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On Watchlists

Before I start this evening, a quick story:

One day in March, I got an e-mail from an older gentleman, and he said, “Hi, my name is XXXXXX.  Please call me.”  The name sounded familiar but I couldn’t place it.  So I called him, and he asked, “I own a decent amount of Berkshire Hathaway.  Can you explain to me why the value of the put options Buffett sold have risen from 3Q11 to 4Q11?”  After talking to him for a little bit, he said, “So you really don’t know.”  I replied, “Yes, I don’t really know, but give me a couple of hours, and I can give you a decent answer.”  So I told him I would give him an answer via e-mail, and follow with hardcopy.  As it was, we were both wrong, the value of the put options had fallen.

But then it hit me why the name was familiar — he was one of the Superinvestors of Graham-and-Doddsville.  You never know where you might go, or who you might meet just because you write some obscure blog.  Oh, yeah, you might just get to go to the US Treasury, and meet you-know-who. ;)

And now a question from a reader:

I’ve learned a lot from your blog. Thanks for the effort you put in to maintain it. (Today’s post was great… was just listening to my Intelligent Investor CD while driving last night and was thinking about how Graham talks about the need to be businesslike when investing).

I had a question about your investing process, specifically how you track stocks that look interesting to you.

For instance, I use value line and I flip through the pages on a daily basis, jotting down interesting tickers in a notebook. I then go to a few scans and watchlists, again jotting down tickers I’d like to research further. After that, I take my list of tickers and do some brief research to determine if they should go on my watchlist. This is where I need to change a few things. I use Morningstar to track my watchlists, which is great because it keeps track of all of the financial data automatically, but the problem is that as my watchlist grows, I find certain cheap stocks on the list but I can’t recall why I put them there. There is no spot for notes on Morningstar’s watchlist, so I thought about using a google spreadsheet, but I really don’t want two different things to track.

Walter Schloss was famous for not owning a computer and simply flipping through value line. There must be a simpler way to track stocks that look interesting!

Just wondering if you could share any thoughts on how you track potential stocks and how you refine your watchlist if it starts to get too large. Thanks David.

I don’t have a permanent watchlist.  I generate ideas three ways:

1) I read a lot of articles.  When an idea sounds clever, I write it on a small piece of paper and set it in a pile to age.

2) I study industries more than companies, and look for strong companies in weak industries, and levered companies in industries that are likely to remain strong for awhile.  I use Value Line here, and screen for companies that might yield a 15%/year return, while being above average in terms of balance sheet strength.

3) I read through the 13Ds of a group of ~75 investors that I respect, and look at the companies that are large holdings relative to market cap that are still being acquired.

Then I take all of my ideas once per quarter, shortly after the 13Ds are filed, and compare them against existing portfolio holdings against a variety of valuation metrics, sentiment variables, and other factors.

I then rank all of the companies as a group, looking at where the middle company in my existing portfolio is.  Companies I don’t own that are above it are candidates for purchase.  Companies I own that are below the middle portfolio company are candidates for sale.

I then sit down and analyze, and pair off stocks to sell versus stocks to buy, unless there is some reason to increase or decrease the number of stocks in the portfolio, which is usually around 35.  Presently it is 34.  I  buy/sell 2-3 stocks per quarter.  That keeps things fresh, but allows me to hold companies for longer periods of time.  (My turnover is 25% of the open end mutual fund industry.)

After I make my series of buys and sells, I throw all my work away, and start accumulating data for the next quarter.

My sense is that it pays more to think of your portfolio versus candidates than to track candidates.

The main idea here is that we should always be improving the character/quality of the portfolio.  Trade things that are worse for things that are better.  Human beings can do that trade.  What is hard is for people to assemble the best stocks.  Getting a bunch of “pretty good” stocks can be done, and it does not mean they will outperform all the time.  Getting a portfolio of all of the best stocks is impossible.

So think economically — try to improve your portfolio regularly, regular incremental improvements yield a large economic improvement over a market cycle.  At least, that has been my experience. :)






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7 Responses to On Watchlists

  1. hippoicthus says:

    A bit off topic, David, but something I’ve been thinking about:

    Given your comments about incremental improvements, what do you think about the idea that investment manager performance should be judged not by the returns of the portfolio, but by the returns of the new ideas and sold ideas versus the static portfolio? i.e. measure the value of the decisions made recently versus those made in the past?

    Given the wide availability of 13-Ds and our ability to copycat others with low-turnover strategies, might this not be a better measure of the value investors are getting for the fees they’re paying?

  2. mediocrepat says:

    David-

    Love the blog, and really appreciate each new submission you create.

    I’d love to hear more about “valuation metrics, sentiment variables, and other factors.” Are these quantitative formulas that I could adopt for myself? I like the idea of ranking your current and prospective holdings. What method do you use to assign a value to each company for grouping?

    Thanks again,
    Pat

  3. [...] nothing with David Merkel in terms of timeframe and strategy, but respect his process and the words regular, incremental improvements remind me that doing the little things over time adds up to a big thing. Joe Fahmy trades high [...]

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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