How to Find Investment Ideas
Years ago, I wrote an article called Finding Investment Ideas for Your Portfolio for About.com, a division of The New York Times. I’ve been thinking for the past few days about how it is that I seem to come across so many opportunities and then I realized that most people like me are always looking whereas the average American isn’t.
By that, I mean that every time I walk into a business, without exception, the first thought that occurs to me as I look around is, “I wonder if this company is publicly traded.” If it looks promising, I add it to a mental list and during my regular research periods each week, I pull all of the information I can about the company, or the corporate parent, and begin attempting to value it conservatively. It only takes a few, or even one, great investment in a lifetime to be financially independent.
If my friends and family could actually hear my thoughts, it would be amusing. As we walk through the aisles of Wal-Mart, I am thinking to myself, “Wal-Mart has a net profit margin of 3.3%. So, if I buy this $49.95 video game, the stockholders, who are the owners, are going to generate after-tax profit of $1.65 on the sale. With a dividend payout ratio of roughly 30%, $0.50 of that will be distributed as a cash dividend and the remaining $1.15 will go toward expansion or stock buybacks. With 3,810,171,967 shares of stock outstanding, each share of the company is entitled to $0.000000000433051 of the profit.” Sometimes, I actually pull out a calculator to compute figures as I stroll besides the shopping cart.
It’s almost like a game of chess, or solving a puzzle where the pieces are constantly moving and half of the box is missing. I love the game. Particularly, I like that if I’m right, I make money for the people about whom I care, so they can buy nicer clothes, pay off their debt, take vacations, or send their kids to music lessons. That matters to me far more than the idea of owning a Net Jet. It provides me with a real sense of satisfaction. Most people can’t say they actually make a difference in people’s lives. I can.
Yet, this idea of looking for such opportunities never occurs to most people. Here’s an example from my own family …
Ed’s Sporting Goods: An Example In My Own Family
Members of my extended family owned a business called Ed’s Sporting Goods that at one time was the largest sporting goods retailer and team dealer in Northwest Missouri. Now, it was a successful business – far more successful than the average entrepreneur and something about which the owners are, and rightfully should be, proud.
I remember going out to lunch with my Grandma Kathryn at a local Chinese restaurant (we’ve done that since I was a kid whenever we’re both in town) and talking about stocks. She said that for years she had been thinking about buying shares of stock in Dollar General but had just never gotten around to it. I understood this perfectly because I had done the same thing with Apple (despite making a ton of money on companies such as American Eagle Outfitters, I stood by and watched Apple skyrocket 1,400% without buying a single share, even though I switched from PC to Mac both personally and at my businesses, knew how well it was doing, and greatly admired its management team!).
Anyway, a few days later, this got me thinking about how we often ignore what is right in front of our face because we are familiar with it. During its 25+ year rise, Ed’s Sporting Goods was a huge dealer of Nike products, from shoes to apparel. I started working on the math and asked myself, “What if they had taken just a tiny amount of the cash – even as little as what they spent on a part-time employee, and had instead regularly bought shares of this company that they knew, from first hand experience, was doing very, very well?” I don’t remember the exact result, but I figured that my Grandmother and Uncle walked away from somewhere north of $4 million by missing that opportunity.
Why? People aren’t taught to look for those opportunities unless they come from wealthy families which, at that point, we were not. They also missed Wal-Mart, which placed two of its first 150 stores in St. Joseph and Warrensburg, where some of the first Ed’s Sporting Goods were! Walton’s company was literally a start-up right alongside their retailer, in the same city, and they shopped there personally. The same thing with Microsoft. The store, due to its screen printing business, was one of the first to adopt Microsoft DOS and later, Windows 3.1. The same goes for Rawlings Sporting Goods, which is now part of Berkshire Hathaway. And Blue Chip Stamps, which my dad said they used in California all the time, which is now part of Berkshire Hathaway. And Benjamin Moore, which operated a store next door, and is now part of Berkshire Hathaway. And Champion apparel. And Reebok. And Pepsi, which apparently my Grandfather drank all the time. The list goes on and on … but it shouldn’t be depressing, it should be exciting that every few years, we are all presented with more investing opportunities.
The Bottom Line
The bottom line of this is to point out that we are all surrounded by opportunity all the time. Here’s the million-dollar question (literally): How many people do you know who actually devote hours each day to identifying and then acquiring those opportunities? Most people would rather spend time studying new washer and dryer models, upgrading their furniture, or reading the sports pages.
There’s nothing wrong with that. But if you spend more hours each week planning on spending money, such as looking at new cars or houses, than you do planning on how to acquire more cash-generating assets, the result is going to be a drastic reduction in your standard of living. This pattern seems to be playing out with a lot of my friends from college who now seem to realize that you aren’t successful because you have the house, or you have the car, or you have the clothes. Those are merely by-products of having the wealth, which (again) consists of cash-generating assets.
Update: I’ve written an update as of April 16, 2014 detailing how this missed opportunity has now cost them at least $8 million.
Reader Comments (4)
Comments are presented chronologically, with replies indented beneath the comments to which they respond.
Jacob Mast
February 24, 2010
Joshua;
I enjoy reading your posts. (I wish I had known this stuff years ago!)
I don't know much about investing or I should say, thinking like an investor is a major paradigm shift for me. The investment advisers (such as Dave Ramsey) that I usually hear say, 'don't ever buy individual stocks!' What I'm getting from you is to always be looking for a company that is well run and then buy shares in that company. It seems risky to me but hey, my current plan of living from paycheck to paycheck is definitely not very safe either...
Anyway, you are a major source of information for me as I am endeavoring to educate myself and later, as I feel confident, step out and start doing.
Thank you so much and keep posting! -Jacob
Joshua Kennon
February 25, 2010
Replying to Jacob Mast
If you don't understand stocks because you are just starting out, you probably shouldn't own them. I may try to dig up a report to show you a reason why - I found a company (huge - you'd know it instantly) a few years ago that looked like profits were going up but buried in the 10K was a section that showed management was screwing with the pension discount rate, which had the effect of increasing reported profits but not the actual money stockholders were earning. Had I not seen that, I may have concluded the stock was cheap. Someone who doesn't know how to value stocks could have walked right into that trap.
Don't get me wrong - I love individual stocks and they are a big part of my strategy, but my point is that it comes down to a few, key things that will differ for everyone:
1. Spend less than you make, and make sure you keep lots of liquidity on hand to cover cash needs. If you don't have a lot of debt, and always keep plenty of reserves, it's virtually impossible to go bankrupt or starve to death.
2. Once you've done that, don't use your money to buy assets that depreciate (such as televisions, cars, or clothes), but rather those that generate a constant stream of CASH income for your household each month without a lot of work from you. You are going to have areas of expertise that you understand, for instance, that I don't as a result of your individual talents and background.
These assets can be anything you understand - private businesses, "special operations" (I may talk about these later), car washes, rental houses, apartment buildings, song rights, patents, trademarks, copyrights, software royalties, stocks, hotels, etc.
One of my first companies was called Mount Olympus Awards. We set it up so it required virtually no money of our own originally (we sold products online, received the cash, then used the cash to pay the vendor to make the product, with the vendor then shipping directly to the customer). Within the first couple of months of operations, we were generating a few thousand dollars in cash profit each month. It grew from there until we were the most successful online letterman jacket business in the United States. This provides me with a stream of earnings that I can use for other things. In my case, I use them to buy stocks but for someone else who understands, say, real estate, they may want to pick up some storage units because they understand those. Honestly, I have no role in the company day-to-day and couldn't even tell you the last time I set foot in the actual office for it. Everything comes electronically, I check sales, profits, and search engine statistics. It requires maybe two hours a month at most of my own time. In the beginning, years ago, it consumed my life.
Someone once put it this way: Everyone works. The difference is, some people get paid to build a house and make a one-shot paycheck for every nail they hammer into the wood. If they stop hammering, they stop getting paid. Other people save their money, build a house, and then rent it out to someone. Long after they've stopped hammering, they are still getting monthly checks from the person living in the house. Thus, the nails for the second guy are like an annuity stream, or a goose that keeps laying golden eggs.
I'm wired differently. At this point, I know enough about GAAP accounting that I'm emotionally comfortable watching a stock lose 50% of its value without getting upset if I believe my premise were correct. The key is, even if I turned out to be wrong and had big losses, the assets that generate STREAMS OF CASH PROFITS (such as Mount Olympus Awards) provide me new capital to rebuild those loses (heaven forbid) or diversify into other things.
Everyone needs to put together a collection of assets like this because then, if they were to lose their job or want to take time off, they don't have to panic about the lack of a paycheck coming into their household each month. It's more difficult if you have to do it as a first-generation wealth builder (trust me - I know), but that just means you have to focus on things that don't require capital. I know of one guy that started a personal blog and built 7 or 8 entries a day, all designed to hit the top of Google for search. By the end of the first year, he was generating $3,000 per month in profit from advertisements. Now, if he lost his job, that would provide at least some cash for his household. Better yet, he could keep working and use that money to build his other investments. That's the model I like. Stocks just fit into them as a part of the overall picture. For some people, they won't be present at all. For me, given my background, my passion, and my knowledge of accounting, they are a much larger part. That's just due to my wiring and interests.
I hope that makes sense.
Jacob Mast
February 27, 2010
Thanks! That is helpful.
Yes it is very tough to get started saving up money for investments, I'm married with 3 young children and my primary source of income (construction) is quite slow.
I like the idea of things that don't require any capital to get started. That person with the blog, are his earnings unusual or is that fairly doable?
I knew that many people have blogs but I didn't know that you could actually make money with them. Facebook is about as close I am currently to having a blog and I don't know of any way to make money from that.
I did buy my first domain! Do you have any good advice on websites? I'm sure you do seeing as how many you have going! I haven't developed the site yet but it is to be an outlet for things fine and practical at least some of which I'll make myself. Also we are interested in making artisan soap to sell but that may be some time down the road yet.
Question; if so few investors have been able to outperform the S&P 500 than why wouldn't one simply buy into it?
Odai
June 13, 2013
Replying to Jacob Mast
I know this comment is 3 years old, but I thought I'd leave my knowledge for anyone else who may read this. I've run well over a dozen blogs myself, as well as a couple webcomics and a failed magazine. I've run ads and bought ads.
Bottom line - it's hard to make any substantial money on ad-supported services, which most for-profit blogs are.
The problem stems from how easy it is to get started - you can start blogging for free, which means a lot of people do! There's millions (billions?) of blogs, covering almost any conceivable niche. Because of this, the amount advertisers will pay is fairly low.
As I see it, there are 3 good ways to solve this "lost in a sea of blogs" problem:
1. Have master-level knowledge of a subject, or maybe a unique perspective. Anyone could start a blog competing with Joshua's, but how many of them could offer the same quality of advice that he does? Very few people.
2. Don't advertise - sell something. Look at Scott Berkun. He runs a popular blog without ads, but uses it as a vehicle to sell his books. I doubt I would have heard of him or read his books if not for his blog.
3. Experiment. Be willing to spend hundreds (even thousands) of dollars and lots of time, founding blogs, running ads on Adwords, monitoring Google Analytics and Google Trends. Hope to find a very profitable, relatively untapped niche market. Frankly, I think the effort would be better spent selling actual products on Amazon or something, but it could work.
...
To answer your second question, Joshua actually recommends buying into index funds for normal people.
Although my knowledge of investing is still beginner, I believe the reason most actively traded funds perform poorly is because stock movements are hard to predict, because fund managers are trying to prove their worth and so take risks, and because active traders pay higher taxes and more fees.