Five Reasons to Build Your Own Investment Models

Would you choose a prefabricated house or something you designed yourself?  

Take pride in what you build.

There isn't a correct answer, it's situational.  Sometimes you need shelter quickly.  Sometimes you want to see your vision turned into reality.

Generally when you are first starting out, working with what's readily available makes perfect sense.  Why would you put a lot of time and effort into building something when you don't know what you want?

But as you grow in knowledge, you start to develop insight and preferences.  You see what materials you like, you know how a certain layout would be not only beautiful but highly functional and you know the neighbourhood where it would fit in perfectly.

I think something similar applies with investment analysis.  

When you start out, you work with ratios and statistics that were built by someone else.  The cost is low and they do the job, hopefully.

But as you work at it and are exposed to new ideas you realize there's a whole world beyond PE ratios and dividend yields. You see how different variations of a familiar ratio would give you more insight.  You learn about calculations you cannot find for free.  You develop your own vision and something else:

You want confidence in what you are working with.  Is the information you base your investment decisions put together correctly?  If you build it yourself you’ll know it’s right.

You want to know how it's built.  There are variations in even the simplest ratio.  Sometimes the quick and dirty option is OK, but sometimes subtly matters.

You want information no one else has.  You realize that if you rely on the same statics as everyone else you are condemned to wander forever in the world of the efficient market hypothesis.

It’s fun and rewarding to build and work with your own creations.

Creativity begets creativity.  The more you work your own concepts, the more fuel you have.  It unleashes further ideas.

You know where you are in your investment life cycle.  If it's time to start turning your vision into reality, there's only one place to do it: INVRS.

Using Images in Your Investment Analyses

Visual content in your articles is a must nowadays. This post will provide some guidelines for incorporating images into your work.

1. The first image attracts.

These people are all consuming information.  Images help guide them to your's.

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The first image you pick for your article should be eye-catching, draw readers in and make them curious.  Large, colourful or beautiful images are good choices, as are images of people – we’re drawn to pictures of other human faces.

A shocking image can also work but use with caution.  You might attract some people, but you can also alienating your readers.  If you go this route, make sure it’s relevant.

2. Use a meta-tag to tell search engines what your web-page is about.  Choose clear, simple language that will describe the image in terms of what people may be looking for.

3. Generic or stock photo images that you see everywhere aren't as powerful as unique, scarce or premium images.

4.  Use approximately one image to every 300 to 400 words.

5. Pictures, graphs, charts all count as images in your articles.

6. Speaking of graphs, they should illuminate, not obfuscate.  Help your reader – simply graphs by eliminating unnecessary clutter. 

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There’s a lot of information on this chart.  Is all of it relevant?

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This chart expresses one idea clearly.

7. If you have no choice but to use a more complicated image, use annotations to draw your reader to the key point.

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This chart is annotated with red circles to highlight relevant information.

If you are working with a multi-row, multi-column chart bold or highlight what you want your reader to focus on.

8. Use your images to communicate, reinforce or give more authority to an important idea.  Images tend to stick with us more than words and the combination even more so.

9. Do not confuse your reader or make them work too hard.  If your image has that effect, eliminate it.

10. Remember, images are important.  Choose them with the same care you take in creating your headline.

Bonus tip: part of the INVRS functionality is to create unique graphs, including ones based on your analyses.  Sign up for our free two week trial and learn what a difference our software can make to your work.

Thanks for reading.

Using a Scientific Framework in Your Investing

It's fun.

What is a scientific framework for investing and how can it help you?

The scientific method is arguably the most important development in the history of humankind.  It's a creative structure that stimulates curiosity.  It pushes you to be objective, rather than emotional in your approach and it encourages you to look at the world with uncluttered senses.

It also gives you a decision-making system that, if you are faithful to it, should see you avoid pitfalls like buying high and selling low or following the crowd.

The scientific method

Incorporating a scientific framework starts with the scientific method.  Let’s revisit it:

Step 1~Be curious and observe the world around you~

Step 2~Ask a question when something intrigues you~

Step 3~Do background research~

Step 4~Build a hypothesis~

Step 5~Create an experiment to test your hypothesis and run It~

Step 6~Collect and analyze the data and draw a conclusion~

Step 7~Report your findings

That’s all there is to it.  Let’s see it action with a hypothetical example.

Step 1) Be curious and observe the world around you.

You notice that certain small cap bio-technology stocks periodically gap open and then continue to rise until their value has increased by at least 50%.

Step 2) Ask a question when something intrigues you.

Are there any indicators that might uncover one of these small-cap bio-tech stocks before their price begins to rise?

Step 3) Do background research

You notice in a couple of these stocks earnings drop one to three quarters before the price starts to rise.You investigate further and notice an increase in selling, general and administrative expense is the reason.

Step 4) Build a hypothesis

A small cap bio-tech company will increase its marketing spend approximately six to nine months before the release of a significant new drug or other major development.

Step 5) Create an experiment to test your hypothesis.

After careful deliberation, you decide on the following experiment:

• Create a portfolio of small cap bio-tech stocks in INVRS,
• Graph them based on price over the last five years and note the dates when prices started to increase significantly,
• Research news stories and determine the reason for the increase.  Categorize the increases by reason.
• Create a template to determine the average SG&A spend over an appropriate period and compare it to the spend in the three or four quarters prior to the price run-up.

Step 6) Collect and analyze the data and draw a conclusion

After collecting the results and analyzing it you make the following conclusion:

“Of the ten instances of price increases, 80% were related to a new drug or other significant technological development and other 20% were related to a take-over announcement.  Of the eight related to innovation and in the nine months leading to the price increase, one increased their SG&A spend by 5-10%, five increased it by 11-20% and two increase it by more than 20%.

Based on this evidence, I conclude that an increase in SG&A spending is a leading indicator of a price increase for small-cap bio-tech stocks.”

Step 7) Report your findings

Write a blog, article or white paper about your findings.

The process can be iterative

You don’t have to stop after the final step.  Whether you prove your hypothesis or not, you can go back and do more research, tweak your hypothesis, or refine your experiment.

In the example above, a next step might be to create a test for false positives.  Or in other words, measure the likelihood that an increase in SG&A doesn’t lead to a future price spike.

What about profit and market advantage?

Clearly the degree to which you publish your ideas might be limited by economic constraints. You might want to keep certain ideas to yourself, so the reporting might be to a small group or you might take a position first or put a paywall around your work.

I hope this article gives you some ideas about how you can use the scientific method in your investing.  We'd love to hear your stories about using it.

Three-Dimensional Stock Analysis

1D, 2D, 3D, more...

Most analysis is done on a single stock and rarely involves contrasting it to similar companies.

The value of peer comparison is well understood, but few people do it because the time investment makes it untenable.  If, for example, it takes you one hour to analyze a stock, comparing it to just four peers means a four-fold increase in time.

This time hurdle is what forces most analyst/investors to limit themselves to two-dimensional analysis – vertical (ratios created by going down financial statement/market data at a single point in time) and horizontal (ratios created over more than one period).

The third dimension is peer comparison.

When you take a horizontal or vertical ratio or valuation calculation and you compare it to a group of peers, you are adding a third dimension of analysis.

Let’s say you are using a p/e ratio.You know what it is currently, you know how it ranged historically.  You’ve got two-dimensional insight on that value. But when you compare it against the ratios of peer companies, you have more context, more insight.

INVRS was designed for peer comparison with our portfolio-based analysis.

First, it’s a snap to find peers – you can use our research tab or stock screener to quickly assemble a group of related companies (for more information watch our video on portfolios).

Next, with a couple of clicks you can add candidate stocks to a portfolio.

Finally, run the portfolio against all the analysis criteria you want.  It takes no more time than doing the analysis on one stock.

Adding a third dimension to your analysis can make a difference on so many levels – it can give you inspiration for new ideas, it can help keep you more objective and give you insight that other analysts just don’t have.

I hope to be reading one of your three-dimensional analyses soon!

Improving Your Security Analysis and Writing Skills

Your stock is rising in every respect.

Whether you’ve been analyzing stocks for a while and want to improve your skills or you're just getting started, this postl will discuss some simple ideas about how to boost your craft.

It's a two-part answer.  Practice, of course, analyze and write, but also read the work of other people.

On practicing

You’ve probably heard the maxim that practicing for 10,000 hours at anything will make you an expert.  Well today’s the day to start putting in the time.

Below is a strategy that focuses on the process, not the outcome, of meeting your goal.  It's about developing the habit that will carry you to success.  

On the other hand, focusing on the outcome, for example, writing an article a day, might not be possible sometimes.  Circumstances beyond your control can arise and will leave you feeling frustrated.  

However, committing to a process always results in success.  And there are just three simple steps to it.

First, consider what your most important goal is.  Let’s say it’s to become a better analyst and writer.

Next decide what is your best, most productive time of the day.  Morning? After your mid-afternoon work-out?  After everyone goes to bed in the evening?  Figure it out and then use your most productive time of day to reach your most important goal.

Finally make a time commitment – one hour, two hours, three.  Whatever you can do.  Even if it is only a small window, don’t underestimate the psychological boost you’ll get from commitment.

Once you committ, that time is sacred.  Don’t do anything else - no email, no phone, no distractions  Get the support of your family to keep this time to yourself.

On Reading Other People’s Work

We highly recommend reading the work of other people.  In fact, we think you should read as much as you write.

The good news is, you can count a lot of reading towards this.  Reading the work of other investor-analysts is a given, and you can select from multiple platforms and mediums.  But it can be in other areas too.  For example, blogs about good writing.

When you come across an article that you've especially enjoyed, take a moment to observe what the author did.  How did they lay it out? How did they use use white space and images?  How did they get and hold your attention?

Reading can help make you a better writer.

That’s it for now.  Please let me know if you have any questions or comments.