If running an effective quant screen was the only thing required to find new stocks ideas, investment success might not be as elusive as it is today. The fact is that investment idea generation is as much an art as it is a science. As Michael Hintze, Founder of $12 billion hedge fund, CQS, recently stated: “As investment managers, we’re all trying for alpha. However with technology, we don’t get paid for knowledge anymore, because knowledge is everywhere … we now get paid for imagination”. If imagination is an increasingly important source of alpha, it pays to define the sometimes nebulous process of idea generation. With this in mind, Livewire reached out to our contributors to ask them to share one of the most effective ways they produce new stock ideas. Insights provided by OC Funds Management, K2 Asset Management, Katana Asset Management Bennelong and Totus Capital.
Be open to ideas from all sources
Julian Beaumont, Bennelong Australian Equity Partners (VIEW LINK)
New stock ideas can come from all sorts of places. Sometimes you stumble across a new idea when researching another stock. The CEO might endorse a supplier or customer, or better yet, give credit to a competitor. For example, shopping centre managers are a very good source of identifying which retailers are performing best, and retailers will know which particular products are selling well. To the extent relevant, we will follow companies listed in overseas markets to gain insights into ASX-listed companies. One unusual case recently was a company we followed that had been listed on the New Zealand Stock Exchange for some time, Michael Hill International. The company actually changed its listing to the ASX, and this meant that we could buy it for the funds at a time when it wasn’t well known or covered.
Define your universe then meet the management
Robert Calnon, OC Funds Management (VIEW LINK)
The most effective way to generate new stock ideas is not rocket science: it involves burning shoe leather. Covering small and micro caps, the OC team has a broad universe of stocks to stay abreast of (just under 2,900 stocks are currently in the ex-100 universe) and one of the primary means of identifying the next potential portfolio holdings is through an extensive company visitation program. Each year, our team has more than 700 meetings predominantly with company management, but also with listed and unlisted competitors and independent industry experts.
OC has a strong focus on risk and one of the most effective tools we use in identifying new stock ideas is through screening out almost 2,300 “risky” small caps. These stocks are typically unprofitable, overly complex or are undiversified commodity-based businesses.
Company meetings to understand business and also the industry dynamics
Nick Leitl, K2 Asset Management (VIEW LINK)
The volume and velocity of information in the world today, especially in financial markets, continues to increase exponentially. Deciphering the noise and understanding key facts is critical for the idea generation process. At K2 Asset Management, we generate ideas from numerous information channels, however getting out and meeting with companies and their management is one of the most effective ways for us. In addition to providing important insights into the performance of their own business, management can also share their views into the industry in which they operate and how the industry is evolving. It also gives us the opportunity to cross-examine competitor behaviour and validate information from other sources.
A fruitful process for finding ‘short’ ideas
Sam Granger, Totus Capital (VIEW LINK)
At Totus we are looking to buy good businesses with tailwinds for earnings growth into the medium term. Generating new stocks ideas that meet our criteria is difficult and requires us to cast a wide net. We read widely, organise numerous company conference calls, attend company meetings, travel to conferences and speak to industry contacts. Whilst there are no short cuts to this hard work, one of the things we study is the buying and selling of company insiders. This strategy has been particularly fruitful on the short side of late, as we have seen a number of large sell downs from private equity and company founders immediately prior to large downgrades. Recent examples that come to mind are Estia and Vocus.
You have to be relentless
Romano Sala Tenna, Katana Asset Management (VIEW LINK)
In a word, the most effective way to generate new stock ideas is to be relentless.
- Relentless in talking with advisers and other investors;
- Relentless in what you read;
- Relentless in meeting with management;
- And relentless in developing sources for new ideas such as forums, conferences, newsletters, economic commentary, trade publications and quant screens.
As John Maynard Keynes wrote:
The game of professional investing, is intolerably boring and over exacting to anyone who is not entirely exempt from the gambling instinct.
Of the above, if pushed to highlight one area that has provided the highest likelihood of success, it would be developing a wide network of quality advisers. Ultimately we still have to put every idea through our internal selection process and needless to say, we will never abdicate the decision making component. But an experienced adviser/broker/analyst who understands the nuances of the market, can provide the best ideas with the highest likelihood of success by applying their own time, logic, experience and filters.
A word of warning: all investors are impacted (to varying degrees) by the views of others, so just as it is important to filter out bad ideas early in the process, it is even more important to be vigilant in filtering out ‘bad’ advisers.