Creating Your Winning Stock Watchlist

If you're starting to invest on your own, creating a watchlist of companies to follow and wait for the right price is the blueprint for success. But how do you go about creating this list, and when do you know is the right time to pile money into these great companies?

I think Li Lu summed this up beautifully in this Q&A he had recently:

"You must understand yourself relatively well and then you can be picky in your choices. Once you understand a company, you can just sit and wait until an opportunity comes when the price gives you sufficient margin of safety. At that point, you won’t lose money even if you’re wrong. This is when you can go all-in. This is why you should focus your research on things that you can understand well and understand clearly. And since you will only be choosing a few companies, you might as well choose the very best ones. Of course, you can also choose the smallest companies or those whose price is already cheap. If you understand them well and there is sufficient margin of safety, you will not lose money. In short, you want to invest in certainty and avoid uncertainty. When price can give you certainty, then price becomes the most important consideration. When your own knowledge, ability and judgement can give you certainty – especially when you have been researching truly exceptional companies – then you don’t need to constantly change your watchlist every few years. You can just keep going and let the companies own compounding do the work for you."

I gleaned a lot of information from this short quote.

1. He mentions the margin of safety (MOS) multiple times.

2. You must understand yourself well, and know what you can and can't understand.

3. Price and certainty are correlated. The right price can give you the certainty that you won't lose money.

4. Don't waste your time trying to understand a bunch of companies.

5. Research a few really good companies and follow them closely.

This is what he's done for decades on his way to extraordinary market gains. This is what I'm understanding more and more for myself as well. You only need to follow a few very good companies that will be around 10+ years from now. If you can truly understand the underlying economics of these businesses and can forecast into the future with some certainty what the company will be valued at, you simply follow them and wait for the price to get to your margin of safety price then pounce on the opportunity.

He makes it sound easy, and perhaps it gets easier the more you do it. I feel at the beginning it's just a tonne of work. You have to lay the groundwork to try to understand your circle of competence, learn about the great companies you're going to follow, then be patient as the price fluctuates (and hope it comes down to your MOS).

Here is how I go about does these things:

Understanding Your Circle of Competence

Charlie Munger says you need to be able to understand the company that you're looking at. I feel this gives some room for adding companies into your circle of competence. If you've been reading for hours every day for 80+ years you're going to understand a lot more than someone who barely reads. The key is that you should be able to understand. This means you will need to put time in the future to improve your understanding.

If you feel that it's impossible for you to understand something, or that you are bored to tears reading about a potential company that you're looking at, this is a good opportunity to throw it in your (as Buffett calls it) "Too Hard" pile and just skip it and move onto something else.

For me the hardest company to understand that's on my watchlist was Micron. I've read for many, many hours about the company itself as well as the underlying hardware that it creates. Although I feel I have a solid understanding of the business I still don't know the exact ways their products work. For that, I'd need to be an engineer and I'm not. But I feel like I understand the industry well enough and can predict with certainty where it will be in a few year's time. For me, that's enough to understand something.

I remember looking at Raytheon, as it's owned by many great investors (I know this using Dataroma). But when I started looking into it and what they make, I just decided I don't care to put the time and effort into understanding all their business segments and I simply moved on with my life.

This post has already gotten too long so I'll cover the following two areas in a future post:

Learn How To Identify Great Companies and Follow Them Closely

Determine Your MOS and Be Patient

Until then, have happy holidays!!!