How to find the best investment ideas that others will miss

Every fund manager’s presentation has a section entitled “process”, explaining how the manager chooses the stocks in the portfolio. These “processes” are all more or less the same. They begin with the broad sector of companies compatible with the investment mandate. These are filtered by a computer program that screens their financial data and share-price history for value, share-price momentum, earnings growth and “quality” (cash generation, for instance).

A team of analysts takes the highest scores and researches company strategy, the markets served, the growth of that market and the company’s share of it, competition and barriers to new entrants. Meetings with management are held, sites perhaps visited and a report is written. Many managers claim to speak to customers, competitors and suppliers, although the reliability of this exercise is doubtful. The team discusses the report and a decision is made.

Herd-like behaviour in fund managing

The result is that managers chase after the same stocks. Some put more emphasis on growth factors, others on value, but the former tend to rule out high growth (companies such as Nvidia) because they cannot envisage a company sustaining earnings growth of more than 15% per annum. The latter are wary of recovery stocks because, although cheap, they score poorly on quality and share-price momentum.

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Completely ruled out are investment ideas derived from observation, anecdote and inspiration, but as Peter Lynch, the legendary manager at Fidelity, explained in his book One Up on Wall Street this can be a great source of ideas that conventional managers always miss.

About 12 years ago, my wife, Judith, went to the Edinburgh Fringe and noticed while sitting in bars between shows that people were drinking a colourful, refreshing and delicious concoction called an “Aperol Spritz”. She thought it would be worth looking into the company that produced it. That firm turned out to be Campari, which was then little more than a one-product company.

Our European analyst at Investec pronounced the shares, trading on about 20 times earnings, to be rather expensive, discounting considerable growth, but in the next eight years, they went on to quadruple. Aperol sales took off and Campari’s sales were boosted by the growing popularity of the Negroni.

Thirty years earlier, Judith had given me another great tip: menswear retailer J. Hepworth. It had bought a small, failing womenswear chain called Kendall and converted four shops into a new format called Next. On the basis of visiting one store, she predicted it would take off, so we bought some shares. Over the next few years, they trebled in value until she pronounced that their clothes were becoming too ubiquitous. We sold, and the share price then collapsed. I later bought 50,000 shares at 25p for a fund I managed on a spur-of-the-moment decision prompted by a broker. Unfortunately, I cashed in a couple of weeks later at 40p, only to see the shares continue upwards. I bought back in at £4 a few years later, being able to suffer the pain of missed opportunity no longer, and it continued to be a great investment. The shares now trade at nearly £100.

Another great success was instigated by a casual comment made by a friend in the fashion business after the Christmas concert at my sons’ school. She asked whether I had taken a look at what Stephen Marks was up to at French Connection. So the next morning, I called the broker and requested a meeting. I was told that Marks didn’t really want to see investors, but that if I went down to his offices in Chelsea late that afternoon, just before he went off until the New Year, he would make an exception. So I did.

I immediately liked him for his obvious disdain for anyone who worked in financial services. But what was really interesting was the impending roll-out of their new brand, FCUK. I bought the shares the next day; FCUK was a huge success and the stock multiplied in value.

In the mid-1980s, I worked at a US brokerage firm called L. F. Rothschild, investing the firm’s and clients’ money in corporate transactions. I recommended to my boss on the desk, Mark, that we buy into Rowntree, whose shares looked reasonably priced and which I thought was a prime takeover target. He then gave £20 to a secretary and asked her to go across the street to the kiosk and spend it on sweets, but only those produced by Rowntree.

A taste test for investment

She came back with a bag full and he spent the rest of the day chewing through them before proclaiming: “this is a great company. We are going to buy lots of the shares”. We did and Nestlé bought the company soon after, but I was disdainful of his investment process. In time, I came to recognise how wrong I was and that this sort of original research was much more important than examining the accounts and brokers’ research.

After the water companies were privatised at the end of 1989, the brokers arranged visits to several of them. I went on one to Severn Trent, the most interesting aspect of which was seeing an unmanned reservoir and water treatment facility in mid-Wales. The taps could be turned on and off remotely down a telephone wire, requiring an employee to turn up only once a week.

The company that made this clever piece of kit was called Rotork and it turned out that its “valve actuators” were also indispensable in petrochemical plants and the extraction of oil or gas. It was clear that the acceleration of investment in the water industry would be very good for Rotork and the need to rebuild Kuwait’s energy infrastructure after the end of the first Gulf War would also benefit them later. The shares were a great investment for the next 30 years.

A visit to a coal-fired power station during the privatisation of Powergen also provided a key insight. The power station, we were told, employed 2,200 people on two main shifts. The question was, where were they all? As we went from one part of the site to another, I counted them up but got nowhere near the 1,000 or so that should have been on the day shift.

As we were leaving, the coach passed an enormous canteen, absolutely full of people drinking tea, chatting, reading the papers and playing cards. Management had assured us that much had been done to reduce costs and headcount, but clearly, there was much more to go for. Powergen turned out to be another great investment.

Sometimes, though, I made a complete fool of myself. About 12 years ago, Walter Price, the manager of Allianz Technology Trust, came in to make a presentation on the performance of the trust, in which we had a large holding. He was one of the worst presenters around and it was a struggle to pay attention even in a one-on-one meeting.

I noticed that the top holding, accounting for more than 10% of the portfolio, was a firm I had never heard of. Moreover, Walter told me that it wasn’t even in the technology sector. Worse, it was a car company! In an attempt to shake off my torpor, I gave him a really hard time about it, expressing my amazement that he could have so much of the fund in a way off-piste investment and that the non-executive directors tolerated it.

Of course, the company was Tesla. The compound return of Tesla since listing on Nasdaq in 2010 has been over 50% per annum. At least that acutely embarrassing meeting alerted me to the genius of Tesla and its founder.

Also, there is a saying that “the graveyards of Wall Street are filled with people who were right too soon”. I remember sitting opposite Archie Norman at a lunch soon after his appointment as chairman of Marks & Spencer in late 2017. Given his outstanding corporate record, I was confident he would turn the business around, but the share price of M&S fell another 70% before it turned a corner in early 2020.

Still, as Peter Lynch observed, keeping your eyes and ears open and your mind engaged can enable you to pick up investment ideas that the herd of professionals will miss. Patience may be needed, opportunities will be missed and mistakes made, but gains made by being ahead of the crowd are the most satisfying of all.

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