Over the years I've gotten lots of PMs from posters asking investing advice from the value investing perspective. I'm probably averaging one to two a week. I've answered every one so far, but sometimes it's a hassle to answer well, and sometimes I feel like i'm repeating myself.

So I'm creating this thread, and I'm going to populate it with all the PMs and my responses I've had over the years, so that if you have a question for me you can skim this and hopefully find it already. I am also curious as to how my perspective and answers have changed over the years, so it will be a nice exercise when I get to the ones from five years or so.

Feel free to post new questions for me on this thread, or you can always PM me

I'll start with todays question.

Hey DesertCat,

Ive been reading up on investing for the last years and getting more and more interested in the stock market and investing, and value investing in particular. Im studying economics and majoring in finance, and I want to up my skills in this field (for my own part and maybe it would be valuable for a job application) and start to invest my own money. Untill now I have just invested money in an index fund, but feel that I start to gain much knowledge and feel I just need to jump into it soon.

I feel that i have a good grasp of what the books ive read on value investing are trying to convey (buy with a margin of safety, find good and solid businesses with moats, understand the businesses you are buying into and so on), but I still feel I dont know how to go looking for good businesses. Ive just decided to do as Buffett says and start with the A's, but after reading some financial statements, I dont know quite what Im looking for, even though I understand financial statements, know my porters five forces (I know this doesnt perfectly relate to value investing, but it should help I guess), I dont quite know what is a good business. So my question I guess is if there are any books I could read that are more geared towards the actual analysis of businesses, some examples from analysis done online or maybe you have some tips for someone who needs a push to get started?

I guess my best advice would be reading the Buffett shareholder letters, BerkshireHathaway.com has them back to 1980 or so. But all that you'll learn is to find and identify moats, and there are all sorts of them.

For example, I used to own NICK because I felt it had a moat, but it's not an obvious one. It's a auto finance company that specializes in clients with bad or no credit. NICK's competitors are highly automated using call-centers, which lowers their costs of servicing the loans, but also means they have to contract out for repossessions. But NICK has offices in every town/city they serve, so they have local managers who understand the market, area, businesses, etc. And they'll do their own repos if it will save the company money.

How is that an advantage? It provides them with valuable extra information on their borrowers credit worthiness. They know if the borrower is working for a stable business, whether he has relatives in the area they can contact in the event of non-repayment, etc. They don't disclose all the info collected or how it's used, but I think they have computer systems that incorporate the extra information. Essentially they can cherry-pick the best clients from a group that has the same raw credit scores, and that cherry picking makes a big difference.

How do I know it's an advantage in practice? Looking at 15-20 years of consistently higher profit margins and lower losses than their competitors.

What's the moat? Setting up offices in local communities is an expensive undertaking that's 180 degrees opposite of how the competition is run. They'd have to invest heavily, change everything, etc. I didn't worry about the big guys with NICK, I worried more about another regional competitor with a similar model but better execution, but never saw one while I owned them.

I guess my best advice would be to do a screen for higher margin businesses and you should find the ones with stronger moats.

I think every successful business with good margins has a moat of some type, and some strength. Even your local hardware store has some sort of brand value they built historically that still keeps them in business against the big guys, for the time being. Your job as an investor is to find it, and weigh it, and only buy the ones that are strong and will last for a long time.

If you want help on finding interesting opportunities in the market, read Greenblatts "you can be a stock market genius". It's not focused on good businesses and moats, per se, as much as transactional opportunities, but it's a good read.

I will definitely be taking advantage of this thread.

Good thread idea. Fwiw, re: the first question, I highly recommend Bruce Greenwald's Competition Demystified in addition to what DC wrote. It breaks down several misunderstands of competitive advantages (differentiation, first mover, etc) and dispenses a simple framework for understanding and identifying enduring competitive moats.

DC,

Have you invested in liquidations? If yes, can you outline your liquidation analysis?

Liquidations can be a fruitful investments, one of my first investments as a "value" guy was a liquidation that looked to be too good to be true, but wasn't. I learned then that when companies decide to liquidate the existing shareholder base sometimes dumps their shares.

I think this is an example of hyperbolic discounting, a behaviorial phenomena that is a big reason why markets aren't efficient. The original investor bought shares in an operating company often hoping the shares would go up 30, 40, 50%, or even double or triple, and hopefully soon. When it enters liquidation and they are told they'll "only" get a 10-20% return, and they'll have to wait up to an entire year, their original desire is disappointed. Instead of thinking how good that return would be vs. the average stock, they take their money now and find somewhere else to gamble on a big win.

As far as a general liquidation analysis, it's pretty simple and the same in a general fashion, the specifics is where the work is. Essentially you have to estimate wind-down costs, liabilities, any future revenues, and the value of current assets. You discount heavily things that are uncertain, so you hopefully end up with a valuation that gives a substantial margin of safety.

It all goes back to reading financial reports, and digging through the foot-notes. For example, if you see they have reserved for a potential tax liability, and when you research it become convinced that odds of paying it are low, you can factor that into your analysis. That's your "edge" against people who just take book value or company estimates at face value.

I think there is a general tendency for stocks to decline befire their delisting becomes official. Some funds have blanket restrictions against holding unlisted stocks, and there isn't often countervailing demand to offset their sales since the bigger investors are gone.

And it makes sense there might be a rebound when the sellers disappear. But I don't pay much attention, in fact I don't differentiate where stocks are listed, I focus on fundamentals. It just so happens that the majority of my portfolio ends up being pink sheeters, probably because of greater mispricings.

I'm always buying with a catalyst in mind, and relisting can be one of them, but it's not usually a strong one. I'm more interested in a company that's going to be sold, or fix it's business, or even better has fixed it's business but the market hasn't recognized it yet, or is changing it's capital distribution policies (i.e. substantial dividend increases instead of pissing away money on bad subsidiaries), etc.

Obviously the key with pink sheet stocks that have trivial volume is to be extremely patient about buying and never paying up, and rigorous about your valuation and the minimum margin of safety you will accept. Same is true about selling as well.

Value investing alone should be enough to earn above market returns with below market volatility, assuming you are decently skilled at valuing businesses, evaluating risk, and patient about putting your money to work. But if you can focus on investments that aren't just attractively priced but have catalysts that help drive market recognition of their true value, that's the path to beating the market by much wider margins IMHO.

I don't screen for pink sheets, I screen for value catalysts, but the best priced ideas I find are typically trading on pink sheets or OTC, I assume because of the information gap.

Pink sheets deserve a bad rap, there are many boiler room types. If you know what you are doing it's pretty easy to detect frauds, esp. the boiler room types, but most people can't. In fact they find them appealing because they don't aren't patient enough to wait for the magic of compounding to work over years.

Lots of them still have reliable numbers. Even while delisted they they have to follow SEC rules, file quarterlies, annual reports, etc unless they also deregister their stock with the SEC. And I've invested in deregistered companies that still provide audited financials.

Legit businesses tend to stay legit. The likely fraud I posted never had a business, or financials, at least in the last 6 years. It's an old ticker symbol someone got control of. And that type of fraud is obvious. The other types of fraud (a real business with fudged financials) don't happen very often, and your risk is only slightly higher in a pink sheets. After all of it's a real business with a real board, real employees and real shareholders, there are a lot of ways fraud can be revealed, and there are lots of incentives for it to be revealed by non-participants.

I used to be a member of ValueInvestorsClub, which is like a by invitation only version of 2+2 for value investors. You post ideas, get comments, etc. To join you have to writeup an idea that meets the mods criteria for quality and usefulness.

Currently I'm in a private group that has our own forum, about 10 smaller value investors/managers. But to be honest, I never got much out of VIC, and I rarely invest in ideas someone in my group find. My best ideas I find by skimming through the SEC edgar database for interesting filings.

I'm not sure if Buffett ever really got specific about the 50%, but the only difference between investing $1M and $1B is the number of opportunities. He wasn't specifically saying pink sheet, or OTCBB, he was saying microcap stocks are illiquid. Sometimes they'll still be listed on the Amex or Nasdaq (but aren't due to stay there much longer).

And he wasn't talking about international markets, even though there are lots of opportunities there. He was just saying that microcap stocks are priced so much less efficiently he could churn out much higher returns. He's got more tools in his toolbox than i, so I'm sure he is also talking about opportunities in bonds, options, etc, that are too small to capture in a large fund, but mainly it's microcap stocks, because that's what he does.

BTW, Buffett also invests his own personal savings outside of berkshire. It's at least a few hundred million, if not a billion by now. I've seen him file positions with the SEC in microcap positions with me on at least two occasions when I was first starting out, about 5 or 6 years ago.

7 years, I've seen enough to know that 50%+ is possible, but probably not for a part time investor. It's really a full time grind researching and analyzing ideas, and the more ideas you look at the better your returns will be.

I think I averaged around 40% (Edit: pre-tax) the first 5 years until the market crashed. I bottomed out about 35% below my peak. I believe I'm up 40% so far this year (Edit: early Nov. 2010), and my annualized at only around 26% since the beginning of 2003, not sure if I calculated everything properly.

But I do know that my returns suffered from being a part time investor and not doing enough research to find enough ideas and enough due diligence on the ideas I chose. Plus from hubris because I used to work much harder but after the first 4 years got lazy and sloppy (and played way too much poker) because everything came to me so easily.

This year I'm trying to refocus and make up for lost time, we'll see if I can churn out a consistent 40%+ again.

Interestingly, I just realized I made a significant logical error in calculating my results. My excuse is I don't do this very often, like once a year. Basically I used all the outflows for my living expenses/taxes, and added them to my current portfolio value, then divided the result by my starting amount. This gives you an accurate calculation of your gross profits, since your outflows were profits you spent.

But the problem is doing it that way values outflows in present day dollars, so if I took $50,000 out in 2004, it treated it as if I didn't earn that return until 2010. Anyways, long way to go for an explanation, but using excel's XIRR function it gives me a 36.7% gross annualized return (before taxes). Which makes me feel quite a bit better and I think supports the idea that a full time effort by a skilled value investor could easily produce 50%+ returns.

You can learn from everything, the more you read the smarter you get. Supposedly Buffett still reads a few thousand company reports a year, I'm too easily bored to read more than maybe five hundred. I guess my best advice is to find a niche. Even good value investors don't always beat the market by much because they get bogged down in value traps. The key to outperformance is finding catalysts. Catalysts can be growth itself, or events like mergers, new management, new business lines, recapitalizations, etc.

I think every 10x makes things harder, but the differences aren't super great. I'd guess a reasonable goal at 100k would be something like 50%, 1M 40%, 10M 35%, 100M 30%, 1B 25%, etc. Buffett and Greenblatt would crush those goals though.

Taking on clients has many costs and difficulties. First, it turns investing into a sales job. Second, you have to invest in the right legal/accounting to do a fund correctly, and that's an additional cost not worth carrying until you have big enough clients. Then there is the extra time spent hand holding clients.

As a first step you can manage separate accounts for each client. I did that for a while at ameritrade but it was friends and family and it creates a lot of extra trading work and keeping track of who owns what, and people end up with different returns. I was also playing lots of poker and it made me uncomfortable having that responsibility when I wasn't working 100%, so I fired my clients, fortunately just before the market tanked so I at least left them with good results.

Right now I'm in process of moving to interactive brokers. It has a "friends and family" master account structure that allows you to managed up to 16 accounts as if they were one single account to reduce your trading/management overhead. It also has a great API, I'm using it to write some automated portfolio tracking/management software to make it easier to track buy/sell opportunities and portfolio composition. And it has some automated buy/sell algorithms that reduce trading overhead.

If everything comes together as I hope, I'll probably go out and get some friends and family money to manage as separate accounts. This time I'm a lot more motivated and the systems I'm putting together at IB should greatly reduce busy work of managing accounts and ensuring everyone gets similar results.

Eventually a investment partnership makes sense, but one step at a time.

My usual advice is the key Ben Graham/Fisher/Greenblatt books (Intelligent Investor, Common Stocks & Uncommon Profits, How to Be a Stock Market Genius), along with Influence by Cialdini, and all of Buffett's shareholder letters which are free off of the BerkshireHathaway web site.

Lastly as the bible/manual/textbook, Security Analysis, the 6th edition which is really the 1940 version with updated comments/sections from top value investors.

The only thing I wish is that I started sooner and took it more seriously. Like poker you get better with more experience, and the more work you put in looking for ideas, the better you'll do.

Ok, that's enough for now. Those were the most interesting questions since November 10. I hope someone finds it useful, I tried to delete all the names in case anyone who pm'd me didn't want their privacy violated. Thought it sure looks weird to me as laid out, like a bipolar talking to himself.

And I couldn't decide whether to delete my returns, but I shared them with one member, so I guess I can share them here. I hate the idea of sharing unaudited returns as any fraudulent shill can brag about fake returns to try to gain followers/investor, and while I'm being honest, you as an objective reader have no way to know that. Even in the poker strategy forums big winners don't like to share results, both for the same reason and to avoid attracting smart players to their games.

But the stock market is a wee bit bigger than specific subsets of poker games, and I'd like anyone interested in value investing that it doesn't always have to produce boring solid returns, though that's still a noble objective. Honestly I think I still have many leaks that have hurt my returns over the years, with poker being #1 by far.

Could you talk a bit about your screening process? What filters do you use to narrow down the list of 10k+ stocks out there?

Also if anyone trolls this thread I'm banning them btw.

Really good stuff. I make 90% of my trades on small and microcap stocks from the short side, but have not made too many trades that weren't day trades from the long side.

1. Can you give some examples of pink or otc stocks that you have bought for value and the specific reasons for these buys?
2. When you say you are looking for value catalysts, are you talking about news events like FDA announcements, lawsuits, or something else, because most of these companies don't have earnings. Where do you get your information? I noticed the major news wires and Tradethenews don't cover small and micros very well.
3. Do you ever trade stocks coming out of bankruptcy with their shares price in tact? Take a stock like TRXAQ or VRMLQ last year. What would you be evaluating to see if this meets your value criteria?
4. If you are investing for value, how do you make a decision to cut your loses if prices move against you and how do you determine when to sell the price goes in your favor?

I don't use stock screeners any more, I have a service that provides SEC reports, and I give it a list of criteria to search for, and a list of companies I find attractive. Other than if I read about a business/industry/market situation that sounds interesting (in the WSJ, NYTimes, etc) i'll dig in. Then guys in my group often bring up stuff and I'll give them my thoughts in exchange for their finding the idea, and vica versa.