Let me explain my TV addiction: I watch lots of basketball, too much, but that's part of who I am....I watch some series, such as Downton Abbey (seems like a remake of Upstairs, Downstairs and almost as good), The Good Wife, Missing, and a few others, including The Shark Tank on ABC on Friday nights. Most investors can not only enjoy the Tank but also learn quite a bit about good investing.
Here's the basic premise of the show: 5 successful investors sit in a room and wait for an entrepreneur to present a business case for why one or two or all of the sharks should invest in the business. They sit and listen for a while, then start peppering the presenter with questions. Most of the questions run like this:
What are your sales?
What were your profits last year?
What are your margins?
Why do you value the company so highly?
What seperates successful entrepreneurs from ones that walk away with no money seems to come down to this: they know their numbers. They are energetic and totally committed to their businesses. They have a product that answers a problem. They have sales, not just ideas. They have reasonable valuations.
If you're an investor, start using some of the sharks' techniques. Pretend a stock is making a pitch to you for money. Don't get emotional about it. Don't buy the hype or the hope or the potential; buy the actual business. Keep your valuations realistic. If apparel companies have price to sales ratios between .3 (Quiksilver) and 2 (Nike) with an average for the industry of .5, then don't be too enamored with one that has a Price to sales ratio of 3 or more. (You can compare stocks' PSRs (price to sales ratios) on Yahoo!Finance.)
Keep the stocks you invest in at the low end of valuations. It's what the sharks do. As one of them said recently, "As much as I like you and your company, I'm a disciplined investor. You're asking too much for the percent of the company you're selling. So I'm out."
The sharks have lots of money for a reason: they don't easily part with it. They've all earned it from building their own companies, then selling to someone else. They know what it takes to be successful. And they don't overpay for anything.
As investors, focus on that last part, about not overpaying. It's easy to get caught up in a company's promise. But it's much more rewarding to buy ones with real earnings, ones that grow every year. Be as parsimonius as the sharks. Don't over pay for a company just because you like the story, of if you meet the CEO, because you like the person. Look at what the company has accomplished, not what it might deliver. Then compare those results to others in the same industry. And buy the leaders, not the laggards.
- Ted Allrich
April 17, 2012