Hopefully, I have your attention on this one. I know this article may seem presumptuous, as I am not known as an investment specialist. But if you have a few minutes and an interest to learn about a process that works for me, please read on. This article is a little longer than usual but I think worth the read.
I have developed an approach and process that is currently outperforming the stock market indexes and I want to share my generic process with you for your possible benefit. I am not worried about giving something proprietary away. There are more than enough investment possibilities for everyone out there and I am at that stage in my career where I want to give back.
But why me to offer this to you? Let me provide a little on my educational background not included in my bio on my website. I finished all coursework for a doctorate in investments in the larger field of finance some thirty-eight years ago at LSU Baton Rouge. Then, I wanted to work in companies and not invest in them. So I switched and finished my doctorate in strategic management with a minor in finance. Instead of going to work for one firm, I spent almost thirty years in strategy consulting, working for many firms. OK, enough of my “hero sheet”. But I think I do know something about strategic management and finance.
If we so-called management experts are so smart, why don’t we use management frameworks to develop unique approaches to picking stocks in which to invest? We should be able to assess our own track record of beating the market in terms of stock price appreciation and dividend yield. I do not know of a single management guru who does this. They may be secretly making millions, but I do not know about them. Tune into any of the nightly business news television shows or read your stock analyst reports from your Scottrade or TD Ameritrade accounts. You will read some fundamental finance information (like PE ratios) but also such things as trailing earnings analysis and the like. For the uninitiated, your head can start swimming.
Management experts think that financial results are the end result of good management practices and processes. Financial results then lag good management practices and processes. Another way of saying this is that good management practices and processes are lead indicators of eventual good financial performance. We should be able then to grade a top management team and their firms on how good their management practices and processes are relative to their rivals and to predict eventual finance success.
Distinguishing Systemic and Unsystemic Risk
Before I give you my generic process to do this, we need to distinguish between two kinds of risk that for-profit firms experience. One is the overall risk at the current time in a firm’s industry and the overall economy. This is called “systematic risk”. The other kind of risk is the risk that adheres to just one company. It covers such things as bad luck (like what happened to Chipotle in their e-coli disaster), management blunders, management getting into legal troubles and the like. This is called “unsystematic risk”. Investment gurus tell us systematic risk can be neutralized or “diversified away” by having a portfolio of unrelated stocks. They also say that we have to live with the gambling aspect of unsystematic risk and basically “suck it up” by demanding more expected returns for riskier firms, or do not invest in them.
My approach turns this on its head. If what we management experts have been saying is important to firm strategic advantage, organizational health, and eventual financial performance, we should be able to invest some of our available money in three to five what we have to come to view as almost sure bets. Things such as being agile and fast, lean six sigma quality, lean start-up principles, innovation, great execution, great operations, noticing emerging unstoppable trends before rivals do, great leadership, great teams, great people processes and cultures that value transparency and accountability are a few of these aspects. Pure financial analysis does not care about these aspects, but management experts do. I think the following quote by Bill George, then CEO of Medtronic (from Bart Madden’s great little book Maximizing Shareholder Value and the Greater Good), is very illustrative of this view:
“The best path to long-term growth in shareholder value comes from having a well-articulated mission that inspires employment commitment. Companies that pursue this mission in a consistent and unrelenting manner will create greater shareholder value than anyone believes possible. There are simply no shortcuts to creating long-term shareholder value. Sustainable growth cannot be achieved by a series of short-term actions. Real value can only be created by the hard work of dedicated, motivated employees that develop innovative products and services, establish intimate customer relationships, and build organizations over an extended period of time”.
Using strategy and management frameworks to pick stocks:
- Develop or pick one comprehensive strategy and management framework to use. The Balanced Scorecard, Hoshin Planning and others are candidates. Mine is called the Business Performance Engine and for those interested, I have articles and working papers on my website. By the way, this is the exact same framework I use to help top management teams with the strategic management of their firms. I just adapted it to be an investment tool. But you develop or pick one you like and use it.
- Develop a scoring survey based on the elements in your framework. I have developed seven-point behaviorally anchored rating scales for mine. The score of 1 means that element is hurting organizational performance. A score of 7 means that element is “next practice” ahead of “best practice” at a score of 6. But a lot of different survey approaches can work.
- Score all industries every eighteen months on how favorable they are for protecting industry profits for all players in their industries. Rank high to low. The reason for this step is that it is easier for an individual firm to perform well in an overall favorable industry than in an unfavorable one. At the time of this writing, watch and apparel manufacturing are terrible industries in which to compete. The solar energy industry is a very favorable industry in which to compete. But these scores can change in as little as eighteen months, so vigilance is key. Unless you have industry data, you will need to subscribe to industry data vendors to help with this assessment. I use IBIS World. Their service is a little pricey, but I think well worth it.
- Pick several publicly traded firms in each of three to five very favorable industries.
- Buy a few shares in each of these firms. Go to their websites and find the email to send to Investor Relations. Tell them you are a shareholder who will be assessing their firms for further investment. They sometimes will respond. But this is a test and if they do not respond this is the first black mark against this firm.
- Download their 10Q, 10K and Annual Report documents. Pour over them with a first read. Make notes.
- Then take your survey from Step #2 and score each of your elements based on what you have read a second time in their documents and any observations you get from the Investor Relations group. You might even be able to interview the CEO and CFO, but this is rare unless you are from one of the big investment firms. Develop a rubric to make a decision to invest in those firms. For example, there are thirty “Drivers” in my framework, each scored 1 through 7. If a firm were to score a 7 on all thirty Drivers (not likely) the top total score would be 7 times 30 or 210. If a firm scored a 1 on each Driver, the total score would be 30. So set your rubric based on the high and low possibilities from your framework. For me any score higher than 174 is an investment go. This basically says 85% of the Drivers score a 6 or a 7. But you can set your rubric based on your risk tolerances.
- Perform some financial analysis. In particular, assess debt levels and try to forecast expected free cash flow over the next five years. If you do not know how to do this, form an investment club and invite a financial expert to join.
- Invest for the mid-term (five to seven years) and maybe the longer term (greater than seven years) in your chosen firms. Never invest for the short term but take your losses early if your bet turns out to decline or languish in neutral for more than one year.
- Assess your performance relative to how the overall stock market is doing. Learn, alter your framework if need be, and stay the course through further investment.
Assessing Three Solar Energy Firms
I have enjoyed beating the market 80 percent of the time with this approach and process. At the time of this writing (June 2017), I am using this process to assess three firms in the solar energy industry: First Solar, Sun Power Corporation, and Canadian Solar Inc. Recall these firms are in a very attractive industry setting for profit protection potential and solar use for heating and cooling is booming globally. But with this incoming political administration, their stock prices are significantly down due to the perception the administration will favor fossil fuels. Security analysts say these are a buy but I do not know if they will pass the assessment of my process. I will have to see.
You can do this too if you want to do some hard, but fun work. BTW some have asked me to get into the investment advice business. I will not do this as I have only been at this for three and a half years. I can take my own losses on the chin, but I would not like to feel the pain of others in those few occasions where we have to expect to take losses. But if there is enough interest I could develop an online university for a very fair tuition to train people on the details of how to do this using my framework and process. Thanks for reading and happy investing.
This article is part of a series on what causes a firm’s value to increase
Dr. William Bigler is the founder and CEO of Bill Bigler Associates. He is the former MBA Program Director at Louisiana State University at Shreveport and was the President of the Board of Strategic Planning in 2012 and served on the Board of Advisors for Nitro Security Inc. from 2003-2005. He has worked in the strategy departments of PricewaterhouseCoopers, the Hay Group, Ernst & Young and the Thomas Group. He can be reached at firstname.lastname@example.org or www.billbigler.com.