Time Allocation In Investing

In business, time allocation is central to success or failure. In investing, the decision of whether to know a little about a lot of companies, or a lot about a few companies, is crucial. Peter Lynch, the former highly-successful manager of Fidelity's Magellan Fund, once wrote, "The person that turns over the most rocks wins the game."

Turning over rocks is one way of looking at it. Another: when trying to find water, one thirty-foot hole is likely to get better results than thirty-one-foot holes.

I used to screen all US companies -- about ten thousand with a market cap of over $5 million - every two weeks. I now screen every quarter to identify the 200 that look at least somewhat interesting. I spend the next three months studying the sixty that look most attractive on the surface - the most I can know in any kind of depth. I read other analyst's reports, SEC filings, management conference call transcripts, study charts until the next 10Qs or 10ks come out, at which time I screen again.

I look for two hundred each quarter with these characteristics:

· high average return on capital (or equity in the case of banks and insurance companies)

• low debt
• low capital expenditure requirement in relation to earnings plus depreciation,
• stable or improving margins and capital turnover over the last two years.

I then sort by financial strength and financial statement trends looking for the most interesting sixty:

• debt in relation to equity
• interest coverage by operating income
• liquidity trends (inventory, receivables versus sales; cash and receivables versus payables, total current liabilities, debt)

Knowing a little about a lot of companies, an investor can get a pretty could handle on relative value - what, for instance thirty different companies with annual growth of 10%, no debt and an average return on capital of say 20% trade at in relation to TTM earnings and free cash flow. Knowing a lot about a few companies, you can know why for instance return on capital has gone up 25% over the last two years - expansion into new markets maybe, or pruning mediocre products or new management.

Or think you know. From there the subject quickly gets into whether or not the impact of personal bias and judgment rather than strictly facts - a personal relationship with management versus a thorough understanding of the margins, capital turnover and relative value for instance - is positive or negative in investing. I've encountered investors who think because they are friendly with management the numbers don't matter. I've become buddy-buddy with CEOs a couple of times myself and gotten my head handed to me.

I don't do that anymore, but more out of concern about how it will affect the quality of my decision-making than a desire to protect time, although both are of course important.

This blog was inspired in part by an article by Mike Schlesinger Turning Over The Most Rocks on the MicroCapClub website.