Paul Samuelson put it best when he said investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas. The biggest mistake people make when it comes to investing is looking for sexy stocks. These are stocks that are always in the spotlight and always in the news. Sexy is great if you are looking for lingerie, a mail-order Russian bride or an Italian sportscar – but it has no place in investing.
Here are three steps you can apply in order falling into the sexy trap.
Step 1: Invest in a Business Any Idiot could Run
The more simple the business the better. Peter Lynch in his book "One Up On Wall Street", says you should invest in a company any idiot could run because pretty soon an idiot would be running it. He provides the example of an undertaking business. What could be simpler than collecting dead people, slapping on a little rouge and eyeliner, presenting them to friends and family and then tossing them into the ground or into an incinerator? The beauty of this business is that it is simple (any idiot with a black station wagon and a Mary Kay catalog could do it), it is not cyclical (people die regardless of whether the economy is booming or in recession), and business is always guaranteed (the only certainties in life are death and taxes).
Step 2: No-One is Covering the Stocks
Buffett is looking for diamonds in the dirt. Are you going to find them alongside the busiest highways or do you need to do some bushwhacking? For the city slickers who think that milk comes from a carton and wild animals roam freely through the streets of big African cities, let me regale you with the definition of bushwacking: to make one's way through the woods by cutting at undergrowth, branches; to travel through woods; to pull a boat upstream from onboard by grasping bushes, or rocks. To find these gems, you need to sharpen that machete and get rid of some bushes.
One way to find them is to focus on stocks that have little or no analyst coverage. In other words, very few people cover the stock which means that it is flying below the radar.
Analysts prefer to cover sexy stocks because those are the stocks that the unwashed masses want to buy. This comes directly from the playbook of Peter Lynch in "One Up On Wall Street". According to data from Bloomberg as of November 2019, 50 stocks were covered by more than 40 analysts.
They were mega large-cap stocks like Apple, Amazon, Google, Facebook, Alibaba, and Tencent. What diamonds are you going to find in these blue chips if they are being analyzed to death by an army of analysts who have collectively spent billions of dollars in Ivy League educations, personal tutoring, and psychoanalysis?
We are interested in stocks that have two, one or zero analysts. Of the 91,326 public stocks around the world, more than twenty percent are covered by two analysts or less. On this list, there are many penny stocks – rats and mice companies that are effectively worthless. Some companies are in far-flung regions where we do not understand the language.
To weed out the rats and mice, we look at stocks with a minimum market capitalization of $500 million. To avoid the language barrier we limit the search to major English speaking countries (United States, United Kingdom, Canada, South Africa, Australia, and New Zealand). The universe now filters down to 118 companies.
One gem that stands out is Amerco. How about this for a boring business (the information is courtesy of Reuters): AMERCO is a do-it-yourself moving and storage operator through its subsidiary, U-Haul International, Inc. (U-Haul). The Company supplies its products and services to help people move and store their household and commercial goods through U-Haul. It sells U-Haul brand boxes, tape, and other moving and self-storage products and services to do-it-yourself moving and storage customers at its distribution outlets and through uhaul.com and eMove Websites. The Company operates through three segments: Moving and Storage; Property and Casualty Insurance, and Life Insurance.
As of November 2019, two analysts were covering the stock: Ian Gilson from Zacks and George J Godfrey from CL King and Associates. For the 10 years ending November 5th, 2019, the stock delivered a total return of 966 percent assuming all dividends were reinvested in the stock. This is an annualized return of 26.7 percent which was more than double that of the Standard and Poor 500 Index. This is not an investment recommendation – I am simply singling this stock out as an example candidate.
Step 3: Low Institutional Ownership
This is another strategy from the Peter Lynch playbook and works in tandem with the analyst coverage metric. It is unlikely that institutions will own large slugs of stock in a company that has little or no coverage. In this case, we have the perfect example – Buffett's very own Berkshire Hathaway.
As of November 2019, Berkshire was the sixth biggest company in the world with a market capitalization of half a trillion dollars. Only four analysts were covering the stock and only 21 percent of the shares were held by institutions. The largest institutional holder was Fidelity with 4.25 percent of the shares followed by Capital Group with 3.36 percent.
This stands in stark contrast to the ownership and analyst profile of General Electric. As at the beginning of November 2019, 65 percent of the shares were held by institutions and 30 analysts were covering the stock. In terms of performance, Berkshire has destroyed GE delivering 460 percent more total return to shareholders over the 20 years ending 2019.
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