Tuesday, November 6, 2012

An Alternative Way To Research Stocks

Everybody has heard of the homespun wisdom that you should only buy stocks that you understand. It’s the sort of idea that makes the likes of Peter Lynch and Warren Buffett so popular with private investors. The reason for this it offers an accessible brand of stock selection and comfort to the public.  In this article I want to discuss how private investors can best use knowledge in their everyday lives in order to generate good investment ideas.

Understanding What is Relevant

In my opinion the best investors all have one quality. They are very good at data mining. They are the sort of people that can receive a mass of information and facts and then quickly discern what is relevant and what needs to be acted upon. We can try to do this in our everyday lives by talking to people around us and learning useful info from them.

The key is to be able to separate useful information from the background noise and this is not as simple as it sounds. The best way to explain myself is to give some examples.

LED Lighting

A friend of mine works in the lighting industry and we occasionally discuss what is happening with her sales force. It’s a good way to get some anecdotal evidence on the construction industry although I am always cautious on just relying on her input. We once discussed LEDs and she gave me some fascinating color. It seems that the construction industry already uses LED lighting extensively but they use it in difficult to reach areas which require little maintenance. In other words, they are mainly used in areas where their longer life and brightness give them advantages that overcome their higher initial cost.

This is actually a key ‘tell’. What it means is that the purchasers and sellers of LED lighting are already having a dialogue and are aware of the underlying benefit of the lights. Therefore when LED lighting get closer in cost to traditional forms then the transition to using them should be smooth. And in this regard I think Cree (NASDAQ: CREE) is going to be a key beneficiary. Its LEDs are best in class and its lighting solutions should see a sharp pick up as LED costs fall.

Surgeons ‘R’ Us

Purely coincidentally I’m friendly with a few surgeons. Whenever I see them I always ask them what is hot in the industry. The one thing that is always mentioned is Minimally Invasive Surgery (MIS). Not only are these techniques easier to use but they also lead to better patient outcomes. And this is the key insight. According to the surgeons, the result is lower hospital costs as patients can be let go earlier and further procedures are not necessary.

The two names that keep coming up are Covidien (NYSE: COV) and Intuitive Surgical (NASDAQ: ISRG). Covidien’s MIS sales have been surging in recent years as it has recorded quarter after quarter of double digit gains in Energy (MIS) solutions. There is no indication that they are slowing and once the company slits up i would expect more analyst attention to focus on how strong underlying sales are.

Similarly, Intuitive's robotics systems offer the opportunity for clinics to expand the number and type of procedures that they can undertake.  Adoption of its Da Vinci system has been rapid as a consequence as it can significantly increase a surgery's revenues. The stock may well have pulled back as it failed to meet the highest expectations but nevertheless the long term story looks good.

Yogi Bull

I know nothing about yoga and don’t care to learn much either. However, I do know a few women who rave about it and as any player knows, the best way to get into a girl’s affection is to get her talking about herself.  Consequently I have come to believe that the world would come to an end if Lululemon Athletica (NASDAQ: LULU) wasn’t allowed to sell its yoga gear. Yoga is rapidly becoming an indispensible part of dealing with urban stress and the company has hit a real sweet spot in servicing the market. Other sportswear manufacturers have attempted to muscle in but the yoga set are a particular bunch. They know what they want and its Lululemon.

Those Who Know

Another example of this approach is reading across from industry experts and picking up on trends that they are seeing. One such case is with monoclonal antibodies. I was lucky enough to be friendly with the director of a firm that supplies antibodies to biotech and pharmaceutical companies. Even in 2008 their sales were going ballistic. Without necessarily understanding the medical science behind their growth, it was clear that the industry was gearing up to develop their pipelines with antibody based research.

A bit of digging around reveals that one of the leading players in antibodies is Bristol-Myers Squibb (NYSE: BMY). It’s $2.4bn purchase of antibody discover Medarex in 2009 gave it substantive research ability in antibodies and it is known as a leader in antibody drug conjugates in oncology. Furthermore it recently signed a licensing deal with Vical incorporated in order to use its technology to develop antibodies.

Using Scuttlebutt in Your Own Investing

These examples are just a few illustrations what how investment knowledge can be gained by talking to the people around us. It doesn't take great expertise or insight to be able to do this. It just requires us to be curious about the world and then know how to relate that to investing. In other words finding the right question to ask of the right people or recognizing when someone has told us something with direct relevance to a stock or an investment decision.

We can read huge numbers of analysts’ reports on stocks and think we understand the companies inside it but sometimes the things that really matter can be garnered by talking to people around us. It is the sort of approach that Peter Lynch espoused and Warren Buffet never lost by money by not buying companies he didn't understand!