

Whilst I am making progress on building a portfolio with ‘good’ dividend companies, I have created a problem with amassing a great deal of information during my research.

With this in mind I was wondering if there were any ‘tips’ on how best to organise this?

I have newspaper / magazine cutouts, information from various books written down on A4 pads, extracts from your website and many others.

The term paralysis by analysis springs to mind. I appreciate that this may not be a subject that you could provide a steer with. It’s just that it is starting to demotivate me on a subject that like.

Thank you for reading this message and keep up the excellent work.

I can certainly relate to the reader’s frustration, as I’m sure many of you can.

Even ten years ago, I would see my stock quotes just once a day in the morning newspaper. Sometimes I’d go to the local library to look up the by-then dated company information that was printed in a monthly shares magazine.

Today, by contrast, investors can have any piece of public information available with just a few keystrokes.

In some ways, this easy availability of financial data makes research less time-consuming.

However the amount of data can also unnecessarily obfuscate the process, and make investing decidedly less fun.

You call the shots

It’s important to start with the premise that investing is a decision-making business. As with most decisions you need to make, you’ll never have complete information nor will all of the data you compile necessarily lead to one conclusion.

Still, you must make a decision to either buy, sell, or do nothing.

What’s great about investing is that doing nothing is a valuable option for individual investors. As Warren Buffett said in 1999, “You don’t have to swing at everything (in the stock market) – you can wait for your pitch”.

In other words, when you’re managing your own money, you don’t need to buy or sell a share if you don’t want to.

This advantage for individual investors shouldn’t be underestimated.

Professional money managers don’t often have the luxury of doing nothing. Their clients usually insist they take action, any action, and falsely equate action with the manager earning his paycheck.

With that in mind, a key to good investing research is to relax.

There’s nothing wrong with saying, “I don’t understand this” or “this isn’t the right time to buy this share” and moving onto the next idea.

Keep the notes you’ve taken on that particular idea to review at a later date.

Go your own way

I believe the best way to reduce all the information you feel the need to keep track of is to focus your investment process.

Each investor’s research process is different. An investor taking a dividend-focused approach, for instance, will likely collect and process data differently than someone with a high-growth approach. That’s what makes a market.

What’s important is that you develop a process that’s repeatable and simple.

The start of a good, repeatable process is to establish some simple screening criteria that greatly reduce the thousands of available shares to a few dozen or so that more closely fit your objective.

To illustrate using a dividend-focused approach, I’ve previously outlined a few screening criteria. The next step in that process would be reviewing the screening results and identifying a few companies that are worthy of further research.

I suggest studying one company at a time, otherwise you’re likely to be overwhelmed.

Once you’ve found a company to research, read the last two or three annual reports and the most recent interim report to get a better feel for the company’s business. If you don’t understand how the company makes its money by that point, I’d pass on the idea.

If you still like the company at that point, take a closer look at the balance sheet, cash flow statement, management, and if you’re an income investor how the dividend has grown over time.

Another key to a good investing research is to focus on avoiding mistakes rather than seeking winners.

When you’re looking at the financial statements, you don’t need to get bogged down in the details (unless you’re an accountant by trade or really enjoy digging into the numbers).

You do, however, want to look closely enough to ensure that the company is profitable, that it generates solid cash flow, and has a balance sheet that’s appropriate for its line of business.

This should sound obvious, but it’s amazing how many messages I get from other investors suggesting I look into a company that has yet to generate a pound in profit.

How do they manage it?

I’d also suggest taking a closer look at the company’s management to see if the leaders of the company are properly incentivised and what major investment decisions (mergers, expansion plans, and so on) they’ve made in recent years.

Have a look through the board’s remuneration report found in the annual report (it’s found in the proxy filing in the U.S.).

Here are a few questions you’ll want to answer

  • How is management compensated relative to its major peers?
  • Upon which metrics are management’s annual bonuses based?
  • Are these the right metrics for this business?
  • Have management’s investment decisions made the company stronger or weaker compared to the competition?

Price is what you pay, value is what you get

If you still like the company at this point, I suggest getting a feel for the company’s valuation and comparing it to the market price.

Even the best company can make for a bad investment if you pay £1.50 for it when it’s really worth a pound.

Admittedly, valuation is part art and part science, but again, your aim should be avoiding mistakes – the purchase of overvalued shares – rather than seeking successes.

Anyone can make a share look cheap in a valuation model by changing a few assumptions. Err on the side of conservatism with your forecasts, and if the market seems to be assuming too much growth for now, consider waiting for a pullback in the share price.

The valuation phase is another area of the research process where I see too many investors being overwhelmed by the data or, alternatively, feeling that the more complex and detailed their models are the more likely they’ll be right.

In my experience, even simple models like the dividend discount model that use a few data points can tell you a lot about the market’s expectations and the company’s value.

Seek to follow the 80/20 rule – find the 20% of available data that explains 80% of the valuation.

Manage your time wisely

Finally, it’s important not to follow more companies than you can reasonably cover, given the time you have available for research.

It’s always fun buying new shares, but remember that each company requires what I call maintenance research – that is, reading the quarterly or half-year results, the annual reports, updating model assumptions, keeping up on management changes, and so on.

If you have only a few hours a month for research and you own 50 separate shares, you’ll certainly feel overwhelmed with all the data you need to analyse.

I’d much rather own five shares that I know very well and can reasonably manage than own shares in 50 companies but have little idea of what’s happening at each one.

You might ask, “But what about diversification?”

Well, that’s where index trackers can help even us active investors.

If you can only follow five companies, carve out a portion of your portfolio dedicated to active investments (say 40% of the total) that will contain those five companies. The balance can go into a broad-based tracker fund.

Back to basics

If you’re feeling overwhelmed by your investing process, remember to relax, focus on the parts that are repeatable (because your process should improve with each iteration), and seek to simplify rather than complicate it.

Please post any further thoughts or questions you have in the comments section below. It’d be great to hear from you.

It’s hard to believe it’s been a year since my previous post on Monevator! I promise not to make a habit of being away for so long.

Note: You can bookmark all The Analyst’s articles on dividend investing. The archive will be updated as new dividend articles are posted.

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{ 6 comments… add one }
  • 1 Jon August 14, 2014, 3:43 pm

    The effort and work should all be front end loaded. Once I’ve bought my shares in Glaxo, Unilever, Tesco etc there is no need to analyze further and read reports. That’s the beauty of purchasing blue chip, buy and forget, sleep well at night dividend shares. Other than dealing with corporate activity, get on with the rest of your life. There is nothing you can do even if the company hits the buffers.

  • 2 magneto August 15, 2014, 10:58 am

    This post brings all the memories back, of why we mostly now use trackers.
    While interesting and challenging, so much time was needed to focus on individual co’s data, which takes the eye off the ball, when the investor should be thinking about overall allocations and distributions dependent on valuations offered by the market, which IMHO are the main factor in achieving a satisfactory performance.
    Being old fashioined we kept A4 folders (one folder for each market sector) with a pocket for each stock, and with buy/sell/yield history facing forwards and any key information facing to the rear.
    As dividend investors, focus was on dividend growth, cover, etc and any likely changes to the future dividend trend. Key measure for us was PE/Total Return (Yield + Growth).
    One day the penny dropped that with a few exceptions, all the stocks were cheap at the same time and all expensive at the same time. So succesfully picking those odd exceptions to the overall market(s) achieved very little.

  • 3 The Investor August 15, 2014, 2:07 pm

    @Jon @magneto — Interestingly, I agree with you both. 🙂

    I’m a big fan of the passive HYP approach that Jon alludes to, but I don’t really practice it anymore myself. Instead, I have a universe of about 50-100 shares that I feel I know pretty well, that I tend to move money between. So I need(ed) to do a lot of initial research into that universe of companies, and any new entries, but beyond that it’s mainly keeping updated and watching valuations.

    But that of course is still much more work than trackers.

    As I’ve said many times, IMHO nobody should invest actively unless they love the whole process, that’s for sure. Even if you want to take some risk for superior returns, you’re probably better off trying to get a bit of long-term leverage (e.g. a mortgage) and investing that in the market than trying to beat the market while having a bad time doing so.

  • 4 The Analyst August 15, 2014, 2:49 pm

    @Jon Thanks for your comment! I agree with you in the sense that patience is required when making long-term, business-focused investments. And focusing on the steady inflow of dividends from large-cap shares can help you in that pursuit. However, I still think it’s important to take periodic notes on your companies’ progress — since, after all, you are a part-owner in the business — and make sure your thesis is still intact. Even large cap companies run into trouble or in some cases have to cut their dividend, so a half-year or annual review of existing holdings seems prudent.

    @magneto Thanks for sharing your thoughts! I think most investors should split their equity holdings between trackers and invest in a few shares that they can understand and enjoy following. I see great benefit in using both. Whether or not you outperform the market by a great margin, owning individual companies helps you stay interested in the market and can help you better understand business (recalling Buffett’s quote that “I am a better investor because I am a businessman, and a better businessman because I’m an investor.”).

  • 5 Gregory August 15, 2014, 3:13 pm

    @The Analyst
    ” invest in a few shares that they can understand and enjoy following”. Especially in small caps or micro caps. Institutions and gurus like Buffet know the dividend aristocrat companies quite well so you should concentrate the less known and local ones.

  • 6 Rob August 16, 2014, 10:26 am

    These days it is sensible to assume that companies are run by greedy liars. They are the guys that got to the top of corporate greasy pole. In very few cases was it because they were good at their job. They were just more ruthless and ambitious than the other guys.
    The information they publish in the stock Market statements needs to be viewed in that light. They don’t want to give you bad new, only stuff that increases the share price and allows them to create a bigger empire so that they can pay themselves more. Mostly by awarding themselves options based on increasing earnings per share.
    Of course not every comany is like that. But figuring out who the good guys are is very very difficult. If you can, you are probably on to a winner, apart from all the stuff about markets, competitors, and the way the business is funded.
    Audited accounts are the most useful part of the data set. But they are prepared by accountants who are selected by the board and presented, at best, 2 months after he period end. So they could be as much as 14 months out of date.

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