A Disciplined Approach to Investing

Thursday, July 30, 2009, 11:00 AM ET -

The GeoTeam believes that developing a disciplined approach to investing can greatly increase your chances of excelling in the stock market. In this regard, there are many strategies that one can employ. For those interested, I will share with you a brief glimpse of the methodologies the GeoTeam utilizes in its quest to uncover diamonds in the rough. In the end, it is not the rocket science that most professionals who want your money will make it out to be. Peter Lynch's book, One Up On Wall Street, launched my personal and professional investing career and still remains my investment bible. His insight into value investing, complimented by the GeoTeam's calculated use of momentum-based principles, has helped us to identify growth companies in a timely manner.

Step One. Define Your Company Universe

In this step, narrowing down your potential pool of stocks is the main goal. Once accomplished the rest is quite simple. Think about it. When all venues are included, there are over 20 thousand stocks floating in the United States investing universe. Sorting through the list to identify potential winners can seem like a daunting task. Although investors may have various ways of accomplishing this task, I believe that many become frustrated during the process. However, once a primed down list has been created, your wealth building journey can begin. The following is glimpse into the methodologies we utilize to isolate a focused list of stocks from the investing universe.

Technical Triggers. While fundamental analysis remains the crux of the GeoTeam's approach to investing, technical triggers are invaluable and accessible tools that can be used to seed your research.

12 month high: widely accepted as long-term strength potential of a stock.
3 & 6 month high: interim highs can offer insight into the early recovery potential of stocks during recessionary periods much like the one we just had. We used these indicators quite effectively in identifying the stocks that led the way out of the recent carnage.
3, 6 & 12 month lows: these benchmarks present investment opportunities when companies may have unjustly been beaten up by Wall Street.

Press Releases. We typically peruse every earnings press release to spot companies that:

Report 30% quarter earnings per share growth.
Report unfavorable earnings, but with positive commentary that could present opportunistic scenarios.
Significantly beat analyst estimates (used mainly as a day trading tool)
Report news that meets our special situation criteria. (GeoSpecial)
Report news that meets our GeoBargain criteria.

Fundamental Screening. The premise of fundamental screening is to discover stocks that meet several of the GeoBargain criteria. Here are a few examples:

Outstanding shares less than 50 mill, EPS growth over 30% and price under $30.
Float less than 10 million, EPS growth over 30% and price under $30.

We prefer not to use P/E as an input because GAAP earnings per share data may not tell whole story as they often include non-operating items. The GeoTeam uses Non-GAAP earnings per share figures to calculate P/E ratios.

We also prefer not to use too many criteria in our screens as nothing can replace the human perspective, especially since a substantial amount of the data from financial vendors is inaccurate. In fact, the lack of dependable data is a growing problem for small and microcap companies.

Relationships with Reputable IR Firms. The GeoTeam has established relationships with reputable investor relations firms, introducing us to new opportunities. Exchanging thoughts leads to a more robust understanding of certain aspects of a company that ordinarily wouldn't be found anywhere else.

Step Two. Categorize Your Findings

Once the investment universe has been reduced to a manageable list, it is time to perform the grunt work. Our goal is to determine if a stock will be:

a GeoBargain or GeoSpecial based on fundamentals
a trading opportunity
discarded

Fundamental Reasoning. The main question you have to ask about your trimmed-down list is, "Are the events that led me to add these stocks to my list justified?" To make sure this question is sufficiently addressed, the GeoTeam diagnoses SEC filings, shareholder letters, company presentations, relevant press releases, analyst estimates, company guidance, conference calls and interviews. We also develop valuation scenarios in which we focus on non-GAAP data as a supplement to GAAP data. After these activities are performed, the GeoTeam can determine if a stock qualifies as a GeoBargain or GeoSpecial.

The following examples illustrate how participating in conference calls reinforced the belief that Orchids Paper (TIS) and Cpi Aerostructures (CVU) should qualify as GeoBargains. In both cases, the conference calls cleared up misunderstands arising from their earning press releases. As expected, the stocks ultimately recovered from the initial investor overreaction.
- Example 1 - Orchids Paper conference call notes (TIS was identified as a GeoBargain on Feb.4, 2009 at $9.78. Price at time of this article was $22.89)
- Example 2 - Cpi Aerostructures conference call notes (CVU was identified as a GeoBargain on Feb. 4, 2009 at $5.00 per share. Price at the time of this article was $6.50)
The review of SEC filings is an extremely value-added activity that, when done properly, can offer valuable insight into company specifics omitted from other publicly available information. The following examples illustrate how the use of filings helped us to pinpoint important information and act on timely information in advance of less inquisitive investors.
- CSGJ 2009 10Q highlights industry dynamics that may jumpstart growth, ideas covered in our article Capitalizing on China's Stimulus Plan, Part I. (CSGJ was identified as a GeoSpecial on June 13, 2009 at $1.25 per share. Price at the time of this article was $1.68)
- OPAI most recent 10Q indicates that liquidity position drastically improves, as indicated on GeoInvesting on may 22, 2009. (OPAI was identified as a GeoSpecial on June 5, 2009 at $0.54 per share. Price at the time of this article was $0.74)
- ABAT 8K provided guidance information several days in advance of its related press release, as indicated on GeoInvesting on April 2, 2009. (ABAT 8K was identified on April 2, 2009 at $2.53 per share. Price at the time of this article was $4.31)

Trading Opportunities. Although trading is a minor part of the GeoTeam's focus, we realize that it can be a lucrative activity when combined with the diagnosis of company fundamentals. We are seeking companies that are beating analyst estimates or internal guidance. One of our favorite plays is to trade stocks that analysts had forecast to post a loss but turned a profit. Examples of stocks we traded or own on this premise:

JRN reports earnings on July 21. Opens at $1.13. Closes at $1.77. (Price at the time of this article was $2.71 per share)
MEG reports earnings on July 22. Opens at $2.72. Closes at $4.33. (Price at the time of this article was $4.65 per share)
SPF reports earnings on July 22. Opens at $2.60. Closes at $2.68. (Price at the time of this article was $3.38 per share)

What we like about this approach is that in many cases the trades run for several days.

Discarded Stocks. The stocks in our discarded lists did not meet any of our fundamental or trading criteria, although some may remain on our watch list if there are compelling components to their stories.

Step Three. Establish a Sell Discipline

The GeoTeam engages in sell discipline routines on a daily basis. For more information, please go here.

For the more casual or less seasoned investor, performing steps one and two may not be realistic. If pressed for time, an investor may want to choose only one method. Twenty years ago, while I was a working college student, I used to perform this task all day on Sundays, solely using new high data outlined in the Barron's, Investors Business Daily or Wall Street Journal. Today, the internet enables investors to attack this process more efficiently while using a multitude of different angles. If you still don't have the time or discipline to perform the entire investment task, you can always check in with us every once in while.