Knowledgebase 2019 Part 1


The main topics in this Knowlegebase are divided into:

Basic Rules of the Board

My Historical Results

My General approach and Philosophy

Evaluating a Company

Portfolio Management

Adjusted vs GAAP Earnings

What is My Buying Policy?

What is My Selling Policy?

Calculating Portfolio Returns

Dips and Downturns

On Insider Trading

Thoughts on IPO’s and Secondaries

Investing Ethically


Professionally Managed Money

Teaching Investing to Kids

Investment Primer

How to Post in Italics, Bold, and make Tables

If you are searching for one section in particular you can either scroll to it, or use the “find” or “search” function of your computer to search within this post: topic headers always start with ## so you can add that to the start of your search to go straight to a topic (e.g. “## Some Topic”).

## Basic Rules of the Board

Our board has rules. It’s not like other boards. If you don’t follow the rules your posts are likely to be deleted, and if necessary you may even get barred from the board. That’s just the way it is. Life is hard sometimes. :grinning::grinning:.

If you are new to our board, you should read these Rules Of The Board, which explain what we are all about, and which I try to post weekly. If you are not new to the board, rereading it occasionally will still be a good reminder.

Assistant Board Managers: Bear (PaulWBryant), Austin (CMFALieberman), Matt (XMF BreakerForce), Benjamin (Locke), I. M. (imyoung), and Lenny (ldigout) will each take some of the load of running the board off my shoulders, and act as Assistant Board Managers. I really appreciate their aid.

This board is for the discussion and analyzing of individual growth stocks in a cooperative and courteous manner and, secondarily, the philosophy around investing in them.

That means that there are subjects that are Off-Topic for this board. There’s nothing wrong with them as topics. There are other boards where they are welcome, or even the chief topic of conversation. These include politics which, however, quickly spins out of control and ends up with people who had been amiably working together discussing a stock, suddenly viciously arguing. Political posts will be immediately deleted.

Investing subjects that are off topic include technical analysis and option trading subjects, including describing the details of your option positions, or value investing, or turn-around investing, or dividend or income investing, or market-timing, or what Investors Business Daily says the market is going to do next week, etc.

Repeated posts of what long lists of stocks have done in the past week don’t belong. Basic investing questions like “What does EV/S ratio mean?” should simply be googled, rather than filling up the board. Portfolio management is not a subject for this board, and questions about it should be answered off-board if at all.

We have to rule out crypto-currencies and marijuana stocks as most of them are simple speculations and if we open the door to one or two we’ll be deluged with speculative stocks, which is not what our board is about.

One-line posts rarely add anything significant to a stock discussion but fill up the board.

We occasionally have discussed certain very promising small biotechs. They didn’t qualify as growth stocks, but since, thanks to bulwinkl and others, we’ve had good results with most of them, we grandfathered them in. They tend to take up a very small part of board posts.

As far as month-end summaries, most people on the board find them very useful when the poster doesn’t just post a list of names of stocks, but explains why he holds each of them.

Responding to someone with anger because they disagree with you about a stock is simply not done on our board.

Non-investing subjects like how to cultivate apple orchards, or private humorous conversations, can be fun but don’t belong here after one or two posts. That’s just a few, but you get the idea.

This all may sound intimidating, but think of it this way, if you were on a board set up to discuss French cooking you wouldn’t post about how to make Mexican tacos or Chinese spring rolls, and certainly not about politics, or option trading, either. You’d post about French cooking. Well, our board is about analyzing and discussing individual growth stocks. It’s as simple as that!

Remember that you can take conversations off-board. It’s easy! Just check the little box on the reply window that says, “Email this Reply to the Author” and un-check the box that says, “Post this Reply to the Boards.”

I’m not sure what to tell you about appreciations. People who make an especially good post certainly deserve rec’s, but post after post that just say “Great post!” just fill up the board. If you have something special to say about the post or poster, go ahead. For example: “Thanks Joe, your grasp of this field is amazing and I always learn so much from your posts on these stocks, because you clarify issues about such and such that I can’t figure out myself.” That’s different because you are saying something. I do sometimes break this rule, but as host of the board, I feel I should try to recognize and thank people who make especially valuable posts. I’m sure I miss some.

On Blabbing for those of you who are new to the board, you just can’t, CAN’T blab about NEW Motley Fool paid board recommendations on our board (or other free boards). The Fool is incredibly kind to run this board for us for free, and by giving away their recommendations you possibly endanger our board’s existence and everything we have built here. Please pay attention. Similarly, you shouldn’t post what Bert said in his paid board until it becomes public on Seeking Alpha, or what other paid subscriptions say. It’s unfair to paid subscribers. That’s just common sense.

And finally, ask yourself if your post is adding anything of value to the discussion.

## My Historical Results

I started keeping track of my results yearly in 1989, because my wife and I had a baby and I wanted to retire in about 7 years (I did). My wife panicked (“You can’t retire! We have a new baby!”) so I decided I had to get serious about investing. In Jan 1993, I increased my record keeping and started keeping track of my results weekly, and not just annually, as I had done before.

You should know that my wife and I and my family have been living off what I make in the stock market since I retired in mid-1996. That’s 23 years! I have no pension or other source of income except Social Security.

From 1989 to 2007 inclusive I averaged about 32% per year compounded. This produced a rather amazing overall multiplication of my total portfolio, In fact, if you sit down with your calculator and multiply 1 by 1.32 (since I averaged a 32% gain) 19 times, you’ll be amazed too. (It’s the power of compounding). You’ll note that this was not a large multi-bagger on one stock, but on my entire portfolio, the whole works!

I lived through the Internet bubble of 1999–2000. I sold out of Amazon, Yahoo, and AOL one day in January or February of 2000, after Yahoo, as I remember, had gone up something like $30 to $50 per day for three days in a row. I said to my wife, “They may keep going up, but this is insane. I’ll let someone else have the rest of the ride.” The bubble broke about 3 weeks later. Sometimes selling can be the most important thing you can do. I didn’t get out of the market. I just bought non-internet stocks and was up 19% for the year. Sure I could have held through the decline, and 10 years later Amazon came back, even if Yahoo and AOL never did, but why???

I got killed in 2008 like everyone else. Probably worse than someone who was in defensive stocks. It was my first negative year after 19 positive years in a row. I stayed 100% in stocks, selling anything which hadn’t gone down much to buy more of the ones that were down the most.

Finally, I was down so much that even I got scared and started to think of selling out and going into cash. All the talking heads were saying, “Sell! Sell! Sell! Get out! Get 100% in cash!”

I said to my wife, “If everyone is shouting ‘Sell!’ and even I am scared enough to be thinking about selling, there’s no one else left to sell… This must be the bottom.” And it was (Nov 2008).

In 2008, in the big meltdown, I dropped 62.5%, which was pretty terrifying. In 2009 I was up 110.7%. The way percentages work though, after dropping 62.5%, gaining even 110.7% doesn’t get you back to where you started, but I sure felt better.

My Annual Results since 1993:

You’ll note that 32% a year compounded doesn’t mean you make roughly 32% every year. Below you’ll find a list of the gains of my entire portfolio starting in 1993. Numbers are percent gain. In other words 21.4% means every $100 turned into $121.40, and 115.5% means every $100 turned into $215.50.

Two enormous years in 1999 (Internet Bubble) and 2003, when my portfolio was still fairly small, sure helped out.

**1993:   21.4%
**1994:   15.4%
**1995:   43.4%
**1996:   29.4%
**1997:   17.4%
**1998:    4.9%
**1999:  115.5%
**2000:   19.4%
**2001:   46.9%
**2002:   19.7%
**2003:  124.5%
**2004:   16.7%
**2005:   15.6%
**2006:    8.6%
**2007:   22.5%
**2008:  –62.5%
**2009:  110.7%
**2010:    0.3% 

At this point I have a little reminiscence: I remember in 2010 there was a lot of talk in the media about the “Lost Decade” for the stock market, which apparently had finished roughly unchanged after 10 years. I was up 570% in those same 10 years of market stagnation, in spite of 2008, so I was wondering what they were talking about.

**2011:  –14.5%
**2012:   23.0%
**2013:   51.0% 
**2014:   –9.8% 
**2015:   16.0%
**2016:    2.5%
**2017:   84.2%
**2018:   71.4%
**2019:	  28.4% 
**2020:  233.3%
**2021    39.6%
**2022   -68.4%
**2023    26.7%
**2024    27.4% up to the most recent close on May 24.

We are talking 35.4 years from 1989 to May of 2024 inclusive, and that’s a lot of time for compounding to accumulate. Please feel free to calculate it yourself, but as of that last date, I had a over a 2000 bagger on my entire portfolio (even after subtracting the horrible 2022 losses).

A number of people were very skeptical when I first said I had made 30% per year in ordinary markets. Some even implied that I must be lying, that even Warren Buffet couldn’t do it. (But he was investing billions of dollars, like piloting a battleship instead of a speedboat. He had to buy whole companies, for God’s sake!).

Well, 2018, for example, was a slightly down market. The S&P was down 6.6%, and the Russell 2000 Small Cap Index was down 12.5%, but my portfolio was up 71.4%. Others on this board, following the principles that we discuss, were up even more. And it wasn’t magic. I’ve been transparent and given all my positions and their relative size each month, and basically told exactly what I was doing. You’ve followed along with me. It’s real. It takes some work, but you can do it too. I know there will be pullbacks and I will end other years with more or less gains than this year, but it can be done!

Stock picking does work (obviously). Especially if you are lucky, as I must have been. Some people say you can’t beat the market in the long run. They are wrong.

Please note: I wrote in the 2015 edition of the KB that it’s a lot harder to make great returns as the amount you are managing gets larger. I explained that I can no longer get in and out of a stock position on a dime as I could when my portfolio was a tiny fraction of the size it is now. I just can’t be as nimble as I was, and I said that I’ll be very happy now if I can average 22% growth per year instead of 32%.

Well, in the seven years of 2016 through 2022 inclusive, since I wrote that, I grew to 611% of what i started with. I compounded at just under 30% even with the horrible 2022. Again, I really don’t think that is a realistic expectation going forward.

## My General Approach and Philosophy

Most of my stocks start with a recommendation and write-up by someone I have a lot of confidence in. This could be someone on the board, Bert, The Motley Fool, or more rarely a write-up by someone else on Seeking Alpha.

I want rapid revenue growth. My ideas about that have become inflated in the last couple of years and where I once might have looked for 20% to 25% as very fast growth, I’m now looking for 40% growth, and sometimes more.

I look for a stock in a special niche, with something special about it. I guess this could be considered a moat. It also could be considered a potential big future. I want a company that does something special, a rule breaker, not a company that just makes a commodity product well.

I look for recurrent revenue. I want my company to have last year’s revenue repeating this year and building from there, and not a company that has to go out and grow by selling the whole thing over again. God, this is important! It usually means software, and a SaaS model, and NOT selling things. You just can’t keep growing at 40% selling things. And when an economic slowdown hits, people will put off buying a new car, or a new house, but companies won’t tear out the software that keeps their company going. Software also usually means not capital intensive, and it also means high gross margins.

I really want high gross margins.

I look for rapidly improving metrics like rapidly dropping losses as a percent of revenue or increasing profits if they are already profitable, increasing gross margins, rapid customer acquisition, improving cash flow, dropping operating expenses as a percent of revenue, etc. If some metrics aren’t improving (S&M as a proportion of revenue, etc), because management says they are taking advantage of a greenfield opportunity to gobble up all the recurring revenue customers they can while the getting is good, I generally approve, but want to see those revenues really growing.

I want a dollar-based retention rate over 110%. I look for one over 120%, and I’m impressed by one over 130%. A high Net Promoter Score is nice too, but there’s no easy way to get that information.

I look for positive and growing Free Cash Flow (FCF). If the company isn’t there yet I’d want to see progress in that direction.

It’s been a long time since I’ve been in a company that didn’t have a lot of cash and little or no debt.

Almost all of my companies are founder led, but I think that’s mostly because they haven’t been around for generations. I look for substantial insider ownership. I want the company executives to have the same interest as I do in the stock price rising.

I don’t want the company to have huge customer concentrations (top three companies making up 30%-40% of revenue). But I don’t seem to have to look for those features, they just come with the territory.

I constantly monitor these factors and I exit if they seem to have changed for the worse, or if I think I made a mistake in the first place, or if I’ve lost confidence, or if there are new facts.

I don’t sell out of a stock because the stock price has gone up. Ever. That’s not a sufficient reason to me, no matter what it does to the EV/S. If my position has become too big I’ll trim my position around the edges…

When I first started out I didn’t mind concentrating your investments in four or five companies. However, when you are retired, and you are investing for a livelihood, and you don’t have any other income to replace potential losses, it’s safer not to let any position get too big. You should rarely, if ever, let a position grow bigger than about 15%, and even that is usually way too much. I’ve been breaking that rule lately and letting positions grow to 20% or 21%.

I usually start with small position and let it grow. Sometimes, I add to a position while it’s growing. I almost never start with an oversized position. I usually don’t buy a full position all at once, or sell all at once, but I taper in and taper out, unless I have a good reason to get out in a hurry. (Although when I had a smaller portfolio I sometimes would buy or sell an entire position at one time).

You can’t really keep track of more than 20 or so stocks, and that’s an absolute outer limit. I greatly prefer a much smaller number of stocks, as they are easier to keep track of. You need to read all the quarterly reports, and the transcripts of all the quarterly conference calls, which gives you a busy earning season. They often say a lot more on the conference calls than in the earnings press release. Reading the transcripts works much better than listening to recordings as it takes a quarter of the time, and you can skip the forward-looking statements messages, etc. Look at investor presentations too. And get a news-feed from your broker on each of your stocks.

You can beat any mutual fund over the long run. You can’t tell much from a mutual fund’s results because you are always buying last year’s results. For example, if it’s a oil company fund, and last year oil stocks were in, it will show great results, but this year it could do terribly. Also, you are always buying the results the fund had when it was much smaller and nimbler than it is now, because those good results they had when they were tiny made people pour money in.

I pay no attention to 2-baggers, 5-baggers, 10-baggers, etc, in individual stocks, nor do I count them in considering investments. This is relevant because this way it never crosses my mind to think anything like “This stock is slowing down, but it’s a 9-bagger. Maybe I should hold it for another year to try for another 10-bagger.” Going from a 9-bagger to a 10-bagger is only an 11% gain. If I’m no longer in love with the stock, I should be able to put the money into a new stock that will be up 30% in a year, and it will never even cross my mind that I missed having a 10-bagger. Here’s another way to think about it: If you have an 80-bagger on a stock that grows to an 85-bagger it sounds exciting, but it’s only a 6% gain on your money. If you take the same money and put it into a new stock where you just get a tiny little 2-bagger, you’ve made a 100% gain on the same money. Which is why I don’t pay attention to trying to get multiple baggers. If they happen, fine, but it’s not my focus.

If you were to put a small amount of money in every stock listed on the market, you would eventually pick up every 10-bagger, even every 100-bagger, that occurred. You’d be able to brag “I have fifty 10-baggers now, and three 100-baggers!” But so what? You’d just be doing as well as the markets as a whole, by definition, as you’d be investing in the whole market. My goal, and my entire focus, is increasing the value of my entire portfolio. As I pointed out above, having a multi bagger on my whole portfolio is what counts, not on individual stocks.

Not accepting that an investment could be a mistake as it continues to go down is a dangerous error, and could be very expensive. A big problem investors have is getting attached to their previous decisions and not being willing to consider that they may have made a mistake. Some of the most angry I’ve seen people get on these boards is if you criticize a stock that they’ve fallen in love with.

I try to always pay attention to criticism of a stock, to reevaluate my investments, and to get out if it turns out that I’ve made a mistake, or if the situation has changed. Which is why I rarely end up holding stocks for 5 or 10 years.

Sometimes changing your mind in the face of new evidence, and selling when necessary, is the most important thing you can do. If you are wrong, you can always buy back in. I think that being willing to change my mind in the face of new evidence is one of the most important skills I have. And learning that it’s okay to change your mind when appropriate is one of the most important things I try to teach on this board. Let me remind you that I sometimes make mistakes getting into a company (big mistakes, on occasion), but that I am willing to consider the possibility that I was wrong, and change my mind when I see that I actually was wrong. And that that is very important. Although I realize that I make mistakes, I don’t regret my decisions. I figure I did the best I could at the time. And sometimes I make mistakes getting out too. So what! I can’t be right all the time.

I buy no bonds of any type.

I don’t invest in options. They are too much distraction for too little gain. Also they are a “zero-sum game”. That means if you sell an option, whatever you gain, the person who bought the option loses. Exactly the same amount. And vice versa. There is no total value creation. And you are competing against professionals!

I’m usually nearly 100% in stocks, and only rarely and briefly as much as 3% in cash. I have a couple of small accounts in which I can buy on margin, but my amount of margin is rarely as much as 2% or 3% of my total portfolio.

I don’t invest in futures. I tried them when I was younger and saw a bunch of money disappear overnight. They are also zero-sum games and you are again competing against experts.

Dividends aren’t a big part of my investing. In general, I treat dividends, if I get them, as just fungible dollars. They just get mixed in with whatever cash I have in the account and I don’t think of them as “income,” as opposed to “capital gains.” If I’m withdrawing some cash to live on, I don’t in any way separate out the dollars that came from dividends. This is just the way I do it, and it seems the simplest to me.

Trading in and out is self-destructive. You remember the trades where you made a few dollars and it encourages you, but you forget the losses. Never take a position to make a few percent. You should be investing in stocks that you can see at least tripling.

I always buy with the idea of holding indefinitely, never with the idea of a short holding period, but in practice I guess my average holding period is six months to three years. I sell when I’ve fallen out of love with the company or I think the story has changed, or I think that the price has gotten way out of line.

Never miss getting into a stock because you are waiting to buy it a few cents cheaper. The decision is whether you want to invest in it or not. Once you decide, take a starter position, at least. Don’t wait around for a slightly better price. When it’s at $110, I can guarantee that you won’t remember or care whether you paid $20.10 or $20.30, but you’ll be kicking yourself if you didn’t get in. The issue is: Do you want to buy the stock? If the answer is yes, don’t fool around trying to buy it a bit cheaper. You are buying with a long-term perspective.

**I assume that any good stock I might want to buy probably traded at a lower price some time before I found out about it…**Duh… But so what? I can’t go back and buy it in the past. What I care about is whether the stock is a good buy now. I see too many people who are “waiting” for a price to go back to where it had been, for a lower price, a better buy in point, or whatever. They may get it and save a $1 or $2, or they may miss getting in, and miss a $50 eventual rise in the stock. Don’t try to wait for the price to go down before getting into a stock. Geez, you are getting into it in the first place because you think the price will go up, not down. If you like it and are convinced, at least take a starter position now.

I definitely don’t sell winners just because they have risen in price (not as a policy, anyway). I only sell if I have a specific reason.

Sometimes you have to sell. You can adopt the MF mantra that if you just hold on it will come back in time, and maybe it will. But I hope to employ that money in much more profitable ways than watching a stock go down and then hoping it will start to come back. It you sell it five years later because it never came back (as they occasionally do), you not only suffered the loss, but you suffered the opportunity loss as well. That money could have been making a profit for you in another company’s stock during those five years.

I’m in no way a trader. I never, ever, ever, EVER, buy a stock thinking I’ll try to sell it in a week or a few days for a small profit. I always buy for the long term, but sometimes decide I’ve made a mistake, and just sell it. And I don’t worry about whether I made an error in selling. I worry about what I’m going to buy with the money. (I sometimes even buy back something I’ve previously sold. I’ve bought a stock that was an error both times, and I got out both times).

I usually pay little attention to what the indexes are doing as my goal is to average between 20% and 30% per year, and it’s an internal goal. If the market was down 15%, I wouldn’t feel I did well because I was “only” down 10% and I “beat the market”. It’s not a game. I need to make money at this as my family and I live off what I make. Because the MF compares to the S&P, I’ve also compared my results to the S&P for comparison since I started this board, and more recently added four additional indexes to give a more complete view of the market.

You can beat any index over the long run, in spite of what you may hear.

You don’t have to be right about the stocks you sell, just the ones you hold in your portfolio. It simply doesn’t matter what happens to a stock after you sell it. The only thing that matters is what happens to the stocks that you are holding. Think about that!

If you sell 10 stocks over time because you have legitimate questions about them, and you were “wrong” about some of them (they eventually do all right and move up), so what? As long as you put the money in stocks that you are happy with, that’s what counts!

There’s no such thing as “I was so far down I couldn’t sell”. The stock price has no memory of the price you bought it at. It’s at the price it’s at. That’s the reality of now. The question about any stock is “What decision should I make about it now, at its current price and its current prospects?” Not, “What price did I pay for it?” unless you are planning for tax losses or gains. Price anchoring is a big mistake.

Forget the price you bought something at. It’s at the price it’s at now. If you think you should sell it, say to yourself “I’m fed up with this stock and I no longer like its prospects. Where else can I put the same money where it will do better?” That takes a lot of the emotion out of the decision.

In making a decision to sell, it doesn’t matter now what price you bought it at. What matters is what you think it will do from here! If you suspect that it may be down for several years, or even down for good, don’t focus on what you paid for it. You can’t make it go back in time to where you bought it. I’d suggest you put the money into something better.

It’s not logic, it’s common sense. For example: I originally bought some ABC as high as $21 and $22 (as well as some around $17 and $18), but when I decided to get out and put my money elsewhere because it wasn’t panning out, it never even occurred to me, and I mean that honestly, it never even occurred to me, to wait until it got back to $22 so I could break even on those shares. I sold at an average price of about $17.50 by the way. (It was at $14.48 when I wrote this entry to the Knowledgebase).

Another example that I’ve used before: Early in the 3D printing craze I bought some DEF at about $15.30 I think. That was the price it was selling at. I never considered trying to wait to get it 25 cents cheaper or even a dollar cheaper. Later that same year it got to $190 for about a 12-bagger in less than a year. Do you think I remembered, or cared, whether I spent $15.10 or $15.40 per share?

I added to my GHI even though it had run up considerably from my initial purchases. I had initially bought at $27, but I added a lot more at $47. Should I have hesitated because it had been cheaper a few months ago? Should I have berated myself because I didn’t buy more then? And maybe decided to wait and see if it would sell off so I could get some cheap? No way! I bought it at the price it was available at. I eventually sold out two years later at $144.

When I first bought JKL at $38 and $40, it had been as low as $25 just seven months before. So what could I do about that??? I wasn’t even aware the company existed seven months before! I bought it when I found out about it because I thought it was a buy then. Now, none of that is “logic.” It’s just common sense as I see it.

The MF has a lot of propaganda about how you should almost never sell. However, if you make a well thought-out decision to sell several stocks for what you perceive to be good reasons, and then make an equally well thought-out decision to buy several replacement stocks for what you also perceive to be good reasons, it’s simply not plausible, and it’s even silly, to assert that you will not end up better off. It would imply that your judgment in picking stocks is just terrible. If you look at two stocks and say to yourself “This one is a Sell and that one is a Buy,” don’t you think that on average the ones you think are buys will do better? I’d bet a bundle that, on average, the ones you figure are buys will do better than the ones you figure are sells! If not, why are you bothering to evaluate stocks at all?

Why hold on to your failed positions? They have little going for them except that you are already in them. I doubt you would dream of buying most of them now if you didn’t already have a position in them. I just don’t think you should hold on to a poorly functioning company on the basis that it might transform itself into something successful some years from now.

I’m not saying my replacement stocks always do better than the stocks that I’ve sold. What I’m saying is that I do my best and use my judgment, and over time I expect that companies I think are going to do well will, on average, do better than companies I think will do poorly. (If not, I should just put it all in an index fund.) If I sell a particular stock and it then outperforms my replacement stock over the next quarter, so what? I’m not perfect. I’m just trying to do a good job. That’s how I think about it anyway.

To simplify, the Gardners’ point of view is that if you buy the same amount of 19 stocks and 18 do terribly but one is a 20-bagger, the one that is a 20-bagger will make up for all the losses. Therefore you should never sell your losers. That works in theory, and on paper, but in the real world, if it’s a portfolio with your money in it, it doesn’t work at all. That’s a pretty radical thing to say, so I’ll make clear why it is so.

First of all, if you don’t sell any of the successful stock on its way to becoming a 20-bagger, it soon becomes 70% or 80% or 90% of your entire portfolio, as the losers shrink. Now you have a portfolio with 19 stocks but one is 70% or more of the entire portfolio. You are not going to sleep nights with one stock at 70% or more of your portfolio. Not with your real money in the portfolio. Remember, this stock doesn’t have a sign on it saying it will end up as a 20-bagger. It’s just a stock and all you know about it is that it’s 70% of your portfolio and bouncing up and down. You will probably sell some of it at varying points all the way up, keeping it at a maximum of 20% or 25% of your portfolio, or maybe less. And the rising stock will thus never balance all the losers.

Add this to the fact that the ones that go down keep sopping up more and more percent of the total investment as you “double down,” “reduce my average cost,” “buy at better value points,” and generally put in more and more money in at lower and lower prices. For example, on the WPRT board, which used to be a MF favorite, when the price dropped from $32 to $25 lots of people felt it was a bargain, and bought more, and at $20 “doubled down”, and “doubled down” a second time at $15, etc. It’s hard for people to see a stock they believe in go down to what they think are ridiculous levels without buying more (it’s at $2.60 as I write in Jan 2020), especially if it’s misleadingly still labeled a “Buy.” People see this “Buy” that is down to half what they paid for it. Of course they will sell some of a winner that is making them nervous to buy more of the “bargain” stock.

Unfortunately, if you had 18 stocks that went to zero and one that was a 20-bagger, you probably would have ended up putting much more into each of the ones going down than into the one that went up, AND you would have sold a lot of the one going up on the way. It’s natural. I’ve done it myself but try hard not to do it any more. Which is why the MF hypothesis doesn’t work in real life. It’s the difference between a series of recommendations and a real-life, real-money portfolio.

If the market was efficient no stock would ever go up or down 30% in a week (it would have been already accounted for), and you’d never be able to make a 10-bagger. Fortunately for us, the market is often very wrong about a stock (either too high or too low at times).

On the Estimates Game. I exaggerate a little for the clarity of the message, but what I am saying is essentially all true. I hope you find these ideas useful:

The earnings and revenues estimate game that the analysts play has put the company CFO’s, who give the outlooks, in a no-win situation. Here’s how it has come to work over time: It doesn’t seem to make any difference how good or bad the actual results are, whether they are up 3%, or 30%, or 70%, or more. The only thing that the headlines pick up is whether the earnings beat or missed analysts’ estimates. (Who cares???)

For example, a company whose earnings are up just 3%, but beats estimates by a nickel, will get screaming headlines. The headlines won’t say “ABC earnings only up 3%!” No, the headlines will say “ABC beats estimates!” The price will undoubtedly rise.

On the other hand, a company whose earnings are up 70%, but misses estimates by three cents, will get equally screaming headlines, not saying “DEF earnings up an amazing 70%”, but saying “DEF misses estimates!!!” The price will undoubtedly fall.

The whole estimates game is only about whether the earnings and revenue beat or miss a number that some analysts have picked. It totally ignores the question of how well the company is actually doing, and how good (or bad) the revenues and earnings really are.

However, the companies aren’t stupid. They have figured this out. And they have started to give lower and lower estimates for their next quarter, picking numbers that they are almost certain to beat (by a lot). They don’t want the bad publicity of missing analyst estimates. (Again, who cares!!!)

So what happens? The companies give low estimates and the analysts say “Good earnings, but disappointing estimates for the next quarter. We’re downgrading them from a buy to a hold.”

Thus the companies are screwed whatever they do. If they estimate high, where they think they will be, and miss, they get the “missed estimates” headlines, and if they estimate low, to let themselves beat estimates handily, they get the “disappointing estimates” headline. They lose either way.

How do we as investors deal with this puzzle? Think “How is this company doing? How much are earnings and revenues actually up?” What matters to me is that the company is growing revenue at 50%, and if the company sells off because of a “revenue miss” (which is a ridiculous term for a company increasing revenue by 50% if you think about it), I might take advantage of it by adding to my position.

I base my purchase decisions on how well the company is doing, and my evaluation of how it will do in the future, and how well its price matches its prospects, rather than whether the company came in two cents above, or two cents below, what the analysts predicted.

Evaluating company results against consensus analyst estimates can produce perverse and peculiar results. Consider this hypothetical: A small stock with three analysts following it has an average estimate of 50 cents for the quarter. Another “analyst” representing a firm that is secretly short the stock, puts in an estimate of 82 cents. This raises the “average estimate” to 58 cents. By raising the estimate he sets the company up to “miss” estimates. After all, it doesn’t matter what the actual results are, just whether they met expectations. Right???

Sure enough, if the company makes 53 cents, what would have been a nice beat becomes a 5 cent miss. The stock sells off for a few days, until people figure out that 53 cents was a very good result, and meanwhile, the firm closes out its short at a profit. Pretty ridiculous, isn’t it. But this hypothetical scenario could, and probably does, play out in the current market.

On trading in and out: No one knows how long a stock price can keep climbing. If you sell now at $135 it could keep going up to $200 before it takes a rest. When it was up $15 from where you sold, would you buy back in or just watch it go? And if you timed it right and sold now, and it dropped $15 would you get back in, or would you wait for down $20? And then if it got to down $19 and started back up, would you panic at down $12 and buy back in? And then, what if it goes down $5 from there? Do you buy, sell or hold? In other words, trying to time the market in these stocks will drive you crazy. If you don’t have a good reason to sell just stay with it and enjoy the ride.

On staying fully invested: You’d be much better off staying nearly 100% in the market and just deciding WHICH stocks you want to invest in, instead of complicating it with deciding WHEN you want to buy, and trying to time the market. For example, you don’t want to buy now because the market is up, but I suspect you didn’t want to buy at the bottom either, because then everyone was saying that the market was going lower. And if these stocks go up 10% from here you certainly won’t want to buy, but if they go down 10% from here, you’ll wait for down 20%, and then if they start back up you’ll wait for them to get back to down 10% again, which may never happen. Just think, if you stay fully invested you can forget about all those crazy-making decisions, and just concentrate on which stocks you want to own for the long term.

About being Number One: A poster on our board seemed concerned that I’d feel bad because his totals were higher than mine. But that’s not what this is all about. It’s not a game where there is just one winner. We can all be winners. The goal is not to have the best record. Not even to beat a benchmark like the S&P. The goal is to be successful, to make enough money at investing to support your family eventually and be able to purchase the goods and services that you need in life. I have never dreamed that I’d be the best investor in the world, or the most successful. Worrying about that will make you crazy. I just want to be a good, successful, investor.

You can think of possessions the same way. There will always be someone with more money, a bigger and better house, a nicer wedding ring, a more exciting vacation, whatever. Don’t sweat it. It doesn’t matter. Happiness isn’t getting what you think you want. Happiness is being content with what you have - on the way to possibly getting what you think you want. It’s today you want to be happy, not in the future. The future never gets here. It’s always today.

## Why and How My Investing Criteria Have Evolved

I used to feel that my most important criteria was investing in companies who were making a profit and growing their earnings and who had a reasonable PE ratio. In the last few year my way of choosing stocks has changed and evolved. Here are the questions I get asked:

Why have I “abandoned” PE as my most important criteria, and Why am I willing to invest in companies that are losing money.

Those are good and valid questions and they deserve a response. Please take into account in reading my response that I’m not a techie and some of my details may not be accurate. And above all, remember that this is just my opinion, the opinion of a non-techie.

After some reflection, it isn’t so much that I have changed, but that the world has changed, and that the business models of the companies I invest in have changed. Companies like the ones I am currently investing in simply didn’t exist before. They have only emerged in the past few years.

There has been a revolution in the world of business, and especially in the world of software. As recently as four or five years ago, with the exception of perhaps one or two companies, a company selling software would sell a customer a perpetual license to use it. Then they’d charge for updates that the customer might have to install, and they’d charge for service, and they’d try to sell the customer a new updated version of the software in two or three or four years. The customer might decide to skip the next version and just wait for the one after if he’s happy with the current one. Think Microsoft and all those Microsoft Office and Word versions you had to buy. It was the same for big companies with their software.

This procedure was bad for both of them. It was terribly inconvenient for the software customer. For example, if there was an update or a patch to the software they had to have their IT people go install it on all 2,134 computers in the company. And there was no visibility into the future for the company selling the software.

There was little if any recurring revenue. For an investor, encountering a growth company that had even a small percentage of its revenue recurring was a major find. The only companies that had most of their revenue recurring were slow or no-growth utility type companies. Think: the electric company!

There was little or no recurring revenue because the customer who bought a perpetual license for a version of the software this year might not buy an updated version for 4 or 5 years. All you had that was recurring were service contracts, and not every customer took a service contract.

It was the same with dollar-based net retention rate. There was simply no such thing. You were essentially making a one-time sale with the hope of making another sale in a few years.

As an investor, PE and profit was all you had to go on (besides hope). Finding a company that was growing revenue at 20% per year was great. NO companies had revenue growth of 40% to 60% on a regular basis. It was unheard of. It was something you couldn’t even imagine, except perhaps for a tiny company growing off a very small base, or as a one-time occurrence.

But then an incredible new world came along in which data, and Internet usage, and Cloud usage, and software usage, have all hit an inflection point and taken off, literally exploded. What these software companies are selling is actually currently needed by every company in every field, whether it’s a bank, a grocery chain, an insurance company or an auto manufacturer. It’s not going to go away. Every company now needs software, needs the internet, needs a website, needs ecommerce of some sort, needs security against hacking, needs to be able to analyze and visualize data, to analyze customer patterns, needs… well you get the idea.

And something amazing called SaaS was developed. It stands for Software as a Service: Instead of selling the software on a perpetual license, you, the software company, lease the customer your software, and the customer makes monthly payments “forever.” You have visibility for the first time in your company’s life, and your customer doesn’t have the large upfront outlay of cash. These monthly payments you are getting are recurring revenue.

You can update your software monthly, weekly, or even daily using the Internet, which keeps your customer very happy and very hooked, and keeps him renewing his lease contract every three or so years. Your software becomes an integral and essential part of your customer’s business. You can sell the customer additional programs, with new bells and whistles that your R&D department just perfected, or sell to additional departments in the same customer company, and your revenue from this customer will be higher next year than it was this year (dollar-based net expansion rate). This is referred to as land and expand.

Because of increasing spend by existing customers, and because of increasingly high demand for what you are selling from new customers, you may see revenue grow by 40%, 50%, or 60%, or even more, each year. This means that your revenue will quadruple or even quintuple in four years, or five at most.

Your margins rise with time because your monthly S&M charges for the recurring part of your revenue are miniscule compared to what you paid for the initial sale. You could make all your updates in the Cloud and it would be even cheaper, and cheaper for the customer too, as the customer doesn’t need to buy all that computer hardware.

This is still early innings. All companies out there need what you are selling but most of them don’t have it yet. You want to go all out to sign up as many of these companies as possible before credible competitors emerge on the scene. This means increasing S&M expense now. You know that while a dollar of S&M expense spent today is mostly expensed against your current earnings, it will bring in (expanding) revenue almost forever in the future. This incredible opportunity also means spending on R&D so you continue to have the best products to sell. But this is all new and greenfield, and the imperative is to sign up as many customers as you can, as rapidly as you reasonably can while still providing good service, and not worry about current profits.

Think about this for a minute. Every good-sized company now uses more and more software every year. They all want to be part of the cloud, they all need what our companies are selling, and most of them don’t have it yet. The opportunities are enormous, and once the software is incorporated in the customer’s business it becomes harder and harder to change providers… really a pain for the customer and a risk of all kinds of disruptions to their business if they tear it out, so they will need a really, really, good reason to change.

So our software companies have mostly recurring revenue, and not only recurring, but expanding recurring revenue as the old customers increase their spend (dollar-based net retention rate), and new customers sign on. This means that each year our software companies add lots of new recurring revenue. And they are growing at rates that will quadruple their revenue in four years. (Actually 50% compounded for four years will quintuple their revenue in four years, but I’m being conservative! :grinning:)

And that’s why I buy SaaS companies, that are growing revenue at rates I couldn’t have imagined a few years ago, and it’s why I don’t worry about them not making a profit now. My other criteria are still there: rapid revenue growth, recurring revenue, lack of debt, insider ownership, a moat, not capital intensive, not hardware, doing something really special, etc, etc, but I’m taking advantage of this new world.

## More Thoughts about Evaluating a Company

I look for companies that are easy to follow. A lot of my companies are recommended by the MF. I invest largely in MF recommended stocks because it helps me to be an informed investor. Other services recommend a stock because “two analysts have raised estimates this month” or “they’ve beaten estimates two quarters in a row” or some such nonsense, where I don’t think the person doing the recommendation even knows what the company does. There is little or no follow-up and, most importantly, no place to discuss the stock. When there is a recommendation from MF, someone has already screened the company and written a full recommendation. That’s very important to me. Besides which there are the boards for discussion, which I feel is a very valuable service. I will get important ideas pro and con, and I won’t miss important news.

Do I need to understand the technology or the industry to buy a company? Someone commented “but I can’t imagine following them because I don’t feel that I understand the industry.” Well I almost never understand the industry or the technology. I don’t know anything about banking but I have invested in SBNY and INBK in the past. I don’t know anything about microchips but I have invested in SWKS and NVDA… I don’t know anything about the shoe business but I have invested in SKX, etc. And I don’t know anything about SaaS but I’m investing in mostly SaaS companies right now. My investments are not based on knowledge about the industry, but on the fundamentals and progress of the company itself.

Wow, if I thought I had to understand the industry, I doubt I could find any stocks at all I could invest in. To think of it simplistically: If you are considering buying stock in Apple, do you need to understand how to build an iPhone, or do you need to know how successful the company is?

Wanting to be an informed investor means that I generally avoid foreign companies. And I won’t touch ANY Chinese company. Not even Baidu. This is due my experience in 2010 or so with 13 little companies (most recommended by MF Global Gains, since closed down), of which fully 11 turned out to be fraudulent in one way or another (The MF was fooled just like I was). You simply can’t tell what’s going on in a Chinese company. Consider that Yahoo is a major company and owned 40% of Alibaba, and the Chinese CEO blithely gave himself the fastest growing subsidiary as a present without telling Yahoo. If it can happen to a big company like Yahoo, what chance do I have? That’s not even touching on the political risk and the government interference risk. I probably wouldn’t invest in companies in other emerging markets either.

Get the information yourself. I suggest that you don’t get information that’s important to you, off Yahoo, or eTrade, etc, but get earnings off the company’s earnings press releases, which you can always find on their Investor Relations website. You just don’t know what Yahoo’s computer is grabbing.

I look for a company that has a long way to grow. A company that I can hope will at least triple or quadruple. I’d never buy a stock at $45 hoping it will get to $55. I wouldn’t buy a stock at $45 unless I though it could get to $150. That means a company that has a long runway. One that ideally can grow almost forever. What I mean is a company where the addressable market is so big that their share of it allows them to keep growing for the foreseeable future. That’s no guarantee that they will, but it’s better than a company that already has 40% of it’s total addressable market, for instance, and can only double once.)

How do you know when a company is too big? Let me try off the top of my head: Can you imagine Nike doubling and doubling again? It’s impossible. They already have most of the market.

Now to generalize that thought: If a company owns just 5% of a market, it has a lot of room to double and keep on doubling, especially if the market is growing too. If the company already has 80% of the market, all that it can grab is the other 20% of the market (which is unlikely, anyway). If a company has most of the market because it just invented the market and the market is hardly penetrated, that’s fine, it has plenty of room to grow (think Apple and the first iPod/iPhone). If it’s an old market and is saturated, that’s a different story.

Finally, there is the problem of big numbers. If you have a chain of 200 stores and you can add 50 a year, the first year you add 25%, but the same 50 stores only adds 20% the second year and 16.6% the third year, etc. To maintain the same 25% growth rate, you have to add a larger number of stores each year, and you run out of places to put them.

If you have another kind of firm, with $100 million in sales, and double it, the next year you will need to add $200 million to maintain the same rate of growth, and $400 million the next year, and it soon becomes impossible, except in rare cases.

I avoid mining and drilling and natural resources stocks, which tend to go in cycles from boom to bust.

I usually don’t usually buy restaurant chains. They seem inherently limited. How many outlets can you build without getting to a point of diminishing returns? I know the Fool has done well with some of them but it’s usually not my thing.

I want management to be interested in making a profit. That’s why I sold out of Amazon some time ago, even though I loved the company. Making a profit just didn’t seem to be on Bezo’s radar screen. He never even mentioned it. Amazon just kept going up without me, but that’s okay. The stocks I put the money in went up too.

## What to Do?

Go to the company website and find out what they do. To get there, google, for example, “Alteryx investor relations” and you’ll get the Alteryx investor relations website.

Read the text part, at least, of their last quarterly report. “Analyzing the financials” sounds intimidating, and probably isn’t necessary. They usually tell you what is going on in words.

Read the transcript of the conference call. You should be able to find it on Seeking Alpha “Alteryx Q1 2019 Transcript” should get it. (Yep, I put it in on Seeking Alpha and it came right up.)

Go back through at least two years of quarterly reports and pull off at least adjusted earnings and revenue. Make a table for each. Let’s look at made up stock ABC. Here’s what their Revenues looked like:

2018: 18 24 25 33 = 100
2019: 32 39 51 56 = 178
2020: 56

You see what a good visual image this gives you. You can see both sequential change and year-over-year change at a glance. And that 78% increase in revenue from 2019 to 2019. And other patterns jump out to the eye as well. For example, you notice that revenue doesn’t rise between the fourth quarter and the first quarter of the next year (it’s called seasonality), and then it does rise in the second and subsequent quarters. When that happens in the future it won’t bother you because you’ll say “Oh yeah, their first quarter’s usually flat with the quarter before.” I do the same with Earnings, and Free Cash Flow, and other metrics that I’m interested in.

Then I do a running 12-month trailing earnings:

12 2012: 22
03 2013: 28
06 2013: 34
09 2013: 48
12 2013: 59
03 2014: 70

This gives you a picture of where they are going and how fast. You should graph this on a piece of log paper. (On log paper a move from 10 cents to 20 cents is the same length as a move from 50 cents to a dollar (100%)).

I remember that the COMPANY may do well, but the STOCK may do poorly, if the stock price has too much growth already factored in.

I’m not sure I can come up with a single calculation that will give you all the information that goes into my thinking about a stock. Often the CEO’s explanations in the conference calls play a considerable role, along with the rate of growth, the company’s competitive position, the PE, how much is recurring income, and other factors I’ve already discussed.


I did try to post the Knowledgebase all in one post, but apparently it was too long and I kept getting error messages, so I finally had to break it up to get the system to accept it.

Sorry for the inconvenience of having it in three parts.



Hi Saul, I’ve been lurking here for a bit, and appreciate your knowledge base, which, even in 2022, still applies!

RE: looking up trends of revenue for past 2 yr: Some tech companies are so new that they don’t have this much history.

How do you assess early stage companies such as Upstart that have only a total of 4 quarterly earnings reports?

Thank you!


looking up trends of revenue for past 2 yr: Some tech companies are so new that they don’t have this much history. How do you assess early stage companies… that have only a total of 4 quarterly earnings reports?

Hi bliss,

What I would do is first look at the Investor Presentation on the company investor relations website. It often will have several years of revenue on one of the graphs or tables.

If that doesn’t work, I’d go back to their SEC filings for their IPO, which is SURE to have several years of quarterly revenue available. (And of course you already have all the revenue from quarters since the IPO).

Hope that helps,



“I remember that the COMPANY may do well, but the STOCK may do poorly, if the stock price has too much growth already factored in.”

I’ve been following here for several years, and this is the part that I struggle with. This is relative to the peer group as Bert says, right? If that is the case then we’re using EV/S? How do I determine this? Or is your point that this is irrelevant? Thanks!

Hi Saul, I’ve been reading up on your knowledge base and there’s one question I’m not getting a clear answer on and that’s cash. you said you are usually fully invested - so what do you do when there’s a market crash? do you not do anything?

Hi Saul, I’ve been reading up on your knowledge base and there’s one question I’m not getting a clear answer on and that’s cash. you said you are usually fully invested - so what do you do when there’s a market crash? do you not do anything?

He’s always fully invested and stays fully invested, and sometimes uses a tiny bit of margin too.

You’ll notice that when things get scary he consolidates into his highest confidence positions. Selling companies he thinks are weaker to buy the ones he thinks are stronger. Also, he tends to sell a stock that has fallen just a little in order to buy one that has fallen a lot, thinking it will snap back.