About Me

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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Thursday, March 17, 2016

why i screen and what i screen for ...

"At a certain season of our life we are accustomed to consider every spot as the possible site of a house ... "

So begins Henry David Thoreau's famous essay "Where I Lived and What I Lived For" the title of which I've stolen for this post. In repayment, I might as well copy the whole first paragraph, which speaks lyrically of investing ones imagination and ends with a most famous and beautiful proverb:  

"... I have thus surveyed the country on every side within a dozen miles of where I live. In imagination I have bought all the farms in succession, for all were to be bought, and I knew their price. I walked over each farmer's premises, tasted his wild apples, discoursed on husbandry with him, took his farm at his price, at any price, mortgaging it to him in my mind; even put a higher price on it — took everything but a deed of it — took his word for his deed, for I dearly love to talk — cultivated it, and him too to some extent, I trust, and withdrew when I had enjoyed it long enough, leaving him to carry it on. This experience entitled me to be regarded as a sort of real-estate broker by my friends. Wherever I sat, there I might live, and the landscape radiated from me accordingly. What is a house but a sedes, a seat? — better if a country seat. I discovered many a site for a house not likely to be soon improved, which some might have thought too far from the village, but to my eyes the village was too far from it. Well, there I might live, I said; and there I did live, for an hour, a summer and a winter life; saw how I could let the years run off, buffet the winter through, and see the spring come in. The future inhabitants of this region, wherever they may place their houses, may be sure that they have been anticipated. An afternoon sufficed to lay out the land into orchard, wood-lot, and pasture, and to decide what fine oaks or pines should be left to stand before the door, and whence each blasted tree could be seen to the best advantage; and then I let it lie, fallow, perchance, for a man is rich in proportion to the number of things which he can afford to let alone."

Thoreau established an early precedent on the great american obsession with real estate.

***

The catalyst to this post is a response to a recent one on the popular microcap blog "oddball stocks" about whether or not screening has any value.

I unabashedly use screens and believe they have tremendous value for narrowing the spots one might consider the site of a house, or for the type of house one might consider building, to paraphrase Thoreau.

***

The goal here is to write about why I use screens, investigate their strengths and weaknesses, explore some that I use and describe the kinds of companies that turn up.

To lay out expectations, I am a fundamental equity analyst and I use screens to look for ideas and narrow my universe. This is not a quantitative guide where one can read a random investing blog and learn "a guaranteed way to make a lot of money without doing any work". I guarantee this is not that.

As with other posts here, I hope readers will walk away with new ways of thinking about companies in general, or investing in general, or a new specific idea to think about on their own or a new arrow for the quiver when it comes to screening stocks.

***

Screens in my view are best for creating "idea funnels" that - when paired with substantial fundamental research - helps uncover some compelling investment ideas.

Pairing screens with fundamental research offsets their two biggest weaknesses:

1. Screens - and arguably all financial data - is backward looking while the present value of an asset is its future streams of cash flow discounted back. The work with investing is "knowing the future" - or estimating it to some degree of probability - and screens don't help with that but fundamental research can.

2. Screens are dumb quantitative tools if used to blindly buy stocks that fit certain fundamental operating parameters (not price or valuation related). But when paired with a qualitative process it can be an exceptional tool of winnowing and categorizing great companies and potential ideas.

I'm not someone pursuing an algorithmic trading mechanism based on bell curves and least squares. I aim to become a part owner of a few sustainable well managed businesses, to own them for long periods, and to buy them at a price that will result in outsize returns should my very realistic expectations for the future work out as expected, and with multiple paths to success. I think screens help identify such opportunities.

***

As an example of how this all works together, a month or two back I ran a screen that kicked out among a short list, $GEOS, a company that at the time had good recent financial results, a long history of "value creation" (ie growing bvps) but was trading at its 52-week low.

$GEOS is a technology company that makes undersea seismographic equipment for mapping the seafloor and is used in the offshore energy exploration industry. Very cool stuff.

My research into the company illustrates my two points above.

1. Backward looking results reflected a backward looking operating environment. The bust in oil prices meant last year's results are no model for this year and next.

2. As a dumb tool it would have lead to a dumb outcome but paired with qualitative work, it helped identify an interesting idea.

Digging into the $GEOS financials, it was easy to identify that the company has been around for more than 20-years and most incredibly, with largely the same management team intact, providing a significant sample size from which to make assessments.

The success of management through several cycles became an important data point for me. Due to acquisitions the deep past wasn't a perfect proxy financially but given the long tenure of management paired with 20 years of public filings, it was quick work to extrapolate patterns of successful behavior, notably making hay during strong energy cycles and exiting those cycles with clean balance sheets, limited capital intensity and a focus on new product development.

All of this is a very simplified way (I put several hours of work into the idea) of saying a patient investor could (and perhaps still can) buy the stock at a point where the market is discounting a bleak future provided they are willing to hold until prices rebound. The beauty of this vs other energy companies in my opinion is the low capital intensity.

So here's in brief a situation where a screen operated successfully as a funnel and when paired with the fundamental research indicated meaningful information that exposed  a long rich history where just the recent past would've provided false comfort.

Incidentally, it's the kind of history that can't be screened for.

That said, ultimately, we deemed the $GEOS idea inappropriate for our clients. At Long Cast Advisers, we believe that capital should have as much integrity as our clients missions. Seeing that $GEOS makes equipment onerous to marine mammals - apparently it disrupts their ability to hear - it failed our firm's "integrity of capital" mission, but the effort illustrates the strengths and weaknesses of screening and how it works best paired with a qualitative process.

***

I've lagged since my last post and have been taking a long time on this b/c I've been working on a handful of home projects. The most time consuming was rehabbing two large pieces of furniture I found at my in-laws house to use as a dresser, desk and storage combo for my kids.

The work involved wasn't that intensive - sanding, priming, paining and replacing the hardware - but due to space constraints, I had to work on each piece separately, so it was like two projects in one.

The boredom of priming / painting was overcome by listening to Marc Maron's WTF podcasts. If you're not familiar with him, he interviews entertainment folk comedians, writers, actors, directors and producers (and occasionally heads of state) in the entertainment business from his studio garage.

I listened to, among others: Sacha Baron Cohen, Charlie Kaufman, Brian Grazer, Crispin Glover, Todd Haynes, Sarah Silverman, Eric Bogosian and the two brothers who make the HBO show "Togetherness".

These are all folks that have hustled hard and endured a lot of failure for their craft and I couldn't help but find similar - nearly identical - dynamics between investing / starting an investment business and the "creative" pursuits of these performers.

I found many analogs b/t the two professions, and specific to this topic, they all filter their material through some sort of screen to determine if a joke is funny or an idea is good.

To an investor, an investment screen is simply an automated form of one of these filters. Other non-financial filters investors use - consciously or not - include the bullshit filter (if it sounds like bullshit, it probably is), the sleep filter (does it keep you up at night?), the exercise filter (how you think about the stock when you're working out), the shower filter, etc.

Are these filters the same for everyone? Investing is one of the most personal exercises and we should all learn to develop and trust our own filters. What I find to be a good idea might be very different from what other people think and - by its nature - is often very different than what the rest of the market thinks.

Just as an artist needs to be comfortable with their filters to engage in original work, so do stock pickers have to comfortable with their own filters to find and invest in good ideas.

As we all mature and improve with our work - in the arts or investing - we can better discover the source of good material and hopefully tap it more frequently. As with the arts and investing, veritas vos liberabit.

***

For my screens, I use screener.co. I have no affiliation with the company other than as a customer. Were I to have any choice, I'd go back to Factset, which I used when I worked on the sell side, but it's wildly expensive for this startup investment manager and Screener.co is a good alternative plus the trial period cost (free) is unbeatable.

Now, for an investor seeking quantitative screens under the familiar academic models, save time and simply go to oldschoolvalue and it will provide a variety of stocks that fit various magic formulae.

I've never really dug into these formulaes (until now) but based on what I'm reading on investopedia, the Piotroski method seems to be the sort of thing I tend to look for with a certain type of investing: book value growth, positive cash flow, and no dilution. That's as good a starting point as any.

However, the beauty of the screener vs OSV is that you can start with those methods and layer on top of it any number of factors to further narrow the field.

Some traditional simple screens I use include ...

recent rev growth + operating margin expansion
long term growth in shareholder equity
stocks trading near 52-week highs or 52-week lows
stocks out / under performing the S&P by more than 20%

... those former two are driven by quarterly results and won't change week to week or between reporting periods while the latter two are price driven and will change daily.

Some more complex screens I've used include ...

receivables growing faster than revenues
inventory growing faster than COGS
recent decline in revs + operating margin compression but growth in operating cash flow, etc etc

... I can easily spend hours tweaking inputs to test different theories of business drivers even if it only results in a handful of new ideas.

Considering the options available in a screen, it can be overwhelming to a novice, but a great jumping off point for thinking about screens is Howard Schillit's classic, "Financial Shenanigans", some of whose pages are taped to the wall by my desk.

It's one of the most important books I've ever read on investing. The proximate reason is that it identifies how companies tend to hide weak performance but ultimately its about how business operations translates into accounting, and accounting is the language investors engage with in their work.

It's a book that helps investor identify the weave in the fabric as opposed to the billow of the flag.

***

I consider screening as an essential tool for investors. There are those that bash screening, I imagine b/c of the weaknesses I mentioned above, since a corollary to those weaknesses are that it doesn't identify companies in turnaround or with undervalued assets on their balance sheets.

Fair enough. But as with all tools, their usefulness varies with the inputs and in whose hands they are used.

Another project I recently worked on was the repair of an old writing table with an unusually arched and severed leg whose repair would make a handsome desk for my office.

I figured to make a spline joint for the repair and consulted with a neighbor who repairs old pipe organs for a living. He suggested I use a chisel and forstner bit to carve out the space for the spline, two things I'd never used before (I'd intended to use an inelegant dremel) and in retrospect I think his advice was driven by his passions as a purist and mine to learn new tools and techniques.

It was a soft wood, and the chiseling was easy ... but imprecise ... and when I was finished and gluing up the pieces it was like holding an overflowing double Shake Shack burger with the sauces oozing out everywhere. It was a total mess. In last minute desperation I salvaged the work with two small cross dowels to lock in the spline and called it a day. I work atop the desk now as I write.

The point is that a chisel and forstner bit, like a stock screener, are only as useful as the experience of the person wielding them. Though I'm a novice at woodworking, I have a lot of experience with screens and I aim to show here a few useful methods to open up and share with others information I use for myself and find helpful in my work.

***

What parameters are important for screening? That's up to investors to decide. And it might change with the cycle or interest or desire to diversify types of investments.

I think a great way for investors to think about this is to start with a favorite company, identify a few trends or financial items deemed material to its success, plug those trends into a screen and see what other companies share that dynamic. I am sure there will be a few surprises.

Sophisticated quantitative investors use this same method - I think they call it multivariate regression analysis - to identify both what is "material" and what other companies share those dynamics, but you can do the same with a very modest amount of effort.

*** 

How often should one screen?

At Long Cast Advisers if we can find 5-10 good ideas a year, we are good shape. So we don't screen every day and when we do screen, we spend a long time honing ideas and parameters.

When filling the ideas funnel, we just follow where it takes us, and sometimes it leads nowhere, or to ideas that might lead to corollaries to other ideas down the road. It opens the door to the imagination and creativity required in investing, thinking broadly about what inputs have lead to said results, how they might be changing, who else might be impacted by them, etc.

Ironically, the screening process is almost the antithesis of the investment process, which is highly regimented, structured, and process / checklist oriented.

On top of the fundamental screens we look at, you can easily layer a parameter for stocks that are down more than 50% in the last 52-weeks, or making new highs / lows, to capture companies that  have sold off / moved up for reasons that the market is wont to do every now and then.

***

Since Long Cast Advisers focuses on small cap stocks, we start by narrowing the pool by market cap and geography and types of companies. There's a video here that explains how to use screener to narrow the pool by a variety of standard or basic functions. (That video helped me to scale the "screener" learning curve).

So here's the basic screen I use most of the time before I start adding parameters ...

I start by narrowing markets to: NASDAQ, NYSE, OTC and unlisted securities.
>> Click on "markets" upper left and add the ones I want to use

Then I narrow search by market cap (>$1M but <$500M) and eliminate companies domiciled in China and industries that don't interest me. (note that i use "create free form condition" for all of these inputs)
Market capitalization <= 500000000
Market capitalization >= 1000000
Country located in != "China"
Industry != "Banks" ...
Industry != "Investment Trusts"
Industry != "Closed End Funds" 

Obviously, you can narrow / expand this however you want; I know many colleagues who think I'm too narrow and love the overseas screening tool, I just haven't gotten there yet.

... then I think about what drives shareholder value, what evidence exists of it, and what kinds of companies I'm looking for at any moment in time.

A simple screen to look for something like this is simply looking for consistent at least 10% annual growth in shareholder equity where net assets exceed liabilities by 10% exceed without debt and acquisitions ...

( Total Stockholder Equity(A) / Total Stockholder Equity(A-1) ) > 1.1
( ( total assets(a) - Goodwill(A) ) / Total Liabilities(A) ) > 1.1

... and then repeat that comparing A-1 to A-2, etc.

A few things to note with these basics:
The time periods like "A", "A-1", "Q", "Q-1" follow the terms without spaces
Spaces are required between operators " / " or " > "
Spaces are required for parenthesis marks that group operators

... you get the hang of it after awhile and i've found the screener founder to be highly responsive to questions about formulae.

something a little more complicated I was thinking about recently is  a screen for companies growing organic revs and operating margin while generating positive EPS. My thinking here was to add a parameter that eliminated companies that had grown goodwill to avoid acquisitive growth.

Step by step:

Look for revenue growth mrq > 5%
( Total Revenue(i) / Total Revenue(i-4) ) > 1.05

Looking for goodwill to be relatively flat over that same period
( goodwill(i) / goodwill(i-4) ) < 1.05

Looking for OpInc margin growth mrq > 10%
( ( Operating Income(i) / Total Revenue(i) ) / ( Operating Income(i-4) / Total Revenue(i-4) ) ) > 1.1

And positive EPS mrq
Diluted EPS(i) > 0

... that resulted in 45 companies under $500M mkt cap that had those parameters as of the recent quarter. But I wanted to look for trends, so I rolled all the same parameters back one quarter ...

Revenue growth LAST quarter > 5%
( Total Revenue(i-1) / Total Revenue(i-5) ) > 1.05

again, goodwill relatively flat LAST quarter
( goodwill(i-1) / goodwill(i-5) ) < 1.05

OpInc margin growth last quarter > 10%
( ( Operating Income(i-1) / Total Revenue(i-1) ) / ( Operating Income(i-5) / Total Revenue(i-5) ) ) > 1.1

And positive EPS LAST quarter
Diluted EPS(i-1) > 0

... and now i'm down to 12 small companies.

Within this list are two I already know fairly well: OTCM, which I've long owned and REIS, which I've looked at a long time but have remained on the sidelines for a variety of reasons. CSCD is also on the list but is getting acquired so not interesting to me.

Now, I'm down to 9 companies that share dynamics with two that I already know really well.

Screener has a nice tool called "company profile" where you can click on the results of your screen and call up a quick chart, description, and summary I/S, B/S and C/F qrtrly or annually and that's where the qualitative filtering starts

the gobbledeegook filter >> does the company describe itself in clear simple language

the balance sheet quick filter >> are there any wild jumps (sequential and y/y) or smooth trends in basic balance sheet items like cash, a/r, inv, payables. I like to see total assets growing without growth in goodwill, and especially shareholder equity trending upwards b/c that's where mgmt is adding value.

From this screen, I get two ideas to go into the ideas funnel - $DLHC and $GV - b/c I've analyzed and understand the staffing and engineering / construction industries very well.

***

I was initially thinking I'd add a variety more screens but I realize it's a bigger topic than I anticipated and this was just my introduction. In the future I'll write about other screens I use without this long intro and I'll also provide readers with a little more of the fundamental process I use as well to analyze the companies.

I think pulling back the screen and defining the process on how I work has so many benefits. And in this day and age of free flowing information, how to add value to the commodity of information is the most essential aspect of knowledge.

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ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS. INVESTING INVOLVES RISKS AND UNCERTAINTIES. IF YOU'VE READ THIS FAR, THANK YOU FOR YOUR INTEREST.

Tuesday, March 1, 2016

A brief observation about "above average" investors

This might go in the "obvious" department but I've recently realized that all investors who are bullish on a stock can find answers everywhere that support their bullishness. I think this dynamic is true from the greatest investor to the worst, and there's something eminently uncomfortable to me about it.

For example, if you ask any investor about their best idea and you're lucky enough to get an honest and sincere answer, then maybe they'll tell you they like XYZ Corp, and why.

And if they're done their homework, then when you ask about the competition, or the input costs, or customer spending trends, or management, or rising receivables, or any of the numerous factors that impacts an investment decisions, they're likely to give you answers that explains away the criticism and reinforces their enthusiasm.

Regardless of outcome, it seems to me that there's a huge problem with this dynamic. How can EVERYONE have this same experience??? We're not ALL above average!!!

I recently asked a friend that manages a $500M pod at a "market neutral fund" for help about this - and although our investment universe and horizons differ materially - he affirmed the notion that bullish investors are ... well, bullish. "When you're long a stock you SHOULD feel good about it. You LIKE the information." But he didn't quite see the issue that I was talking about.

And so I asked him how he - a PM - seeks out information that might disrupt his bullish view and he asked why he would do this. That was a surprising response.

I always look for people who disagree with me. I once had a client at a well known short-selling hedge fund who told me, "when I talk to the rest of the sell side, the minute I disagree with them the conversation stops. But with you, it starts a whole new conversation."

There are few things I appreciate more in life than learning something that changes a perspective for me 180 degrees. As we get older, those moments get rarer, and sometimes they're disappointing, but we need to test our assumptions.

The same needs to be true for investing so that we're not deluded by our own bullishness.

Here are some questions I ask myself when I feel like I'm overly bullish: If I retraced the steps that got me here, would I end up with the same conclusion I had when I first arrived? what would convince me now that I'm wrong? and always the tried and true; what don't I know?

With FTLF, currently one of my favorite ideas, I have not found any new negative information beyond the initial hurdles over the industry that shakes my judgment. As I talk with colleagues who ask questions and raise doubts, it makes me feel more confident about my investment, because I want to be investing in an area that everyone else hates; that's what makes it inexpensive. But even as I seek evidence to disprove my thesis, I just haven't find anything new

"If you know the future, it's silly to play defense. You should behave aggressively and target the greatest winners; there can be no loss to fear. Diversification is unnecessary, and maximum leverage can be employed. In fact, being unduly modest about what you know can result in opportunity costs." Howard Marks, The Most Important Thing

As I think about it, delusion is not often talked about in the investing world but it's a major part of the industry, marketed I think as "opportunity". But the path to avoiding delusion is to always seek incremental information for evidence that disproves your thesis, so as not to be fooled by confirmation biases. That, along with putting the most capital behind the best ideas and having the judgment to be right, is the hallmark of a truly great investor.

-- END --

THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. INVESTING INVOLVES RISKS. IT SHOULD ONLY BE PRACTICED BY PEOPLE WITH ABOVE AVERAGE JUDGMENT.