Books written by two famous professional investors talk about how the common investor can get an edge on their stock research.
It is not likely for us to be able to buy a cheap stock when everyone in the stock market is more knowledgeable about the stock than we are.
In fact, we might get sucked into purchasing a stock that, on the face of it seems cheap, but turns out to have hidden problems beneath the surface.
So, how exactly does a professional investor do their research and obtain valuable data necessary to make decisions?
Yes, they do look at annual reports and other materials, but they do have other methods to learn about a company and what that company does.
Let’s explore this a bit deeper.
What Can A Scuttlebutt Do For You?
If we happened to be a sailor in years gone by, we would know that a scuttlebutt was a water fountain or cask of drinking water that was on the deck of our ship. It was the equivalent to our office water cooler where everyone stands around it talking about the latest gossip.
Philip Fisher was the author of a book titled Common Stocks and Uncommon Profits. He was one of the first people to write about this topic and its modern-day equivalent in a chapter of his book named “What A Scuttlebutt Can Do”.
Much like sailors did, Fisher suggested that we try to talk to employees of the company we are researching, as well as its customers, suppliers, applicable trade organisations and if appropriate, research scientists.
Of course, how far we get with this endeavour all depends upon who is standing around the company scuttlebutt. After all, we can’t randomly walk up to the director of a company’s supplier as he walks down the street and start grilling them about the company we are researching.
In all fairness to Fisher, his book was initially published in 1958. Information about a company was distributed much differently than it is currently. That is why I also suggest reading a book written by Peter Lynch, titled One Up on Wall Street.
The Key Points Of Peter Lynch’s Book
Lynch’s book takes a look at what we already know about outperforming the pros. In one chapter, Lynch recalls inviting CEOs to his office in the 1980s when he was the leading manager of Fidelity’s Magellan fund. He then writes, “On the other hand, I can’t imagine anything that’s useful to know that the amateur investor can’t find out. All the pertinent facts are there waiting to be picked up.”
Lynch notes that most of the necessary information we will need is in a company’s annual report, but if there is information missing from the reports, we can always ask our broker or by visiting or calling the company directly.
He reminds us that when we speak with our broker, we should be firm. After all, we are their customer. If we speak directly with the company, Lynch says the idea is to be polite, show that we have already researched the company and be constructive. If we are a shareholder, he notes, be upfront about it.
Like Fisher, Lynch does suggest gathering information by talking with people, but in a less aggressive manner. La Quinta Inns was one of his most successful investments which he found out about when mentioned to him by someone at the competing Holiday Inn. Another one of Lynch’s successful investments was in Hanes, maker of ‘L’Eggs hosiery. His wife gave him an investing tip on that one.
Caution: Skewed Information Alert
While Lynch encourages obtaining information verbally, he does so with an air of caution. He tells us to be aware that the information we receive can be skewed depending upon the person that is giving it to us. To illustrate his point, Lynch says, “When looking at the same sky, people in mature industries see clouds where people in immature industries see pie.”
Based upon a number of unknown variables, we can ask different people about the same subject and even the same people on different days, and get different responses. Lynch advises that, “there’s no reason for the investor to waste time trying to decipher the corporate vocabulary. It’s simpler to ignore all the adjectives.”
He also states that generally, companies are there to be visited and that is how the average investor can get a leg up on the professionals.
That being said, we know that Lynch stayed for a number of nights in La Quinta motor inns before investing in their company. He also visited Pic ‘N’ Save before he bought into their business and he ate his share of burritos before investing in Taco Bell. I’m assuming he let his wife do the product testing for L’Eggs.
Processing the information
While information gathering is very important, if we don’t accurately process that information, it can be detrimental to our success.
Firstly, I caution you to avoid generalising based upon your own preferences and biases. For example, I may think the new brand with exotic ice cream flavours is the best ice cream I have ever had, but if the majority of others don’t agree, then it’s definitely my own one-sided biasness.
We also need to not make generalisations based upon our personal experience. Simply because our supermarket carries the most juicy oranges, it does not mean that every other person in the country can walk into their local store and get the same oranges.
Warren Buffet’s investment in American Express in 1964, after its reputation was sullied by fraud in New Jersey, is a very good illustration of this.
Because of their tainted reputation, the value of their stock crashed and nobody knew what the future of American Express would be.
To see it for himself, Buffet went to his local restaurant and noticed that customers were still paying with their American Express cards. The same was true when he observed customers using the card to pay for items in retail stores in his hometown of Omaha.
As a result of his observations, Buffet concluded that if was occurring in Omaha, it was likely to be occurring in other parts of the country as well. He was correct. The company was far from failing and was as strong as it always had been. Therefore, Buffet put a bulk of his capital into American Express and that decision paid off very nicely.
Stick to the fundamentals
Collecting information is an important aspect of investing, but it doesn’t take the place of sticking to the basic norms of doing our research and valuation.
We cannot do our own research in a vacuum.
Even with the best intentions, we can still be out of touch with the current valuation of say, a bank and may not be aware that the new mortgage product we recently applied for had already reached its projected level of success.
Even so, we should ask whether an average-sized bank reaching success with a new mortgage product is going to make or break a company. While we are focusing on this one product, for all we know, the market could be focusing its energy on a bad debt situation that is much more important to the company’s success.
In other words, don’t abandon fundamental investing methods.
Fundamental Analysis In 5 Minutes
Not all information about a company is relevant to your investing.
The truth is, you really only need to look at 10 key metrics when it comes to assessing the quality of a stock.
If you’d like to learn how I personally screen out the best stocks on a daily basis, I highly encourage you to download a copy of my 10 Must-Have Checks To Choose The Best Stocks And AVOID The Rubbish.
These 10 criteria immediately saved my students hours of research every day, and only requires 5 minutes to implement, so you can instantly identify the top 1% of stocks available at any time!