Strategy
THE PROBLEM WITH DOING THINGS SERIALLY
The first problem with serial stock selection is that it tends to ignore the fact that the decision is being made on the investor’s time frame, rather than the stock’s time frame. Let us explain. The ability of the stock to generate alpha is highly sensitive to where the company is in its business model’s life span. Typically, stocks generate the most alpha either very early in their life span or very late. In the middle of its life, the industry in which the company operates is often maturing, with new entrants driving down profit margins for existing players and the markets into which the company sells its product or service becoming saturated, leading to decelerating growth.
But the traditional “serial process” rarely takes this into account. In fact, because traditional Sell-Side research analysts need to cover an entire industry or particularly large segment of that industry, they end up with a coverage list that is heavily laden with companies in the throes of competitive battle. They tend to cover relatively few young companies (because they are either too small or aren’t investment banking clients of the firm) and few old ones because they are typically un-exciting, slower-growing and appear (often incorrectly) incapable of providing a portfolio with alpha.
So our trusty Buy-Side portfolio manager or analyst is invariably choosing from a pool of candidates that appear hale and hearty, but which are, in fact, deep into their painful middle age, full of slowing growth, shrinking profit margins, departing managers, saturated markets now full of well-funded competitors prepared to compete on scale and not on innovation. But because the PM or analyst needs to find new candidates for investment on an ongoing basis, they very often choose such stocks because a) the most “information” is available for such companies, thus leaving few unanswered questions during a stock selection meeting; and b) trading in such stocks is easy because of wide-spread Street sponsorship. Justification for owning such names is usually reduced to, “they’re gaining market share,” or “they have the biggest product pipeline.”