More than 5,000 companies are listed in Nasdaq and NYSE. How then does an investor cast the net wide enough to not miss out on great opportunities, but keep the workload to a manageable level?
It is better to know considerably more about a much smaller list of companies. An investor may actually only need to know a few hundred companies and stocks to get through her/his entire investing life. The key, then, is for the investor to find a balance between knowing just enough to let good ideas come in through the door without being so distracted and spread thin that she/he risks "paralysis by analysis."
If the financial markets sometimes behave like a giant circus, then investors ought to consider a three-ring approach. This approach will help investors sort out their priorities, allocate their time most effectively and balance out the need to keep a broad perspective with the equal need to maintain focus and attain a deep working knowledge.
Create Circles of Competences
It is important for investors to create circles of competences - areas where they have above-average knowledge. This competence can come from firsthand industry experience, or it can be a product of years of careful study and attention.
The reality, though, is that it is impossible to be proficient (let alone an expert) in all areas, so investors are well advised to focus their attention on becoming proficient in a few sectors and perhaps finding advisors or analysts that they can trust to fill in the gaps.
Research Up, Down and Side to Side
It is important for an investor to make the most of the time available for research, and one of the best ways to do this is to research vertically (suppliers and customers) and horizontally (competitors).
To properly understand a company, it is important to have more than just a cursory knowledge of its supply chain, customers and competitors. So why waste that knowledge and research? One of the best ways to make the most of that time is to cast the net just a little wider, spend a little extra time and add a few other companies to the research list.
If an investor is researching Coca-Cola (NYSE:KO), it makes complete sense to also research PepsiCo (NYSE:PEP). Likewise, researching Pfizer (NYSE:FE) could lever that knowledge with additional names like Merck (NYSE:MRK) or Johnson & Johnson (NYSE:JNJ).
Three Rings to Control the Circus
One of the best ways to control the chaos that can stem from ongoing financial research is to separate investment candidates into three distinct lists.
The most exclusive list should be the "closely followed" list - stocks that the investor knows well and monitors frequently. It's not necessary to know these companies so well that an investor can rattle off the name of the vice president of marketing, but a strong familiarity with the company's products, markets, competition and recent financial performance is the goal. It is not necessary to follow these stocks on a day-by-day basis, but investors should probably try to aim for at least a monthly update of current news and developments.
The second list is "casually followed." These are stocks where the investor will know the company pretty well, but will only update a few times per year - most likely in time with the company's quarterly reporting cycle. Having a good working knowledge already in hand, an investor can easily move these stocks to the "closely followed" list with just an hour or two of extra work. By and large, a stock on the casually followed list should be a good company with a troublesome valuation or a potential turnaround situation where the investor needs to see signs of real progress before "promoting" the idea to a more closely followed list.
The outer ring will be made up of companies that are effectively barely followed. An investor may recall the name of a company and its industry or products (at least in broad strokes), but little else. In many cases, this will be a list of companies that were once more interesting, but have fallen off the radar for reasons of poor execution, unattractive valuation and so on. Stocks don't typically start off on this list, but there was once something about them that was worth investigating further (perhaps they compete in an interesting industry), and they are worth reexamining once or twice a year to see if their situations have improved.
Perhaps some investors will find that they need a fourth list - a list of names that are looked at once or twice and discarded as candidates, but whose information is kept for the sake of thorough record-keeping.
Create Watch Lists
A watch list is basically what it sounds like - a list of stocks that an investor watches with an eye toward taking advantage of if prices fall enough to create an interesting undervalued situation. This takes the "closely followed" list a step further; these are names that an investor would be prepared to buy and own at the right price or with the right catalyst (a sign that growth has reignited, for instance).
Here, too, discipline and focus are keys to making the most of this tool. A watch list of 200 stocks, for instance, is likely to be too broad for almost any investor to monitor or maintain. Investors should refresh this list at least a couple of times per month. After all, this is generally supposed to be a list of names that an investor is simply waiting to get cheap enough to buy.
Set Aside the Time
The last step may actually be the most fundamental to the entire process. A disciplined investor needs a disciplined process. Set aside time every day (or week) to do the requisite work - both researching new ideas and keeping up with developments in those names on the watch list. It is also invaluable to establish a flow chart for the research approach. Investors can use this like a checklist to make sure they follow the requisite steps and take a methodical and consistent approach to their research.
The Bottom Line
Keeping tabs on all of the potential investments out there can be a daunting task. It is easy to get bogged down or feel overwhelmed to a point where giving up seems like the most attractive move. Above all, consistency and diligence are paramount, but organization can help make an insurmountable task look like a series of manageable routines.
In the case of following the market, it is best for investors to drop the notion that they can follow everything. Individual investors are not hedge fund managers with multi-million-dollar research budgets and clients demanding absolute peak performance. As most people have to fit their investment research around work, family life and many other important demands, it makes sense to create interlocking rings of expertise and knowledge. An investor should focus intently on the best companies he or she can find, and then sort out the rest as time allows.