Investment Strategy – Key Factors and Examples

This article comprises of a short summary of a number of factors that I use in my investment strategy. For a complete analysis of each point enrol in my penny stock Investing course.

After I published my last blog on the importance of having an investment strategy, I received a load of emails asking what some of the factors I used in my own investment strategy. So I selected a few of the key factors to consider when creating an investment strategy, how to calculate or analyse them and why I believe they are important. By the end of this blog, you will have the foundations of how to create your own investment strategy.

Market Capitalisation:

Market Capitalisation (MC) is quite easy to calculate. All you need to do is multiply the total shares on issue by the share price. Now the share price is easy to identify but the total shares on issue can be a bit more difficult. The best way I have found is to go to a company’s announcements and find the latest appendix 3B. Within the 3B there is a section titled “number and class of all securities ‘quoted’ as well as ‘not quoted’ on ASX”. Add the total shares and options in both of these sections and that will give you the total shares on issue. One caveat is I would not include any options where the exercise price is nowhere near the current share price.

An example:

Company ABC has 300m shares on issue, a share price of 10c, $1m cash and no debt.

MC: 300,000,000 * 0.10 = $30,000,000

For a fundamental based investor, the MC is one of the most key factors to consider when creating a strategy. It tells you how much the company is worth and without this piece of information how can you possibly know if a company is “cheap” or has potential for the share price to increase substantially? It doesn’t matter how much profit a company is making or how hot the sector is, if you don’t know the MC then all your other analysis doesn’t mean a thing.

Practical Takeaway:

Calculate the MC of 3 stocks on the ASX. Then tag me in a twitter post (@InvestorSpec) providing your calculations and final MC. I will then check what you have provided and determine if its accurate.

Enterprise Value:

Enterprise value (EV) simply involves taking the MC and any company debt and then minus the total cash or cash equivalents (EV = MC + Total debt− Cash). Total cash and debt can be found in the latest quarterly cash flow report.

If we continue with the investment strategy example above:

MC: 300,000,000 * 0.10 = $30,000,000

EV: $30,000,000 – $1,000,000 = $29,000,000

Enterprise Value is even more important than a company’s Market Cap as it takes the cash component and debt into consideration. From a risk perspective, a company with a MC of, say, $10m but has no cash, is completely different to a company with $10m MC and $5m cash. The Market Cap is important but in isolation of an Enterprise Value there are critical factors that aren’t included, leaving your investment strategy open to extreme risk.

Practical Takeaway:

Calculate the EV for the 3 stocks you calculated the MC for. Then tag me in a twitter post (@InvestorSpec) providing your calculations and final EV. I will then check what you have provided and determine if its accurate.

Valuation of Peers:

Unlike MC and EV there is no hard calculation when looking at Valuation of Peers. It really depends on the company and sector you are researching.
When creating an investment strategy, simply compare the facets and key factors of a company that you like to others in the same industry.

You may be asking why it’s important to know what a company’s peers are worth when analysing a speculative stock. Think about it this way, what if you found a stock which was projecting $5m net profit after tax (NPAT) by the end of the calendar year and had a market cap of say $100m. You then conduct a search and find that within that sector the lowest valuation for any competitor that already had $5m NPAT was $300m. Wouldn’t that information be useful in determining what potential share price appreciation could be gained if the company you were researching achieved its goals? Evaluating a companies peers allows you to understand much more about a company’s share price appreciation potential than you could find by just looking at it in isolation, making it one of the key factors when creating an investment strategy

Is it in the Right Sector?

The sector or industry a company operates in is very important. What makes a share price move is money flow and if there is minimal money flowing into a sector, why fight the market? Finding an undervalued stock in a hot sector can create massive wealth generating opportunities. Now, when I mean hot sector I don’t mean overnight fads or the latest crypto currency token. I mean finding an industry that has great future prospects and is providing a solution to a problem that isn’t going away anytime soon.

Let’s look at the baby formula industry as an example for your budding investment strategy. When China announced in 2015 that it had removed its one-child policy, that sent baby formula stocks through the roof over the coming years. Buying these stocks in 2015/16 created massive amounts of wealth for investors and still does today. This was a result of the highest birth rate increase in the last century, which means lots more baby formula was required to feed all those new babies. So if you can use global events to find sectors that will have sustained money flow for the foreseeable future and find them before the flock get in then you put yourself in a great position.

Now this doesn’t mean you find a hot sector and buy any stock. You must still run every stock through your investment strategy like how you did before, so you don’t get caught chasing and buying a dream rather than a reality. If you are finding out about hot sectors and hot stocks in an analyst report or somewhere on social media then you are already too late. As @iancassel puts it “If you are reading about a company in an analyst report then you are too late. Get ahead of the discovery. Don’t invest where the big money is, invest where it is going to go”.  The key is finding stocks that not many people know about so you can get set before it gets into the mainstream media.

How Many Shares do Directors Hold and what has their previous success looked like?

Now this is a fairly obvious one. If we think about this logically it really doesn’t matter what example of company you are analysing
when creating an investment strategy. If the person in charge has no financial interest in ensuring its success, then what incentive do they have to perform other than their reputation? The majority of speculative stocks are run by directors in numerous companies and simply live off the combined salary of each company. It’s not a bad strategy to get a high income for doing very little. If, on the other hand, a director has a large number of shares in the company then their motivation to ensure share price appreciation is very real. In addition to knowing how many shares the directors hold, you also need to understand how they acquired those shares. If they were free shares or given as a result of the realisation of very easily achieved performance milestone then again the financial incentive to succeed is little.

Find a company that has a director who was the original founder or even someone who purchased the shares they owned on market and you give yourself a much greater chance of success. This is one of the most important key factors to consider when creating an investment strategy
To find how many shares directors hold simply look at the company’s annual report or any Appendix 3Y released post the annual report.

There is another very important factor when it comes to directors: previous performance. Have they created shareholder value through share price appreciation in previous company’s? If not why are you risking your money in this company being their very first success? Investing in a company is more than just purchasing a stake in a business. You are pretty much investing your money in the performance of the directors as they will ultimately drive any form of success. Conducting this analysis is very easy as any director appointments generally include previous companies that director has or is currently serving as a director in. If not then simply google the directors name followed by “ASX” and you should easily be able to find the information you are looking for.

How many do top 20 hold and who are they?

In speculative shares, the “tightness” of the register is very important. When a stock is looking to make a major move, the amount of “sticky shares” will play a massive part in the size of the move. For example, if a company has 300 million shares, only 10% held by the top 20, and they have just announced a major deal then there are 270 million shares that are most likely looking to sell for a small profit and move onto the next “big thing”.

If the top 20 held 50% of the company, the amount of “loose” shares is now only 150m. Now, this doesn’t mean that nobody in the top 20 ever sells into a move, butshareholders with lots of shares will generally have already been in touch with management and like the story/targets the company is aiming for. For this reason they are less likely to sell compared to a register filled with small holders.

In addition to this, if you find a company that has a top 20 register filled with very successful speculative investors who have done extremely well in other companies then you give yourself every chance of emulating their success in this next potential play. It’s important to know what price they purchased their shares at as you don’t want to be buying multiples higher than they did or you risk increases.

You can find a copy of a top 20 register for each company in its annual report. Some companies, publish a top 20 register in addition to the annual report as a separate announcement throughout the year. Legally speaking anyone in the public is entitled to view a company’s register but you must pay a fee up to $250 and state why you want to view the register. Most companies make this process very difficult, as they would prefer not to show register movements outside of the annual report.

How to create your investment strategy is just the beginning. You need to test your strategy to make sure it works and then continue to tweak it based on your performance until you find your edge. Your edge is that place where you have a proven system that can consistently make you money as long as you stick to the plan. Don’t think for a second that this process is easy or even enjoyable in the beginning.

The key to improving your strategy is to have a number of losers to show you what works and what doesn’t. Assad Tannous (@AsennaWealth), Head trader and founder of Asenna capital says, “ If you trade a high prob system & run into a series of losses, the prob on the next series of trades being winners increases dramatically. Then why at this point do most traders suddenly switch to another style? You are either a slave to your emotions or the master of them.”

I love this because it talks more to our human nature than anything else. As humans, we crave things that make us feel good, so when we get a few losses our brain tells us this doesn’t feel good and to try a different style. When in reality it’s the losses that get us to the point where we achieve long-term success.

I have also been getting quite a few requests to post examples of proven investment strategies which have been used to create consistent long term wealth. What better way to start than to explore how Ian Cassel who is a US-based full-time micro-cap investor and founder of MicroCapClub, the MicroCap Leadership Summit, and co-founder of the Intelligent Fanatics Project. Ian’s strategy can be found here.

If you’re looking to take your Penny Stock Investing to the next level feel free pop in and learn more about my newly released investing course.

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