Narrowing Search Space – Looking for Needle in a Haystack
What is common between “searching for needle in a haystack” and “going fishing”? The common thing is you are trying to get one small thing (needle or fish) in a sea of unknowns. That’s where the commonality ends. The approach one takes is different in both cases. In case of fishing, you place your hook in the water and wait for fish to get trapped. Yeah, you may try to fish in location known to be breeding ground. But in the end, fundamentally, you have to wait for the fish to get trapped. In case of searching for needle, you are making a proactive effort to clean the haystack knowing there is at least one needle somewhere in there. A dumb person will try to dive in, but a smart person, will carefully remove small blocks of haystack to reduce search space. You cannot do that with water. Can you reduce water to increase your probability of catching your fish? Probably not.
It is in this context, I believe searching for a good company is like searching for a needle in a Haystack. If you make your search space smaller and smaller, you are likely to find that needle. The only question that remains is how you make your search space smaller? There are many different approaches to narrow down your search space.
Some folks use top down approach of narrowing it down by industries and sectors. Some use market capitalization. Some use metrics like PE ratio, ROE/ROC ratios, growth parameters, etc. Some go by market momentum. Some go by talk of the town. What do I do? How do I narrow my search space?
Step One: I do a lot of reading which includes a whole gamut of subject. It could be about business news, economics, sectors, industries, companies, equity markets, investments, bonds, real estate, gold, etc. You get the point. Right? Pretty vast area. No, I am not trying to narrow my search. All I am trying to do here is be aware of things happening in the economy. What are different avenues for investments? Does any company or business sector standout? Do I like business model? What is consistency? How those business sustain themselves? In this random reading, I end up generating or short listing bunch of companies. Again, it is purely subjective based on what appeals to me. There is no structure and there is no organized logic behind it.
Step Two: So now I have random list of companies? What do I do with it? This is where I start narrowing my search space.
- Gather some general information of the company: How it is listed on BSE/NSE, general news articles of the company, products, markets it caters to, etc.
- Look at its financial overview and subject them to my screening process. During the screening process, I look for cash flow, dividends, debt, margins, profits, and capital usage.
- I spend two hours or less in this screening process.
- I could reject a company completely, or add it to my shortlist for detained analysis.
- As of today, the list for companies for screening is about 40+
Step Three: I have list of companies that have cleared the screen. I spend significant amount of time reading about company in this short list.
- To avoid impulse decision making, I break the process down in multiple small parts. As an example, one day I will look into financials, some other day I may look at general news, some other day I will look what management says and does, etc.
- Here I am looking into trends. I am looking for generic direction of how management is trying to grow the company. Where is it getting capital from? Is it focused on tactical short term activities or long term sustainability?
- I try to put few selective financial metrics in the context of business?
- Once I like them, then the next step is to attempt to determine the fair valuation I would be willing to pay. I identify a fair value range (and not one specific value).
- This gives me a list of companies which I would like to buy. and at what price.
- As of today, this buy list consists of approximately 80+ companies. None of them are in buy range.
Step Four: What is next, do I buy them?
- Existing companies: Asset allocation helps me make decision whether to buy them.
- Buy decent position: In almost all new companies, I will most likely buy them when market price is within my fair value range. Usually, this would be a pretty decent size of approximately one third in value (about 2% of total equity portfolio value). Most recently, I bought and sold Camphor and Allied Products. I mentioned I bought a decent size. This is what it meant.
- Starter positions: On many occasions, I only buy starter positions. This is because, there are certain aspects that makes it relative higher risk. I discussed about this in my earlier post about exacting buying process. The size is usually less than 1% of my portfolio value. For example, I recently initiated starter position in ABCIL (original cost basis less than 1%), Transpek (0.5%), Jyoti Ltd (0.4%). Starter position, allows me to watch them closely and take on low risk.
I have been using this to find companies for my long term buy and hold philosophy. I do not look for approval for validating my analysis or take opinion from others. The best way to learn is “do it”. To reduce risk I jump in with starter positions. Lately, I am also trying to figure out to look for value based opportunities. I am working on it and hopefully, it next few months, I will add those metrics to this process.
How do you screen search companies? Do you fish or look for a needle?
narrowing search, searching for companies, stock screen process, stock search, stock selection
Hi TG, I think it will be very useful to many starters if you write an article on book value & explain that this is what (actually less than BV)an investor will get in case of liquidation so any price more than BV is the premium they are paying to get the desiered return.
I actively look for good products, listening to what others have to say, my own experiences, online reviews, just about anything that praises a product.
To me, that’s a good way of identifying good companies.
Good companies make good products, and good money too, so I try to look for them in this manner.
That is a very good point. I missed it. I do think about it, but subconsciously biased towards oil/utility/consumer staples. I never thought of other products that we use… But now I will.
thanks for the suggestion.
As a newbie and wannabe investor i feel your ‘step One’ is a very good and very important starting point. That’s ‘reading’.
Over a period of last 4-6 month’s i have come to realize that spending a lot of time watching business channels is probably not a very good way to spend time to identify good investment opportunities.
Over this period i have come to like personal finance and individual investor’s blogs (along with books) as a source of information and also for investment ideas mainly because :
1. Of their personal touch and ability to respond to my doubts more often than not.
2. Interpreting loads of data and making it available as usable information.
3. Most importantly the well documentated rationale and the thought process behind each step taken by the investor behind the blog.
4. Also because the blog stands testimony to the success/follies of the concerned investor over a period of time. And I feel this is one thing that’s significantly missing about the information from other sources like analysts/experts on the TV channels or newspaper. There is hardly any record of how often they went wrong or even where there though process went wrong. Also they have a tendency to change their statements to sound right as per the situation.
5. Very nice presentation and focus on behavioral aspects of investing in blogosphere. I find it a very significant missing part in the TV channel programs.
Lastly i want to thank TIP Guy and 30+ other bloggers whom i now read almost religiously, for enriching me with their knowledge and helping me find my needle in the haystack.
Regards
Raja
Hello Raja,
great points. Wow you follow 30+ bloggers… how do you keep track of them?
I only follow few bloggers who write personal experiences and there is some originality. I do not like “should be”, “could be”, “for info” stuff. Again, not that they are bad, it just does not help me. I think I follow may be 10ish….
Best Wishes,
Google Reader. Try it if you haven’t tried yet. It’s awesome for this job!
May be because, am just starting i have included anything that i found worth reading. Hope to churn the list over a period of time
But at this point i think there are more than 10 which are worth it 
from my point of view.
Regards
Raja
Yeah, I do use Google reader. But still…..
Hi Sirs,
Pls suggest is Tata Inv Corp is still a good buy for long term? What should I choose TIL vs Bajaj holding???
Best Regards
Ashish
hello,
can you please hcl infosystems and onmobile global, when you have the time. thanks a ton.
regards,
msk
Sorry, I will pass them! They do not fit into my scheme of things…..
Hi MSK
I have Onmobile with me avg price @285. It certainly does not fit Tipguy’s criteria for a value stock. Most of its metrics are poor – dividend, profit, cash flow etc.
The big thing going for it is the battle that the telecom guys are fighting and the VAS guys might make money off it. The potential is there but the stock tends to dive rapidly for no apparent reason so be careful with this one.
hello tipguy,
i came across your blog accidentally and find it extremely informative. can you please list the blogs on investing that you read regularly, i believe your selection of blogs would be good. i don’t know if i will be lucky enough to find them myself.
regards,
msk
Hello MSK,
I read Rohit Chauhan’s blog regularly (listed as “Value Investing” on Blogroll). In addition, ocassionally, I also visit blogs of folks who comment here on TIPBlog.
Other than that, I spend most of my time reading about companies in general financial media and company websites.
Best Wishes,
I just stumbled on your blog when i was lookng on google. I have to say that the information here was the most complet that I found anywhere. I am definitly bookmarkin this to come bck and read later