My 70 Rules for Stock Investing: Part Two

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I’ve achieved a 15% compound annual return in my personal stock investing portfolio over my 12-year investment career

Robin Speziale | May 31, 2017 | SmallCapPower: I’ve been investing in stocks since I was 18. I started in my dorm room at the University of Waterloo in first year (2005) and haven’t stopped investing in the stock market since. It’s been a passion of mine but also a path that I feel confident enough in to build wealth over time. I’ve achieved a 15% compound annual return in my personal stock portfolio over my 12-year investment career. You can read more about my investing background here.

But what I haven’t gone into depth sharing is how I invest in stocks. My thoughts on the market, which types of stocks I pick, and why. My journey in writing the best-selling book, Market Masters, was certainly an inflection point for me. By meeting with, and learning about top investors’ investing strategies, and their frameworks, I upgraded my own investment approach. Experience also played a crucial role, having invested through the financial crisis (’08), two bear markets, and a handful of corrections. So, while it’s not all perfectly structured, with lots of rough notes, I’ve outlined below My 70 Rules on Investing in Stocks. These rules will give you access to my investment thought process.

For the budding investor, these 70 rules will hopefully be valuable information to help get you started in the stock market. And for the experienced investor, maybe there’s something new that you didn’t think about before, or at least that my rules validate how you’re already investing in the market.  Enjoy.

My 70 Rules on Investing in Stocks:

See Rules 1 to 35 here

  1. A company’s stock price performance needs to match its underlying fundamentals overtime. My favourite companies have stock charts that rise steadily over time, in line with their intrinsic growth, with very little volatility in their stock prices. Just an almost perfect upward trend line. These are difficult to find. But Lassonde Industries comes to mind and is a good illustration.
  2. When I first learn about a new company, I add it to my “watch list,” conduct further research, and follow it for some time before I decide to initiate a positon. I give myself a ‘cool-off’ period to avoid buying any stocks on emotions.
  3. Only 90% of the Canadian stock market is investable in my opinion, with ~ 50 truly exceptional businesses, at any given time.
  4. I get excited when I find a great company that issues black and white annual shareholder reports (without photos), has an outdated and amateur logo, and is still using a website that was designed in the early 2000s. These are the ‘gems’ that have yet to be fully discovered by the institutions and masses. Once companies get bigger, on the foundation of their success, they upgrade all of those things.
  5. It’s usually best when management has a stake in the company and/or is an owner/operator. Because they’re shareholders too. They want the stock price to go up as much as you do. But management must also demonstrate operational excellence, combined with superb capital allocation, intelligence, and a strong drive to compete. Further, management needs to have an achievable vision for the company, with the ability to execute and realize that vision. And finally, management needs to have integrity. Why integrity? If management is caught with having committed a fraud, or breaking any laws, your investment in a company can quickly go to zero.
  6. We’re at a point in time where every industry is getting disrupted by technology. It’s not just the technology companies anymore, like Apple (iPhone) eclipsing RIM (BlackBerry). Everything! Which is why I like to invest in companies that serve a need/want that can’t be easily disrupted by technology in the next 10 years. Food, and drinks, for example. Everyone will still be eating burgers, and drinking coffee, the same way they do today, in 10 years’ time. Technology won’t change that basic human behaviour.
  7. If I don’t think a stock can become an “x-bagger,” I won’t invest in the company. For example, a 3-bagger means that a stock goes up 3 times from its initial investment. $100 invested would turn into $300. That’s why I like to invest in companies that are sized $100 million to $10 billion in market cap. More so on the smaller-end, because if a company “makes it,” I can potentially earn 100x my investment (wishful thinking, and rare, but heck, it could happen! Paladin Labs did it). But then because of the law of large numbers, once my stock grows into a large-cap, I’ll usually sell, and allocate capital into the new emerging opportunities on the stock market.
  8. I favour stocks that have strong tailwinds, like demographic trends, de-regulation, or shifts in consumer taste, driving profits in certain companies that are already selling those ‘beneficiary’ products or services.
  9. I don’t invest in companies that will just be ‘one-hit-wonders’. Growth companies can only maintain their high growth by investing in research and development, expanding their business into new product lines, services, and markets, and/or evolving with their customers, over time. Innovate or die.
  10. As soon as any management blames their problems on external reasons, like bad weather (seriously, I’ve heard this… as if customers can’t shop online), media, consumer taste, etc. I will usually quickly sell the stock. Management needs to adapt to change and accept their issues before they become BIG problems. I still remember going to RIM’s annual shareholder conferences from 2009 – 2011, and listening to the CEOs explain that “people want long lasting batteries, great reception, and keyboards”…….
  11. I closely watch a company’s gross margin over time. Declining gross margins are a sign that competition is driving down prices. And I only want to invest in businesses that have strong pricing power, which is a result of their competitive advantage.
  12. Even great companies have minor setbacks. But the difficult part is separating the minor setbacks from the big problems. I always sell when there’s a big problem that will continually hurt the business going forward. In other words, I sell when my initial thesis to invest in the company is later broken. I don’t wait and see.
  13. Because I invest in more illiquid small-cap and mid-cap stocks, I can stomach volatility; in other words, the ups and down in their stock prices. But that’s as long as the intrinsic growth trajectory of those businesses is up over time. Amazon didn’t go straight up. Successful investors had to have the wherewithal and confidence to withstand the ups and downs in its stock price.
  14. I mostly focus on Canadian equities, which comprise 80% of my portfolio. I feel I have an edge as Canada is my home country. However, 20% of my portfolio is in U.S. equities. I was buying U.S. stocks when the Canadian dollar was at-parity and also above-parity. But I’ll buy U.S. stocks again once the CAD reaches 90 cents. I don’t invest in European or Asian equities, as I don’t believe many companies in those regions are controlled by strong shareholder-oriented managers. Plus, the North American companies that I invest in sell products and services into those regions. It’s a win/win.
  15. It isn’t enough that my fundamental research checks out on each stock. Stock price momentum needs to also be in an upward trend line over time.
  16. I verify net accumulation in a stock by checking its accumulation/distribution on StockCharts.com. If accumulation/distribution is rising, especially in a stock that’s consolidating (trading flat), than that’s a good sign. I want other people buying, and accumulating the stocks that I invest in too.
  17. I do a new scan of North American stock markets – TSX, Venture, NYSE, and NASDAQ – every three months for new issues. Also, some stocks appear on my filter for the very first time because they’ve finally surpassed a metric benchmark, like return on capital. That way I’m always on top of the market.
  18. I’ll use leverage/margin in my portfolio, but won’t surpass 20% of my portfolio’s total dollar value.
  19. When I sell a declining stock, on the basis that my original investment thesis has been invalidated, I’ll invest the proceeds into one of my winners. The winners can make up for the losses and then some.
  20. There’s no such thing as passive investing if you’re a stock picker. I’m checking my portfolio on a daily basis. If I wanted to ‘buy and forget’, I’d cash out and put all of my money into an Index Fund. But that also means accepting those returns.
  21. Losing money has been the best lesson for me. I know what to avoid now; companies, and management teams that destroy shareholder value. And with experience I can more quickly identify and screen-out those bad companies. It’s surprising how many companies are superb at capital destruction. But I also study other people’s mistakes. It’s cheaper. That includes mistakes by hedge fund managers, and other “smart money.” Nobody’s right all the time. As James Altucher says, the investors and hedge fund managers who are successful all of the time are probably criminals (i.e., insider trading) or about to lose everything.
  22. Think about all the assets (intangible and tangible) that a company owns, and not only each assets’ cash flow generating ability now, but its ability to generate cash flow in the future. Having a lot of assets on the balance sheet doesn’t mean anything if the company can’t generate a high return on those assets for its shareholders. I love companies with wonderful assets, like Disney. The worst management teams buy bad assets through acquisitions, at too high a price, and then write off their mistakes later. Management needs to be good stewards of capital.
  23. I go to StockChase.com on a daily basis, and check the “Predefined Scans” section, to see the stocks hitting new 52 week-highs. If I see companies hitting new 52 week highs, I conduct further research and buy based on my aforementioned criteria. Why? Because that break-through price momentum is being fuelled by high demand (i.e., investors and institutions buying the shares). Similarly, stocks that have finally broken out of a consolidation phase (flat-line) are interesting to consider.
  24. I never say, “I missed out on that stock,” if I see it’s gone up 500% in 5 years, for example. Especially if it’s still a small-cap or mid-cap company. Because I know that those great companies can compound many times more. They’re still small. I also never say, “It’s too expensive so I won’t buy the stock”, after simply looking at the P/E and nothing more.
  25. I don’t quickly overlook companies that aren’t generating a profit. They may be the next winners on the market. Amazon, for example. By the time Amazon started to generate a profit, it had already become a $400+ billion dollar company, compounding many times over, and making their loyal shareholders incredibly wealthy.
  26. When I hear that there’s a change of management in a company, it makes me take a second look, especially if I skipped over the company in the past.
  27. I avoid companies that only grow through inorganic growth, i.e. acquisitions, fueled by debt. Because once the debt, or acquisition opportunities, dry up (and often it’s both), the stock will fall straight to the ground for value investors to scoop up. Acquiring companies, and doing just that, isn’t a business strategy.
  28. I like to learn about how successful investors think. Their framework on why and how they pick stocks. You can read my book (Market Masters), or The Money Train, Market Wizards, and One Up On Wall Street, to get into the minds of top investors.
  29. There’s little spread to be made in merger-arbitrage these days, because of high frequency trading, and easily accessible information. And when there is a juicy spread, the takeover could very well fall through. Just look at the failed Ontario Teachers Pension Plan/Bell Canada takeover case. Investors in that merger-arbitrage play got crushed. So, I’d rather invest in small cap companies that could soon be taken over. They’re my “speculative takeovers.” For example, I purchased shares in Rona, speculating that Lowe’s would return to attempt another takeover, having been blocked the first time. Lowe’s did and succeeded in their second takeover attempt, sending Rona’s stock up 100% in one day.
  30. I’ve come to realize that the market is largely psychologically-driven. John Maynard Keynes described the stock market as a Keynesian Beauty Contest, where “it is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.” This can be demonstrated in what I’ll coin, in an homage to “the Nifty Fifty,” “The Sexy Six:” Facebook, Apple, Alphabet, Netflix, Tesla, and Amazon.
  31. I compare my long ideas (stocks I want to buy) with current short positions (as a % of float), and the analysis by any prominent short sellers. I always look to see the reasons why others would want to short a stock. For instance, investors who were long Home Capital stock would have done themselves a big favour by reading what prominent short seller, Marc Cohodes, had to say about the company. But it’s certainly hard to sell when a stock has had a remarkable track record, high return on capital, and stellar share price performance. One thinks, “How could anything ever go wrong?…”
  32. Usually the media headlines (e.g. “The Death of Equities” or “Sell Canada”) are most depressing exactly before the market starts to turn up again after a recession or bear market. Great buying opportunity. Which is why I keep cash on-hand (and still read news headlines).
  33. If I’m buying stocks, and I see that other small-cap funds or hedge funds are buying too, that gives me some validation. But it doesn’t mean it’ll work out. Some of the funds that I follow, which also invest in small-and-mid cap stocks: Turtle Creek, Pender, Giverny Capital, Donville Kent, Adaly Trust, and Mawer New Canada Fund. I also follow analysts like Gerry Wimmer. My portfolio has a lot of overlap with these funds.
  34. There’s always tail risk. Someday, some event will rock the stock market. But I’ll only know about it after-the-fact. Because of that fact (I’m not ALL-knowing after all), I don’t worry about things that I can’t control. I control risk by holding great stocks and controlling what I can in my portfolio.
  35. The stock market exists to help companies raise capital, grow, and be successful. Why would I invest in bad companies that don’t grow? That’s what value investors do (or at least, try). But that’s not why the market exists. Remember, one of Warren Buffett’s best investments, GEICO, was a growth stock!

In summary, if I’m not beating the market’s long term return, (TSX ~10%), or beating it the majority of the time, then I should stop investing in individual equites and instead be putting my money into an index fund. It’s been 12 years (2005 – 2017) and I’m still actively picking stocks, with a 15% compound annual return. Hopefully I can keep it up. Because at ~ 15% compound annual returns, I can double my money about every 5 years, without taking on too much risk.

I hope you enjoyed my 70 Investing Rules. If you did then I encourage you to also read my talk on “Capital Compounders,” which is from the Fairfax Financial Shareholders Dinner (2017).

Disclosure: Neither any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.

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