How I Filter Investment Ideas

My investment process can be divided into two main categories:

Idea generation
Investment research and due diligence
These are the two areas that I spend the vast majority of my investment time (portfolio
management and execution is a distant third!
There is a lot of information in the value investing public domain on how to determine the "uality
or degree of undervaluation of various securities! There isn#t as much information on how to thin$
about the actual search process! In other words% before spending a lot of time going through the
process of due diligence on a specific security% you need to filter through many ideas (presumably
that don#t ma$e the cut!
It can get overwhelming when coming up with ideas! It#s easy to float from idea to idea% gaining a
cursory understanding of many ideas% but never putting yourself in a position to ma$e an
educated and informed decision!
&o how do you go about simplifying the search process'
I#m not sure I have a great answer to that "uestion% as I tend to want to cover a lot of investment
ground myself! (ut I can share a few ideas that have helped me simplify my process% ma$ing it
more methodical and systematic!
Where to Find Ideas
Investing is part art% and part science! The art part enters in various phases of portfolio
management% valuation% position si)ing% and selling% among other topics* The science part comes
into play (in my opinion in the search process! There might be some subjectivity here too% but for
the most part% I#ve tried to refine the investment search+filter process down to a science!
I#ve discussed my search process before! (asically% to broadly summari)e* the places I often loo$
for investment ideas are:
Reading, Reading, Reading (,ewspapers% (logs% -oogle news alerts% etc*
Value Line (I try to flip through each issue each wee$% which sometimes uncovers an
idea or two
13-Fs
Screens
These are the basic areas I loo$ for ideas! .retty straightforward and routine! /eading generates
the most interesting ideas typically and 012F#s are a reliable way to $eep abreast of what the best
value investors are thin$ing about!
The Science of Filtering Ideas
&etting up a search routine is helpful% but you still need a method to filter ideas! I thin$ of the
search process as a conveyor belt that brings me idea after idea! 3ne after another* the ideas
$eep coming so I need to have a systematic way of filtering these "uic$ly and efficiently!
I#ve come up with a few "uic$ "uestions to as$ myself in order to "uic$ly "ualify an idea! These
are very general "uestions that are only designed to dis"ualify ideas% rather than decide if they
might be good ideas! Here are the "uestions I as$ as ideas come past me on the conveyor belt:
o I understand the idea!
Is it chea"!
#re there an$ catal$sts! Insiders!
What are the ris%s!
Will it dou&le!
These are very basic% but they help me "uic$ly determine if I should remove the idea from the
conveyor belt and save it for further evaluation! 4nderstanding simply means that I have a basic
idea of the business and understand why it might be undervalued! It doesn#t necessarily mean in
depth understanding at that moment! (eing able to tell if it#s cheap should be "uite easy! If this is
difficult to explain% it might not be worth moving forward! 5omplex situations sometimes provide
hidden opportunities% but most of my great investments have all been "uite simple% and
sometimes even obvious!
/is$s are important to consider! I divide ris$s into three broad categories to thin$ about:
Valuation
Leverage
'usiness
I want to decide right away if I am ta$ing on valuation or leverage ris$! 4sually if there are ris$s in
either of these categories% I will pass! (usiness ris$ is harder to "uantify% and sometimes ta$es
more analysis! If I understand the idea% I#m willing to give this some room for further evaluation!
The last "uestion 6will it double'7 seems too basic% even somewhat frivolous* but I li$e to as$
myself this "uestion to remind myself that a good investment has upside potential! 8 9: cent
dollar might have very little ris$% but the ris$ it does have might not warrant the : cent upside
potential! I#m loo$ing for low ris$ :; cent dollars% hence the "uestion: 6will it double'7 It#s just
another way of as$ing: 6Is this a :; cent dollar'7 I usually don#t $now the answer to this "uestion
when the idea first arrives on the 6conveyor belt7% but I want to as$ it right away! I want to begin
thin$ing about the ris$ as well as the upside% and how those two relate to each other as soon as
possible! 8n idea with lots of upside but too much ris$ needs to be dis"ualified! 8 very low ris$
idea with not much upside similarly needs to get dis"ualified!
I#m fond of the saying: 6Ta%e care of the do(nside and the u"side ta%es care of itself7! I
live by these words% but there has to be upside available if it is going to ta$e care of itself! This is
important to remember!
&o I might not $now if the idea is a low ris$ :; cent dollar up front (chances are I won#t% but
sometimes I can "uic$ly identify that it isn#t a :; cent dollar! In other words% I might not be able
to confirm that the stoc$ has 0;;< upside% but often times I can "uic$ly identify the ones that
don#t have that upside% at least not without undue ris$!
&o this last "uestion just reminds myself to thin$ in these terms% right from the outset!
&o as ideas come across the conveyor belt% I "uic$ly use these "uestions to determine if they
should be saved for further analysis! =hen I find an idea worth evaluation% I leave the conveyor
belt and head to my office where I begin doing more detailed research which involves further
reading% 0;2$#s% reports% etc*
This process helps me focus on the tas$ at hand! =hen I#m done researching an idea% I#ll go bac$
to the conveyor belt (reading% screens% 012f#s% etc* and inspect new ideas as they come by! The
process is a balancing act between idea generation and more detailed research!
8nd of central importance is the a&ilit$ to )uic%l$ filter ideas!
&oon I#ll write a post on some thoughts on ho( 'uffett filtered investment ideas% which is
an incredible case study in and of itself! (uffett#s ability to filter ideas "uic$ly was% in my opinion%
one of his most underrated s$ills as a ris$ manager!