Cheap Stock Investor-Our Methodology

This Blog is the result of being an active investor for the last 20 year. I had “played” the stock market literally since I was 14 years old and made a little and lost a little. In 1986 I borrowed $700 on my credit line and turned it into $30,000 in less than a year. Then came the crash of 1987. I got out with around $5,000. But it was devastating. Just after that I got a sizable distribution (under $50,000) from a 401k plan. What to do? I sat there and calculated the compound value of my distribution at 5%,6%,7%. Not too exciting. At 15% it did start to get exciting. I thought “how do I make 15% a year?”. The only way was the stock market. But to get this kind of consistent return I figured I would have to work at it–pretty hard–no playing anymore. So I put my distribution in the market and started doing research reading every thing I could and talking to brokers, companies etc. My backgound is financial and I have been the CFO of several companies both public and private, so this helps deciper company financials–and the words in press releases (since I used to write them).

So over the last 15 year ending 2005, my portfolio has grown at a compound 25% a year and is solidly in the low 7 figures. I have taken out more cash that I ever put in. I have 3 IRA accounts, and 5 non-IRA accounts. I have 2 live brokers and I manage small portfolios for several friends and relatives which have done better than the 25% a year on these (it is easier to get bigger % gains on small portfolios of course).

So, how do we do it? By working at it every day. For tech companies we have a valuation formula that works great. By using financial metrics we can come up with very accurate valuations of these companies (it works on smaller medical companies also–but with some filtering). We read their financial reports and get the flavor for where we think the company is going, plans etc. If there are no big “gottcha’s” (like losing big customers, hemmoraging cash, big lawsuits, bad guidance, etc) and the current stock price is less than 60% of our valuation–and generally they have to have a lot of cash–we buy. Once a stock gets to 80% of our valuation we start to think about selling, depending on the stock price action, new earnings reports, guidance, etc.
It works. NTCT and DTLK are examples so far in 2006 as is AVSO.ob. Others are noted in our Profile. We find a lot of very cheap Bulletin Board stocks these days. American Oriental Biosciences was one of our buys back when it was below $2.00 and they moved to the AMEX. At around $5 today–we don’t think it is cheap anymore. These OB-abies are usually thinly traded, but have great potential and are good for small portfolios.

Some rules we consider when investing:

Don’t buy on margin. EVER

Plan on holding a stock for 2 years (but sell it if it hits the target price–even in 2 days).

Stay away from commodities. The past year or so has been great and I have even bought a steel company and an oil and gas company and done well, but only a little. Too risky and unpredictable.

Only buy stocks that you don’t lose sleep over. We generally stay away from companies with a lot of debt. We like cash laden companies with good margins–even if they are losing a LITTLE money.

Try to NOT lose money. Even if you only make a little, losers kill your performance over the long term. We try to get it right at least 80% of the time. Unlike Venture Capital where they are doing good if they get 1 out of 10 right.

Some other stocks that I own (not saying to buy them!) are: SPNC, SCR.a, CPD, EASY, EGY, CTE, IHR, MECA, OTIV, TMR, VERA.ob, RDCM, ARIS.ob.

Good luck to all

Advertisements

2 Comments

  1. Hi. I started to follow your blog 6 months ago. I'm a young (20 years old) italian value investor and I am impressed by your extraordinary results. I looked for something more about your methodology through the blog and the only article I found was this one. I've read it but I still have some questions. First of all I was curious to know something more about your valuation formula; what is it based on? Why can it be used successfully almost only with tech stocks? I have a lot of doubts because your valuations are totally different from mine (but I'm often wrong and you are always right). Finally I was interested to know why do you invest almost only in tech stocks and not in other kinds and what kind of valuation tecniques do you use in those sectors. Thank you for your time and for your wonderful blog!

  2. Hi Andy,
    Thank you for your kind words.
    It took me many years to come up with what I think is a solid way of valuing tech companies. Unfortuately it is proprietary and I am not ready to disclose it. As you may have read in one of my prior posts, I don't do this blog to make money–just for self discipline in investing. But someday I might want to monetize this via a subscription model. What I can tell you is that it has nothing to do with PE ratios, or growth rates, although these are always good things to look at after the valuation is run. It has everything to do with the sales, margins, net cash on hand and a current profitability. So far the formula only works for tech and medical stocks. I have tried to model retail companies, but with no consistent sucess yet. Sorry I can't be more illuminating on the formula.

    I invest (am invested) in all the stocks on this blog. I hate to lose money but realize you can't be right 100% of the time. This formula seems to work 80% of the time.

    Good luck.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s