Investment Idea Generation Strategies for New Investors
As I pointed out in previous articles, the first skill a new investor should master is that of business valuation. Check out my series of articles with videos about different types of business valuations you can do. Once you get good at valuations, then you can turn your focus to the subject of this article: idea generation.
Here is a list of ways to generate investment ideas to put through your idea management system.
- Newspapers and magazines, online articles
- Subscriptions to Value Line or other services
- Coat tail off of well-known fund managers
- Going through an index from A to Z
- Search the Edgar database
Use Stock Screeners to Find Good Value-Based Investment Ideas
Finding companies to research is extremely easy in the modern world. Yes, because it is so much easier to gather information, you many suffer from information overload.
There are thousands and thousands of stocks listed on U.S. stock exchanges alone, not to mention the hundreds of thousands on international exchanges. Fortunately that powerful access to data has also provided us with powerful tools we can use to filter out the garbage and more efficiently discover new value-based stock ideas.
Screening for stock ideas using stock screeners with lots of different variables is one of the major benefits of the internet revolution. As Warren Buffett said " you can find them faster."
Like any tool, the key to successful screening is to know what criteria to put into it. Get the criteria right, and you are sure to come up with a few good ideas to put into your idea management system.
If you are looking for a wonderful company with modest debt and an attractive P/E ratio, for example, you may use the following criteria
- A Return on Equity of more than 15% - This metric indicates a profitable company with a probable competitive advantage
- A Debt to Equity Ratio of less than 0.5 - A reasonable debt load and potential for growth without issuing debt
- A Current Ratio of more than 2 - This means the company can easily pay off its current obligations
The point to make here is to fully understand the criteria and be deliberate about selecting them.
As far as what stock screener to use, start with whatever screener your current brokerage provides. Most will provide at least a basic screener, and some provide very advanced screeners. Getting efficient with screeners will aid you in generating good ideas in a short amount of time.
Find investing ideas in magazines, newspapers
One of my favorite sources for new ideas is Barron's magazine, which you can still get in paper (my preference) and Bloomberg BusinessWeek. Barron's is great because they have a section on 13Ds (good for coat-tail investing) that were filed the previous week, and a section of preferred stock (which is rare).
When you are looking for ideas in a newspaper, and you are focused on value (buying for less then the company is worth by a margin of safety), you should be looking for articles about companies that are performing well, but are strangely inexpensive. Look for comments like "unusually cheap", or "selling for less than twelve times earnings" and similar phrases.
Keep in mind that just because a newspaper or magazine says it is cheap does not mean that it really is. You are just looking for ideas to analyze at this stage, not looking for something to buy. You still need to do your own valuation of the idea to determine for yourself if it is cheap.
Finding ideas that are already in newspapers and magazines may mean that the idea is already well known and you may have competition in buying the stock. It's a starting point, not the end point.
If you are just starting out, you may want to avoid a daily newspaper like the Wall Street Journal. It sounds a bit odd, but the reality of a daily newspaper arriving every day is that it will pile up and distract you from all the things that you need to learn and master to be a good investor.
Consider subscribing to a service like Value Line to find investing ideas
Value Line is a really unique publication and has been a favorite of value investors going back to its founding in 1931 by Arnold Bernhard. Value Line is a great source of potential investing ideas and the way in which it is formatted and delivered lends itself to productive research.
Value Line arrives every week. Each edition is packed with about one hundred and forty companies with detailed financial information going back nine years and organized to capture the key ratios and numbers that value investors should be looking for.
There are several variations of the Value Line service, including the regular service, Small Cap, Special Situations, and Select. I have subscribed to both the regular and small cap service and love them both.
Coat-tail off of value investors that run hedge and mutual funds
Coat tail investing has been a key to success for many early value investors and is one of the best places any new investors could start. If you can find out what a well-known successful value investor is buying, you can reverse engineer their idea to find out why it was attractive.
There are several resources available to you to find out what value investors are buying. The Edgar database at SEC.gov is a great resource to discover what funds are buying by searching for their 13F-HR filings which list their reportable holdings.
By comparing 13Fs from period to period you can find out what an investor is buying, selling, or holding. If you want to make your investing life even easier, check out GuruFocus.com, a website that has already done the brain damage for you.
Fairly often the fund manager will also release a quarterly letter (or monthly) that will have their argument for what attracted them to their holdings. In combination with their 13F filing, you should have enough to go on.
Go through and index from A to Z to discover some investing ideas
Buffett famously said when you are looking for investment ideas "start with the A's." What he meant by this is that you could always choose an index like the Standard and Poor's 500, sort them alphabetically, then go through and screen each one all the way through the index, getting 500 under your belt.
One key to successful investing is to see as many ideas as you can as quickly as you can. Buffett used to "race through the stock tables" meaning he would grab the latest Moody's manual (a similar service to Value Line) and scan them quickly. The opportunities just jump off the page when you can look at nine or ten years of data and statistics on a company all at once.
Search the Edgar database at the SEC.gov website to find ideas of different types
I recorded episode 16 of my podcast "What Works in Investing?" on the subject of searching the Edgar database, so be sure to check it out. There are a number of different types of searches you can do to discover new ideas. Here are some form types you can search for:
10Qs and 10Ks - These are the quarterly (Q) and annual (K) reports companies have to file with the SEC.
· S1s for IPOs - This is the form required to file for an Initial Public Offering
· SC TO-T for tender offers - This form is for companies announcing purchase of a companie's public stock through an offer to buy it in at a specific price. There are three types of SC forms T, I, and C. Each one serves a different purpose.
· 13D and 13G for holders - These forms are filed by activist investors or just investors who have taken a position equal to or greater than 5% of the outstanding shares of the target.
For Thrift Conversions use[6036 and 424b3] in the Boolean search. Thrift conversions are a unique and rare type of transaction these days.
· 13F-HR – Institutional investor holdings This is the filing to search for if you want to see what a fund manager owns at any given point in time.
The hunt for investment ideas is never ending. If you get good at it, you will find yourself with more ideas than time to research them. That is when the idea management system is immensely useful in prioritizing ideas and moving them through a process.
My suggestion would be to start with coat-tailing, get good at that and then move on to some of the other methods I outlined above. This list is not exhaustive, but should keep you busy for years to come. Good luck in the hunt!