Find and buy the best stocks: Do it yourself

The right stock selection determines success, not chart technique or the time of purchase.

This is a manual about how to find extraordinary stocks on your own with a little thinking and work.

Using the example of my best stock in 2019 (+200% profit), I illustrate the individual steps of stock selection, from screening to detailed analysis and purchase.

I am convinced that every retail investor with the right guidance and the will to achieve something can outperform all fund managers.

This is not a promotional promise, but simply my gift to those who are open to learn.

 

CONTENT

Chapter 1
The challenge

Chapter 2
The Treasure Map

Chapter 3
Selection criteria

Chapter 4
Screening

Chapter 5
Analysis

Chapter 6
Conclusion

Chapter 1

THE CHALLENGE

Find and buy the best stocks

Finding excellent stocks has nothing to do with chart technique or finding the perfect entry points, as many people suspect.

Neither do you have to be a genius, nor do you have to deal with stocks full-time in order to become a successful investor.

Although I have studied business administration and worked in banks for many years, I can tell you that these two facts have brought me absolutely nothing. They are even counterproductive.

Why doesn´t a business administration degree work?

In the course of study, one is told that stock markets are perfect markets, i.e. prices represent the value of the stock at all times. Therefore, there was no chance for an individual investor to beat the market and therefore it was best not to try it at all.

Mark my words: Although this is one of the cornerstones of capital market theory, it is the greatest nonsense you can learn as a student.

Why are bankers not good investment advisors?

The bank adviser or fund manager is still seen as the primary point of contact when it comes to investing. He looks professional in a suit and must have a clue, as he can decorate himself with titles such as the CFA (Chartered Financial Analyst) and or other titles. I did the CFA education as well, so I can tell.

Unfortunately, however, hardly any fund manager manages to beat the market. What even worse is, that they make a ton of money regardless of how well they do their job.

Do you have to be rich to make money with stocks?

After my studies, I had one thing above all else: debt. Before I could even think about saving or investing money, I had to pay off first. It wasn’t until my thirties that I started putting some money aside, saving and investing.

Today, a few years later, I can live off my investments. With each additional euro invested, I came a little closer to my goal of becoming independent of my job at some point.

Everyone starts out small, but to not try at all, because you can just bake small rolls at the moment, is the wrong attitude.

What really matters and what will make you a good investor:

  • to be open and ready to learn something new.
  • never give up, even when things get tough
  • to use your mind independently of the opinions of others
  • be willing to reconsider one’s own opinion if it turns out to be wrong
  • to pursue your goals with all your power

There is no need for more. It doesn’t matter what you do for a living or how much money you have at the moment. Today is the first day of the rest of your life. Use it.

The Stock Universe

Worldwide there is an incredible large number of more than 630,000 public companies.

Even worse, the majority of them performs much worse than the market with its average returns of 8-10% per year.

The average yield of any stock is 228% over 20 years. This is only about 4% per year.

Source: S&P Dow Jones Indices LLC, FactSet. Data from 12/31/97 to 12/29/17

The database principle

How can you ever find the right stock in such a huge selection?

We are not just talking about 630,000 data sets but probably millions or billions, because behind each stock there is a complex company with all its products, companies, balance sheets and figures.

Don’t worry! There is a solution.

As a controller, you often face similar problems. You are overwhelmed by data from different sources in different forms, which you have to collect, normalize, filter and concentrate in order to ultimately be able to evaluate them and draw meaningful conclusions.

The same principle applies to all data problems, regardless of whether it concerns company-internal data or data on stock corporations. A wild search does not lead to the goal.

Instead, you have to search for structures in chaos when digging data and recognize criteria with which you then can filter for the relevant ones.

So that you can understand what I’m talking about here, this will not be a dry treatise, but I will show you everything using examples.

You will see how I can find multibagger stocks as normalo and non-fund manager and non-professional trader.

You can do that too!

My journey through the desert of a thousand stocks

Before we get down to business and go through one of my best investments in 2019, I would like to briefly tell you what I had tried before I really started to be successful.

My first stock was Bayer and I thought:

  • Bayer is a cornerstone of the German economy
  • a global group
  • a manufacturer of medicines that are increasingly in demand as the population ages
  • a perfect choice

Wrongly thought. Bayer is in reality:

  • not an innovative group
  • no platform company and not particularly scalable
  • sluggish because it is so big
  • a company with declining revenues and profits

I bought and sold Bayer within 2 weeks and was proud to have made 6% profit.

Bayer Share: 10 Annual Chart

I did almost everything wrong, except that I sold Bayer.

Books over books

I decided to read books to learn from the greatest investors of all time: 1, 2, 5, 10, 15, 20 books and more.

With this concentrated knowledge of the greatest investment legends, things could finally get started right?

Again wrong.

I was actually more confused than ever because in each of these books something else was recommended. I should:

  • Buy boring stocks that no one wants (P.Lynch)
  • buy the hottest stocks and invest only when they reach new highs (W.J.O’Neil)
  • invest as a contrary and do not do what the masses do (K.Fisher)
  • Buy shares and take a sleeping pill (W.Buffet)
  • Buy value shares (B.Graham)
  • Buy spinoffs (J. Greenblatt)
  • Speculate (A.Kostolany)
  • Invest (W.Buffet)
  • Buy small caps (J.P.O’Shaughnessy)
  • Scatter my capital (press, capital market theory) or concentrate (W.Buffet)

And so on, and so on.

So I started trying out all these tips. I bought everything: banks, automotive suppliers, mining stocks, hot stocks, recommendations in magazines, everything.

It is an understatement to say that the results were not satisfactory. Sometimes I won, sometimes I lost. Some stocks I held for 1 year, some for 2 months. In the end, I was lucky when I came out from scratch.

Theory alone is not enough

Something was missing. Theory is usually logically well thought out, but unfortunately rarely works in reality.

I watched some stocks go sky high, while my own stocks didn’t either move nor lost.

After months of back and forth I sat frustrated in front of my PC and watched how a share, which of course I did not have in my depot, rose 10% again and shook my head in disbelief.

That’s when I came up with an idea. What if I tried better to understand why this stock went up and all others didn’t.

Unfortunately, I no longer know what stock it was, but the whole point is that I had to start really tracking stocks and testing their reactions to events.

Like a hunter in Africa, it wasn’t enough if I knew what a lion looked like, how big and heavy it was, and when it was mating.

I had to watch lions up close to understand how they move and what motivation drives them.

Failure is the key to success

Every successful research is the result of thousands of experiments that have gone wrong.

Whoever wants to tell me that he was extremely successful as an equity investor from the first minute, I don’t believe a word.

Similar to a good picture, it is not just the color, the material, the motif or the composition that make it a feast for the eyes, but everything together.

It took me some time to understand this. This time was associated with many disappointments and also with tuition that I had to pay for my mistakes.

Chapter 2

THE TREASURE MAP

pirate treasure map

The wrong approach to searching

Many people go a similar way in their search for stocks, the easy way. They look for specific stock tips on Google or in stock magazines, search forums for what others find good or listen to analysts‘ opinions.

If you do it like almost everyone else, the result is predictable and at most average.

If you randomly select stocks without structure, you can expect an average return of 4%, as we saw in the graph above.

But 4% is not enough for us. We want to achieve the best possible performance, i.e. one that is many times higher than 4%.

Error No.1: Overpriced Mainstream Stocks

The biggest mistake you can make is to focus on the stocks everyone is looking at.

The first natural reaction when looking for stocks is to start Google and e.g. to search for „the best stocks“.

With this selection, we are only looking for stocks that are mostly already overpriced and therefore usually have little potential to continue to rise, but have a high potential to correct, so that we may lose money.

The same also applies to all recommendations in magazines. In most cases, journalists write about what is popular, but not about the stocks that are optimal.

Error No.2: Neglect of the entire equity universe

The second mistake you make with this type of search is to limit yourself unnecessarily to just a few stocks, neglecting the other thousands of stocks.

Treasures are rarely laid out on an altar in the middle of where everyone can see them. They are much more likely to be in secret places that hardly anyone thinks of.

If we search with Google or magazines, we only find the possibly 100 mainstream candidates, but neglect all others.

We want to find stocks that almost no one else has discovered before us.

Error No.3: Analyst Opinions

Analysts are absolute specialists. They analyze every detail of a company day in day out. In fact, they are predestined to find the best stocks.

Unfortunately, they don’t, as a 2016 chart shows.

In fact, analysts are wrong about 50% of the time. You can just as well throw a coin.

There are also other reasons against the search for stocks based on analyst opinions:

  • The most interesting young companies are usually not accompanied by analysts.
  • In order to avoid reputational problems, they mostly reflect the majority opinion.
  • Analysts tend to change their minds abruptly if their recommendation turns out to be contradictory.
  • Analysts set price targets for 12 months, which means that their view is far too short-term and limited.

Error No.4: Forums

The most discussed stocks in forums are often the most attractive buying candidates, but by far the worst choice.

When the mass of people jump on a stock, it is usually already overpriced. Those people who are attracted by the rising share price at last usually are the ones having the least idea about stock investing.

Forums are the birthplace of herd instinct, mass euphoria and panic. It can be extremely dangerous to get infected by it.

The path to the treasure

The path to the treasure leads along the emerald-green river, past the large gorilla skull, through the valley of death before one finally reaches the ancient Inca city. Those who defy all dangers and traps will enjoy immeasurable wealth.

The hunt for Treasury stocks has a lot in common with hunting in the jungle. With the right card in hand, you have to take one step at a time and thus come closer to the final opening of the chest with each step.

If you go without a map and just start running in any direction you may be faster, but you have only a very small chance of really finding it.

We instead will be going down the long but structured path that will most likely lead us to our destination.

Our treasure hunt starts at the beginning, with the 630,000 available shares worldwide.

Step by step, we will exclude stocks that do not meet our criteria in order to ultimately pick the best from the remaining pool.

Step 1: Focus on the American market

We focus on the American market because:

  • it is the largest and most liquid one in the world (if there is no capital, no one can buy shares and prices cannot rise)
  • there is a lot of data for American equities available
  • many young, fast-growing companies are founded and go public
  • relevant Asian and other foreign equities are often listed there
Own evaluation: data from 2018

Step 2: Exclude bad stocks with the help of a screener and certain criteria

The first clue and crucial for limiting this huge amount of stocks is a so-called screener.

This is an online database that allows you to search the stock universe according to certain criteria.

With the equity screener finviz we receive a selection of 7,836 international stocks that are listed on the American stock market.

The art of using a screener is to choose the right exclusion criteria and to use different criteria combinations.

99% of all shares can be excluded this way.

There’s more on that in the next chapter.

Step 3: Detailed analysis of the remaining shares

We take a closer look at the remaining stocks after screening in a two-stage process.

1.) Superficial analysis

We further sort out with the help of key figures and certain knock-out principles. To do this, we need a few minutes per share.

This way a large number of the remaining stocks will disappear.

2.) Detailed analysis

Now comes the real choice, the hand selection. It is important to put the remaining companies through their paces, to understand the business model, the opportunities and the risks.

This is the most complex step, but also the one that makes it possible to find disproportionately good shares.

Chapter 3

Selection criteria

The more different investment books you read, the more different stock selection criteria you come across until you have no idea what to look for anymore.

In literature, a branch is broken for almost every type of company. If you argue correctly, you can find a reason to buy almost any company and countless authors do just that.

To go into more detail at this point would certainly go beyond the scope of this article. I could quote 30 or more different books and add a list, but it is questionable how useful that would be.

Value vs. Growth

People distinct mostly between two types of stocks: Value and Growth

Value shares: Companies whose price is below value, often defined by a low P/E ratio (price-to-earnings ratio) but usually slow-growing companies

Growth stocks: optically mostly expensive shares with high growth rates

For me, over time and with a lot of experience, a few criteria have emerged that have proven to be very successful in the search for good stocks.

I tend to be more interested in growth than value, but there are also stocks that have value and growth characteristics at the same time.

Quantitative vs. qualitative

We must also distinguish between quantitative and qualitative criteria:

Quantitative:those that we can capture with figures e.g. sales growth

Qualitative: those that we find difficult or impossible to measure with numbers, e.g. management quality

If we move on to screening soon, we first use quantitative criteria. Qualitative criteria are also important in the later detailed analysis.

My top criteria for a successful stock selection

I have numbered the following 8 criteria to classify them in their importance. Nevertheless, it is difficult to establish a clear ranking, as many of them are synonymous in their importance or only make sense in combination with each other.

We can use some of them for screening purposes in the next chapter.

1.) Growth strength (quantitative)

Companies that do not grow, do not rise in value and their share price also has no reason to rise, because why should one be ready to pay a higher price for an unchanged thing?

The growth strength is optimally measured by growth year-over-year (in the compared to the previous year) and over several years. The more stable and higher this rate is, the better.

Ideally revenues and profits grow alike. It is even more optimal when profits grow faster than sales, as this demonstrates the efficiency of the company to make more of its sales.

This property of a disproportionate increase in profits is called the scalability of a business.

2.) Management quality (partly quantitative, partly qualitative)

It is crucial that the top management itself has a stake in its own company, as this is the only way to ensure that long-term thinking prevails.

A manager who is highly invested himself cannot simply wrench out of his company from one day to the next, because the rapid sale of a large part of his own shares would certainly cause the rest of his remaining equity assets to fall dramatically.

If the company’s business is going badly, its share assets suffer in the same way as those of other shareholders. So he has the same goal and wants to increase the value of the company and thus the share price as much as possible.

Managers who are only employees of the company tend to prefer avoiding risks. They receive their fixed salary and are usually very well protected by golden parachutes when leaving the company. They do not have the same motivation to drive the company forward as best they can because they only benefit from it to a very limited extent.

3.) Appropriate relative valuation (quantitative)

The best Company is not worth buying if its price is extremely overpriced.

It’s all about not only the limited profit potential that comes with this, but also the higher loss potential of overpriced stocks.

Many people make the mistake of looking for optically favorable stocks, such as those with the lowest P/E ratio (price-to-earnings ratio). But cheap does not necessarily good.

The optimal stock has the most advantageous price-performance ratio.

For example, a company that is only growing at 10% p.a. and has a P/E ratio of 10% is roughly fairly valued.

A company that whose sales grow by 100% and which has a P/E of 100%, is probably also fairly valued and may even be undervalued if it is is able to increase profits faster than sales.

4.) Gross margin (quantitative)

Gross margin = (turnover – Cost of sales) / sales

This margin tells us how much of sales can be transformed after direct costs

The higher the better, because those companies with higher margins are able to create more out of less.

The products of such companies are usually of high quality and superior compared to others.

Low gross margins, on the other hand, fundamentally limit the ability to make profits, as many other costs have to be deducted from gross profit afterwards.

5.) Cash and cash flow (quantitative)

Cash is the lifeblood of any company without which a company cannot survive.

Best are such companies that:

  • have high cash reserves and are not dependent on external money for a long time
  • can generate high positive cash flows themselves and thus keep operations running without external financing and have sufficient money to invest in the future

Such Companies, from which more money flows out than in, come earlier or later into the predicament of having to raise capital.

Often the company collects money for this purpose through capital increases on the stock market, i.e. it sells more shares at the expense of the existing shareholders, whose stocks thereby lose value.

Capital increases in most cases lead to a fall in the price of stocks. If a company have to raise money on a regular basis, these dilutions may eat up stock price gains.

6.) Market potential and market growth (quantitative and qualitative)

Market potential is an basic requirement for future growth. It describes a company’s total potential to generate revenue. For example, if a company sells a special product, which only few people want to buy, the sales potential is limited from the start.

The pace of market growth is a two-sided sword. On the one hand, companies that operate in in high growth markets usually grow faster than those in slow-growing markets.

On the other hand fast-growing markets ususally attract more competitors. In order not to lose market share to competitors, product quality and innovation plays a crucial role for successful companies in those markets.

A high gross margin combined with high growth rates are implicit signs of successful players in growth markets.

7.) Something New/Catalyst (qualitative)

Often it is a change in the status quo that gives a stock a boost and stimulates purchases.

Something new, a new product, a new management, a change in the market can be catalysts that draw investors‘ attention to a stock.

A company that can come up with something new is preferable to those who are not able to do so.

8.) Momentum (quantitative)

Trend-following strategies usually work very well, because on the stock exchange „the trend is your friend“.

Once, have you found a good stock that is rising, you should not get scared away by higher prices and sell off too early.

Momentum is the salt in the soup, as rising prices usually attract more buyers.

Also, at higher prices there are fewer and fewer investors who are in the red because they entered at higher prices. Sales pressure is therefore decreasing. New All-time-high prices can therefore be good entry points because nobody is losing money and therefore does not want to sell.

No Go Criteria

Just as important as finding criteria that make up good companies, it is important to find criteria to exclude bad stocks.

The most efficient way to find the best companies is not to first look for the good ones in the mass of stocks, but to filter out the numerous bad ones.

KO criteria that lead to immediate exclusion:

1.) no growth

2.) no involvement of management in the company

3.) High longer-term losses

4.) High long-term negative cash flows

5.) Highly fluctuating sales and profits

6.) only inorganic growth

7.) a high goodwill in relation to total assets

8.) an exorbitant valuation in relation to growth

9.) Exclusion of certain sectors such as biotechnology, mining companies, most industrial companies

Chapter 4

Screening

finviz – the best stock screener

Screeners provide a user mask for filtering larger databases.

There is a huge selection of screeners on the Internet, free and paid. Which one you use is up to you.

I myself find the screener finviz the most comprehensive and easy to us one.

Go to finviz.com and choose screener.

The free version lets you filter the entire american stock universe according to 65 possible criteria.

The paid version extends those possibilities considerably by allowing you to enter certain values in the filters, which can make the search much easier. In addition, a list can be downloaded into Excel and conveniently filtered there.

Since I use finviz myself a lot, the paid version is worthwhile for me.

However, in the following I will describe the search for stocks using the free version.

The criteria are divided into three categories

1.) Descriptive: e.g. market capitalization, industry, country, etc.

2.) Fundamental: Quantitative criteria such as growth rates, margins, etc.

–> primary search filter for us

3.) Technical: e.g. performance, averages

What do we filter for?

In the last chapter we defined criteria to help us narrow down the stock universe.

The challenge when using a screener is that we can’t use all the defined criteria at the same time.

There are two reasons for this:

1.) Screener data is time-related. Filtering could lead to an exclusion of a stock just because a certain criteria is only temporarily not met.

2.) Screener data is often incomplete. If no data is available, a stock may be excluded even though it meets the criteria, but just the database is not up to date or missing this data.

You will learn more about these two points at the end of this chapter. Therefore, we only use selected criteria for screening.

The most consistent over time are usually growth rates and margins.

Growth

To see which companies were able to increase their sales in the last 5 years, we could now filter for „sales growth past 5 years“.

However, this would have the disadvantage that we would only filter for stocks that have existed for more than 5 years.

However, we are mostly looking for young, up-and-coming companies with strong growth rates.

What we want is a strong increase in EPS (earnings per share) of at least 30% (over 30%).

If we set the filter, #1719 shares remain.

Gross margin

Next, it is particularly important to us that the company has a high gross margin. We filter for Gross Margin > 60%.

As a result, only #375 shares remain.

No losses

Then we need to exclude companies that make losses. We could achieve this by specifying the net profit margin as > 0.

Caution is required at this point, however. Companies that are currently touching the profit threshold can easily fall out with this filter. Also, screeners are always time-based, so fluctuations around the break-even point can lead to an exclusion.

Therefore, we do not set this filter.

Exclusion of certain industries

The list now contains 375 items. There are many more filters that we could set, but with each additional filter we would increase the risk of excluding companies that meet our criteria, but whose data is incomplete (more on this at the end of this chapter).

Instead, we exclude companies that belong to certain industries, which we generally do not consider to be good investments.

At this point, we have to go through the list piece by piece. Here the advantages of the payment version of finviz come into play, with which we could exclude certain industries by „custom filter“ or do this with Excel (which I prefer).

Oil companies

In general, companies that are heavily dependent on commodity prices are no good investments, because no matter how good the management is, a falling commodity price can always destroy results.

Commodity prices are completely unpredictable. For example, the oil price is unpredictably influenced by economic influences, conflicts with oil-producing countries or political decisions e.g. by the Opec.

Biotechnology companies

If you really want to play roulette, buy biotech. Of the thousands of companies that are active in this field, only a very small percentage become actually successful at some point. The success of certain patents is absolutely unpredictable, especially for medical laymen, among which I count myself.

In addition, biotech companies are very difficult to evaluate because they usually generate very low sales and losses over very long periods of time. Only when their products and treatments become marketable, which may take years, they can start to realize profits.

Quickcheck of the remaining 375 companies

To have a closer look at these 375 stocks, we can switch to snapshot view in finviz, or sort them by certain criteria in the other tabs.

The snapshot view gives us a summary view of the individual stocks.

As we scroll through the list bit by bit many well-known names such as Adobe, Activision Blizzard, Salesforce etc. catch our eye.

These are undoubtedly good companies with good growth rates and margins, but we want to find something extraordinary.

With the help of the snapshot view you can get a first impression of the company. However, this view is quite limited, as we cannot see the development of the numbers in detail and over time.

Salesforce Snapshot

Seeking Alpha – the best and least costly database for American equities

At this point, we need more information. The best source I know is Seeking Alpha. There is also YCharts but who is willing to pay $400 per month!

In Seeking Alpha you will not only find the complete P&L and balance sheet for all years and quarters, but also countless detailed analyies for all kinds of shares.

Both are things I could not discover on any other website so far.

If we now want to find out more about a stock which you found on finviz, we switch to Seeking Alpha and look at the relevant key figures in detail.

A long time ago I gave up my newspaper subscriptions of other german newspapers and magazines in favor of a Seeking Alpha subscriptions and have not regretted.

Here are some overviews for CRM as an example.

Screener Tips

The biggest challenge of filtering is the partial incompleteness of the data and the time reference.

Tip No.1: Beware of too many filters

It is not enough to set as many criteria as possible and look at the selection, but it is best to try around and search with different combinations of criteria.

Example: if you filter QoQ (quarter over quarter) and YoY (the last quarter compared to the same quarter of the previous year) you get the following selection.

If we select the tab „ownership“ in the results overview, which shows us how many company insiders own parts of the company (one of our core criteria), we recognize some „-“ positions.

One could conclude that these stocks have no insider positions, but this is not true.

With INMD and GSX we found two companies of which even the majority of the company is owned by the founders.

So the data is incomplete!

This conclusion could only be reached if one had already gone deeply into the analysis of these two companies, what we have not done at this point.

If we set a filter of > 10% for insider ownership, companies with a high percentage of insiders will certainly be eliminated.

Conclusion: Better use fewer criteria and carefully add one filter after another and check which stocks have fallen out.

Tip No.2: Pay attention to the period

This applies in particular to young companies that have only recently been listed on the stock market.

If you filter, for example, by Performance 2 – Year, all stocks listed for less than a year are excluded.

Caution must also be exercised when filtering for growth. It is perfectly normal for results to fluctuate over quarters.

Most companies, even those not sensitive to economic cycles, often have seasonal fluctuations which mean that every year certain quarters perform better than others.

Often costs are cumulated in one quarter, but sales reach the company months later or the product itself is sold seasonally, for example in the education sector.

For these reasons, one has to be very careful, especially with QoQ growth.

Chapter 5

Analysis

We have now gone through the individual positions in finviz step by step and have excluded most of the shares because they did not pass the KO criteria.

Very few companies remain, for which further detailed analysis is worthwhile. Adobe or Salesforce are good growth companies, but not exceptional enough for me.

We want to find an undiscovered treasure that does not increase by 20% p.a. but by 50%, maybe 100% or even more.

Two of those companies I came across during my search are GSX Techedu (articles here) and InMode (new article here).

InMode:

InMode caught my attention because it had its IPO debut on the American stock exchange only a few days earlier and because it had impressive numbers.

Usually I am very cautious about IPOs because they are usually very expensive (IPO = it’s probably overpriced). The company naturally wants to get as much out of the IPO as possible, as do the banks that are promoting it.

But InMode’s numbers shone brighter than those of most other stocks.

At that time I only found the IPO prospectus, which is a kind of sales prospectus that all new IPOs have to present and that contains all the relevant facts for potential investors, but which can usually have 200 pages or more.

What does InMode do?

InMode manufactures equipment that can be used to perform beauty procedures such as the removal of scars or the reduction of wrinkles.

Here is a presentation about InMode.

I myself have not much to do with such „beaty“ things and therefore have no direct customer experience.

However, I know that the market for beauty procedures is growing rapidly. In Germany, with the M1 clinics, also a successful company in this field.

What however, was very convincing, was the rather simple structure of the devices and the feedback from customers on the net.

Prospectus Notes

I have been keeping a stock diary for quite some time now, in which I take notes on general market events, but especially on interesting stocks.

My original notes for InMode can be found on the following pictures (as they are handwritten, they are only available in german. Sorry for that. However a good chance for you to learn some german 😉 )

Selection criteria InMode

1.) Growth strength

Revenue: 30.5m USD (+46% YoY)

Net income: 10.2mio (+59% YoY)

Sales and profit grew rapidly, not only in the first quarter, but even more strongly in 2018 (Revenue +87%, Net Income +154%).

2.) Management Quality

The management had managed to launch a new product on the market within a short period of time and achieved very high margins and growth rates with it.

In addition, the CEO and founder is majority shareholder.

During most IPOs a so-called lock-up period is agreed. This is a contractual agreement under which the largest shareholders agree to not sell shares for a specific period of time after the IPO.

Usually this period, as in this case, is 180 days long.

3.) Relative valuation

Shortly after the IPO, InMode was valued at approximately USD 450 million (USD 14 per share x number of shares).

In addition to the first quarter, the prospectus also included a forecast for the second quarter.

I estimated, that, after the first two quarters, full-year sales for 2019 could be USD 150 million and InMode would be able to transform around 41% of those sales into profits, i.e. USD 60 million.

Thus, InMode was rated with a P/S ratio of 3 and with a P/E ratio of 7-8 at that time.

Pretty favorable for a company that currently managed to increase its sales and profits by 50% and more, right?

4.) Gross margin

The very high gross margin (86%) was impressive too.

Even the best and highest rated software companies usually achieve margins of only 70%.

Companies that can achieve such margins usually have very high quality products for which they can charge very high prices.

5.) Cash and cash flow

InMode had raised USD 70 million in capital through the IPO and now had sufficient cash available to secure its business operations and make further growth investments.

InMode also independently generated positive operating cash flows in Q1 +2.7m USD, 2018: +37m USD, 2017 +15m USD) and would therefore not need to be using up its cash position.

With these figures, there was no risk of a lack of liquidity or the need to restrict investment.

6.) Market potential

The market potential in the field of beauty appliances has been growing for many years and the trend continues. Beauty optimization still has a high value in society and people are willing to spend more and more on it.

The problem with equipment such as what is manufactured by InMode is that the trend towards alternative modules can change. They are fashion products.

7.) Something new

InMode not only produced brand new products, but was brand new itself, thanks to the IPO.

In addition, further expansion into other markets such as Europe or Asia had already been announced in the prospectus as well as additional new products.

8.) Momentum

Shortly after the IPO, there was no trend and no momentum, which could have had a positive impact on the stock price.

However, the share price had not fallen sharply, so that selling pressure also seemed unlikely from those investors who had participated in the IPO.

What everyone else overlooked

However, the cherry on the cream is yet to come.

I just mentioned that InMode did no only present the Q1 numbers, but almost showed the forecast for Q2. Such a forecast is rather unusual for a prospectus in my experience.

Anyone who had not gone through the prospectus in detail could not have known this, as Q2 had not yet been officially announced. Nevertheless, Q2 had already been completed in August, so there was a high degree of certainty that these figures would come through as expected.

During my analysis I was already surprised that the stock had not yet risen despite of the strong figures and the favorable valuation.

Q2 Forecast:

  • Revenue +55% YoY
  • Profit +107% YoY
  • Gross Margin increased even further to 87%

Now I realized that hardly anyone could have read the prospectus and knew about the strong Q2 Forecast.

As soon as these figures were published, I concluded, an extreme rise in the stock price could be the result.

The risks

More and more, I realized that I had a unique opportunity in front of me. Nevertheless, I had doubts, because all this sounded almost too good to be true. So I started looking for the catch.

One must not be blinded by too good figures and evaluations without checking risks and backgrounds.

So I read more about the founder of InMode, Moshe Mizrahy. He had previously founded another beauty company and also listed on the stock exchange. It was obvious to take a closer look at this company called Syneron.

Syneron (ELOS) went public in 2004. Following the $12 IPO, Syneron’s share price had multiplied within a short time, driven by high growth rates and a favorable valuation similar to InMode.

What struck me negatively was the further development after the initial steep ascent following the IPO.

As you can see in the graph, Syneron was a good investment only from the IPO until 2005, but lost all of the first profits in the following years.

The main reasons for this poor performance were falling growth rates and missed forecasts, both of which are poison to the price of a growth company.

Syneron’s story ended 13 years later in 2017 with a takeover by Apax at a price of 11 USD, i.e. 1% below the original IPO price.

Syneron was not a good investment for a buy and hold strategy, but a fantastic investment in the years 2004 to 2005.

What I learned from the Syneron case for InMode

New beauty equipment is usually hip for some time. Just like the youthfulness they promise, they are beautiful as long as they are young. For a good reason the word fashion = mode is part of InMode.

Everyone wants to have something new and popular until there is something more interesting.

Especially wealthy and rich people are willing to spend a lot of money on beauty and youthfulness. This is also the reason why InMode can charge such high prices for its equipment. The doctors who buy these devices and treat their patients with them can easily pass these prices on to their customers.

If InMode was to do well and take a similar path as Syneron, now was the best time to enter the market before possibly all of Wall Street would rush into the stock.

Buy or no buy?

After much analysis and consideration, I concluded that the opportunities outweighed the risks by far, especially because the Q2 numbers were already very certain and the wider market was not yet aware of them.

With very high probability, the market had overseen the very high growth rates and the favorable valuation.

I was aware that with InMode I didn’t have a company in front of me that you could buy and keep for eternity, but for which company does this rule still apply today.

With the release of the Q2 figures, there was a very good chance that the market would start paying attention to InMode.

Hardly any investor would question what the real background of this IPO was and hardly anyone would remember Syneron.

Investors would blindly focus on the numbers and that was my advantage.

In the eye of the storm

So I bought InMode on Aug 13th, 2019 at 14 USD and placed another stop buy order slightly above that level in case the stock should break out after the numbers release.

My expectation was that InMode could rise strongly in the first few months, at least until the end of the lockup period.

Then the numbers were published and what happened: Nothing!

As in the eye of the tornado, there was absolutely no wind. InMode existed in the short quiet phase before the storm would strike with all its force.

Just one day later the time had come and InMode immediately increased by 16% on that day.

This increase in volume showed me that there was material interest from investors and I assumed that this was just the beginning, because even after this sharp rise the stock was still extremely cheap.

I did not want to settle for 16%, I wanted to at least double my money. So I grabed the opportunity and increased my position again.

I had nothing to lose, because I was already clearly in the plus, but had all the more to win.

In the following days and weeks, the price break-out advanced further, only to be interrupted by short, but partially sharp corrections. More and more investors jumped on the stock and pushed it further upwards.

During this time and especially during the course of those corrections I had to stay focused and shouldn’t let the high volatility unsettle me.

Surfing waves with full sails

Three months after buying my first position at 14 USD, the price was already up to 59 USD and thus had risen by a more then 300%!

I didn’t sell at the top price of 59 USD, but at 45 USD.

Before, during larger daily fluctuations, I had partially taken profits on strong days and then again increased my position on weaker days.

Nevertheless with InMode I was able to achieve a return of more then 200% on my whole invested capital.

I had also managed to build up a material position into the rising prices, which at the beginning was 20% of my capital.

Is InMode still worth buying?

The big increase for InMode is, in my opinion, over. It is possible that the stock keeps increasing even further. However, I think another 300% are very unlikely because InMode is no longer such a bargain at the current price as it had been at the time of the IPO.

In the back of my mind I still have the development of Syneron and InMode must first prove that it can keep growing and will be successful in the long term.

We will see. At this stage, I rather assume that we have a second Syneron in front of us.

Update: I reconsidered my opionion temporarily as there is currently an additional chance occuring from high shortseller positons in the stock.

Chapter 6

Conclusion

Minimal Idea Design Concept Yellow bulb on yellow pastel background – 3d illustration.

To stumble over opportunities like InMode is certainly not happening every day, but your can find them from time to time.

The following points were crucial to this success:

  1. No purchase based on a stock tip
  2. Successful narrowing of the stock universe with the right criteria to find high-growth, low-evaluation companies
  3. Detailed fundamental analysis
  4. Find information that the market had overlooked or assessed differently in its importance
  5. Purchase of a material position. With an investment of 2% or 5% this would have been a nice success, but I could only earn a lot of money by confidently investing enough money (but also not risking everything)
  6. Expansion of the position if you are already in profit
  7. Hold the position despite already high profits and partial profit taking
  8. Sell only after the stock appears to be too expensive

Closing remarks

I very much hope that this example has shown what power you can find in equities and that it requires some work, but that every retail investor is able to achieve extraordinary profits if he only knows what to look for.

Stocks have risks but if you do it right, very calculated ones.

For me, stock purchases are statistically calculable bets. You can win or lose, but with the right analysis you can increase your chances of winning significantly.

Crucial is also: if you win, then you have to win big, if you lose, then you have to limit your losses.

Instead of being the inexperienced casino player who plays on luck, you have to become the bank itself and dominate the game with advantageous chance/risk bets.

If you spread your money over several such bets, you have an outstanding chance of multiplying your money over several years.

These insights have changed my life and I hope you feel the same.

This guide focused on the search for stocks. But there is a lot more to know about how to trade stocks. Therefore I am already planning to write another guide, which will deal with the following:

  • how do I deal with emotions when buying stocks
  • how do I act best in which situation
  • how much of a stock should I buy and when and how should I sell
  • how many shares do I need in my portfolio and how do I really diversify

I look forward to your comments and feedback.

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