Research and Identify Individual Investments to Purchase

Researching and identifying desirable individual investments can seem like a daunting undertaking. This is mainly due to the fact that we are attempting to foretell the future from the past and the present.

When it comes to investing, we really would like our investment research, analysis and decisions to be science-like. To guide our investment decisions, we desire mathematical formulas, hard-and-fast investing rules, and economic models that provide simple true and false answers. Unfortunately, investing has not evolved into a science and the tools at our disposal are at best general guidelines. The established investing formulas, rules and economic models are only vague signposts to help us to navigate the investment highway.

With this said, investors must use all of the tools that are available to them. In the first part of Step 10 we outline some of the tools to use and watch out for in researching investments, including how to:

• Avoid misleading scientific tools of investment research. Investors should understand the formulas, investing rules and models, but they need to accept that they are not scientific in their analysis and conclusions.
• Read, read, read, and question. Investors should also read as much as they can. A balanced decision results from studying both arguments for and against an opinion.
• Use formal and informal research. Investors should take advantage of information and research readily available from as many sources as their interest and time permits.

In the second part of Step 10 we discuss how to specifically research Cash, Fixed Income, and Growth asset categories.

Avoid misleading scientific tools of investment research

Before we can begin our research efforts we must create a framework for our investment decisions. As humans, we really don’t like the unknown and we often adopt a scientific approach to our investment decisions to provide us with a set of concrete guidelines to address the unknown, such as the following, for example:

•  We observe a certain outcome and then study the surrounding environment to arrive at a cause and affect relationship. For example, interest rates are rising and we observe that inflation started rising before interest rates. Our conclusion = rising inflation leads to increases in interest rates.
• We reduce and simplify ever-changing financial information into a series of mathematical formulas to build a case for the investment decision (for example: Price-To-Earnings Ratios, Price-To-Book Ratio, Dividend Yields, Cash flow per share Ratio, Price Targets, etc.).
• We study past charts and data seeking patterns that we can extrapolate into the future. Investors that utilize stock market charts and data believe that a picture is worth a thousand words. They use past patterns to forecast future performance.
• Seeking gurus! We hunt for investment people that have outperformed the markets or correctly forecast economic and investment events. It is human nature to believe that events are predictable. Our desire to know and understand future events leads us to hunt for people that we believe can foretell the future. If one hundred people give different forecasts for a future event, statistically, a certain percentage will be correct. Maybe 5 of the forecasts will be correct. Investors quickly fall in behind these 5 forecasters because they just proved they could foretell future investing outcomes. And thus new investing gurus are born!
•  We use investor herding and consensus opinions espousing popular investment themes as a sign that our decision is correct. If everyone says something is going to happen, how can so many be wrong, we wonder? Investors often find it easier to follow the herd when making investment decisions. It does not feel as bad when everyone loses money together and it feels even better to share your success with others.
• Overwhelmed by the prospect of researching an investment, investors often defer to the research of others. In the investing world, investment opinions are more numerous than the actual number of investment options.

Remember:  Whatever approach or tools you decide to use for your investment research, realize that there is no secret to investing. There is no one method, no single answer, no single investment approach, and no single investment guru that can give you 100% investment success, 100% of the time.

Read, read, read, and question!

In fact there are a number of trustworthy tools you can rely on to help you research and identify successful individual investments. Begin your research by

• reading as many opinions as possible. Read newspapers, company news releases, company earnings reports, brokerage research, investment newsletters.
• subscribing to services that provide independent opinions, and think for yourself
• developing and learn to trust your own instincts
• being critical and question what you read. (Don’t simply accept the author’s opinions as the truth. Ask yourself a couple of simple questions as you read such as the following: Who is the author? What is their experience and background? What is their motivation for writing? Are you reading a factual article, opinion piece, or is it marketing literature? Are the author’s opinions and assertions well supported by facts or are they based upon conjecture? The author’s facts may be correct, but is their reasoning or connecting of the dots accurate? Could one arrive at a different opinion from the same facts? When reading facts and data do not simply assume that today’s numbers can be compared to last year’s numbers. Does the data contain Survivors bias or distortions due to a change in outside influences? Maybe the method for collecting the data has been modified. Maybe the measured behaviour is no longer as relevant? If the information is supplied by someone, what is their motivation for having you read the information?)

Note:  Properly researching investments should involve not just reading articles that unanimously support an investment decision, but should also include articles that offer a different view of the same investment decision. By reading opposing opinions that disagree with your thinking, you will either rethink your position or feel reinforced about it. Always be open to the opinions of others, especially those that you might disagree with, because it is impossible for one individual to know all and see all.

Use formal and informal research

Investment information can originate from numerous sources, some considered to be formal and some classified as informal:

• Formal research might include information from brokerage firms, mutual fund companies, investment analysts, investment strategists, company financial statements, credit rating agencies, government agencies and investment subscription services.
• Informal research might include newspapers, news services, magazines, trade publications, press releases, personal experiences, friends, family, and non-investment specific sources.

Investors should take advantage of both formal research and informal research when making investment decisions. By reading formal and informal sources of investment information, your decisions will be bettered informed and balanced.

Researching Cash, Fixed Income, and Growth asset categories

Finally, researching investments can be made easier and more manageable by breaking your research into categories that align with the three main investment asset categories:

• Cash and Cash Equivalents investments
• Fixed Income investments, and
• Growth investments

The amount and type of research necessary for each asset category will vary depending on the complexity of your portfolio design and your Investment Policy Statement (IPS).

When researching the investment options available you should begin by using your written IPS as your guide. Using the IPS guidelines for each asset category will help to make your research efforts more productive by concentrating your time and effort on only those investments that complement and support your financial goals.

In addition, when researching individual investments and making each investment decision, you should have a specific need or job in mind for each selected investment. For example, your portfolio might have a need for an investment within a specific industry or sector (Oil and Gas or Financials). Your research should focus on and help identify the best single investments that deliver the best participation within that sector. Your individual selections should satisfy your portfolio’s needs or perform a certain job.

Note: When we suggest that each investment in your portfolio should have a specific job or job description, we are trying to ensure that each investment decision coordinates and supports your portfolio design and achieving your financial goals. By establishing jobs for each investment, you retain better control of your portfolio’s diversification and asset allocation, and you avoid unconscious over-weighting and under-weighting investment sectors and asset categories.

The following section outlines the details around researching each of the three main investment categories.

Researching for Cash and Cash Equivalent investments

For this asset category, your primary goals are to achieve the highest possible rate of return with the highest degree of safety for your capital.  The best place to begin is with the institution that administers your account. They can provide you with a list of money market mutual funds, Banker’s Acceptance and short-term bond options.

Note: For information on money market mutual funds, sites like Morningstar, Globe and Mail’s Globe Investor – Fund Look Up and InvestingForMe’s sections (including IFM Quotes in our Data Room section) provide tremendous search capabilities.

There are a number of items you should be aware of before you buy Cash and Cash Equivalent investments:

• If you are going to hold cash as a balance within the account or in a cashable GIC, then you want to understand the credit worthiness of the institution holding your account and the supplemental guarantees that might be available. For example, does the institution qualify for coverage under the federal government’s Canada Deposit Insurance Corporation (CDIC), Credit Union Deposit Insurance Corporation (CUDIC), Caisses Populaires Desjardins, Canadian Investors Protection Fund (CIPF), or a similar agency?
• If you are investing in investments that are Cash-like such as money market mutual funds, Banker’s Acceptance, or short-term bonds, then you will need to research the issuer’s credit rating and the liquidity of the investment should you wish to sell it prior to maturity.
• When you search for a list of investment options through the institution that holds your account, each listed investment should display the issuer’s credit rating and the name the agency that provided the rating.

Note: In Canada, the Dominion Bond Rating Service (DBRS) reviews the credit quality of all Canadian companies that borrow from investors. By visiting their website and searching by the issuer’s name, you will be able to obtain the most recent credit quality rating for the investment that interests you.

• Once you know the issuer’s credit rating, you can look at the investment’s maturity date and the offered rate of return in relation to its credit rating to decide if you should own the investment.
• In the event that you need to sell the Banker’s Acceptance or short-term bond prior to its maturity, then the investment’s liquidity will be important.

Note: The term liquidity refers to the level of buying and selling activity that exists for your investment. If an investment is referred to as being liquid, this means that there is an active secondary market for the investment and finding an eager buyer or seller is easy. If you need to sell an investment prior to its maturity date, the more liquid the secondary market, the better the selling price you can obtain.

• On the other hand, investments that are not abundant or popular can be very difficult to sell at a reasonable price. Such illiquid investments must often be priced at a larger discount, often below your cost, in order to find a buyer.
• If you are looking at money market mutual funds, you will only know the past rate of return and not the future rate of return. In addition, you should also review the mutual funds current holdings and its Management Expense Ratio (MER). This information will help you to understand the credit worthiness of the investments held inside the mutual fund and the levels of risk the fund manager is accepting.

Example:  If government bonds have been paying a 1.25% rate of return for the past year and a money market fund, with an MER of 0.75%, has also paid 1.25%, then this might indicate that the fund manager is buying lower quality corporate bonds in order to payout an MER of 0.75% and 1.25% to investors.

Note: There is nothing horribly wrong with a fund manager buying lower quality investments, but you need to have a basic understanding of what it is that you are buying.

Researching for Fixed Income investments

For this category, your primary goals are to achieve a regular, reliable income stream, provide a strong, safe foundation for your investment portfolio, and to help balance the volatility and uncertainty inherent in Growth investments.

Again the investment criteria set out in your Investment Policy Statement (IPS) should be used to guide your research efforts. Focus on individual investments that meet your investment guidelines. Your IPS will have established your criteria for filtering Fixed Income investment options and the desired maturity schedule.

The best place to begin is with the institution that administers your account. They can provide you with a list of all the individual bonds and GICs available.

Note: For real-time bond pricing and bond market information join Perimeter’s Bondview. Bondview subscribers have access to real-time wholesale bond price and yield information on thousands of Canadian dollar Fixed Income products. Bondview presents both the bid and offer sides of the market along with full market depth allowing subscribers to more fully understand the value of their Fixed Income holdings and other issues available in the market.

• In Canada, the Dominion Bond Rating Service (DBRS) reviews the credit quality of all Canadian companies that borrow from investors. DBRS regularly reviews and assigns credit ratings to all public issuers of bonds. By visiting their website and searching by the issuer’s name, you will be able to obtain the most recent credit quality rating for the investment that interests you.
• For information on Fixed Income mutual funds, sites like Morningstar, Globe and Mail’s Globe Investor – Fund Look Up and InvestingForMe’s sections (including our Data Room – Quote Look-up) provide tremendous resources to search, sort and compare various funds.
• In addition, there are subscription advice services, such as 5i Research and  The Investment Reporter.
• For information about Fixed Income Exchange Traded Funds, visit our Data Room – Exchange Traded Funds (ETF) or the individual websites, such as iShares, Bank of Montreal ETFs, and Horizon BetaPro.
• For complete information on preferred shares, InvestingForMe‘s sections (including our Data Room – Preferred Shares section) provides an up-to-date list of individual preferred shares, their current market data, descriptions of each preferred share’s features, characteristics, and issue details.

Researching for Growth investments

Due to the thousands of Growth investment options available and the thousands of various opinions regarding those options, researching this asset category can feel overwhelming and intimidating. Not so if you have already completed the first 9 steps of our Portfolio Design process and you have written an Investment Policy Statement (IPS) to help guide your investment decisions.

The guidelines that you have established for your investment portfolio’s Growth investments will help to narrow and focus your research efforts.

Dedicate your time and efforts researching investments that qualify for inclusion in your portfolio. For example, if your IPS stipulates that your Growth investments must each pay dividends, then confine your research to dividend paying Growth assets.

Researching individual investment options for Fixed Income and Cash asset categories is fairly straightforward because by their nature they provide a high degree of certainty for their end values. This is not the case with Growth investments.

Growth investments provide your portfolio with the promise of future income and market-price appreciation, but no guarantees accompany Growth investments. Dividend payments can be reduced or eliminated and the investment can be worth less than you paid for it.

When beginning to research Growth investments you might want to establish an overall approach to your research and investment selection. For example, are you going to begin with a top-down or bottom-up approach? Both of these are investing terms that refer to a specific investment approach:

• A “top-down” approach means that you are going to first try to identify a growing economy, the Growth sector within that economy and then the best individual Growth investments within that sector.
• A “bottom-up” approach begins with a search for high Growth individual investments first. The overall economic and sector is not part of the selection criteria.

Or are you going use a combination of both? Are you going to use investment charts and trading data in your decision making process? You may want to first use a top-down or/and bottom-up approach to help you identify individual investment opportunities and then refer to the trading data and charts to help with your purchase and selling decisions.

When researching Growth investments, take advantage of both formal and informal research in arriving at your investment decision. For example, an informal approach might be to simply look at your family’s lifestyle for clues to investment possibilities such as the following:

• Take a look under your sink and in your utility closet. What household products do you use? Does one manufacturer’s keep appearing? If you use their products, maybe the company would make a good investment?
• Take a look at your medicine cabinet.
• What services does your family use? (Internet, cell phone, television, computers, etc.) Are you happy with them?
• Where do you shop for groceries? What products do you buy?
• What about your friends? What services and products do they buy?
• When you shop, do you visit the store or do you shop online? How do you pay for your purchases?

Look to your family’s everyday life for investment ideas. In particular, pay attention to what your children and grandchildren buy and do not buy. What activities do they enjoy? Where do they shop? What was on their Christmas list? These may all be clues to potential investment opportunities. In addition, look for new trends. They could be in technology, communications, energy, shopping habits, real estate, etc.

Note: As another example of an informal approach to investment research, in the 1980s, one of our team worked at a retail brokerage firm where one analyst had an enviable track record for identifying new investment trends and themes. One day when the analyst was riding the elevator, he was asked how he identified upcoming trends. He smiled and said that every morning he skimmed the newspaper headlines. He always started at the back of the paper and when he began to see a story moving from the back of the newspaper toward the front he thought a new trend might be developing. His theory apparently was that as the story made its way to the front page, the story would attract a larger and larger following. As the following increased, the investment theme would attract larger amounts of investment capital and thereby the investments would rise in price. The analyst would also begin to sell the theme investments once the story made the front page of the newspapers. While this approach may seem too simple, it does emphasize the importance of money flows into an investment or investment theme.

The investing highway is littered with great investments that never attracted any investment capital. You can find the greatest investment in the world, but unless investors begin to invest more and more money into it, the investment’s price may never go anywhere. And conversely, you can research an investment that, by all metrics, should fail only to watch its market value increase as more and more money chases it.

Investing in Growth assets always involves two forms of analysis: when to buy the investment and when to sell the investment. Most investors devote the majority of their research efforts on the Buy decision and virtually no effort researching the Sell decision.

After completing your Buy research and you have made the decision to purchase the Growth investment, you should then invest some time in defining and identifying the Sell decision. What event, valuation, or unexpected result would cause you to sell the investment?  Consider the following questions:

• Do you sell if you have a profit?
• How much of a profit do you need to have before you would sell?
• What if the investment’s market value declines? Do you sell because the investment did not perform as expected?
• Instead of selling a poor performing investment, do you buy more?
• What if management changes, do you sell?
• What if current management goes out and makes a crazy acquisition, do you sell?
• What if changes to government legislation negatively impact your investment, do you sell?
• What if the investment’s market price moves through some technical indicator, do you sell?

Note: Your selling guidelines should be as well defined as your buying guidelines, before you make your purchase.

Sources for research information are varied and abundant. The investment industry (mutual fund companies, brokerage firms, banks, credit unions, insurance companies, etc.) all generate various amounts of investment research for retail investors. Most provide summaries of past and future economic, business and investment events. Most also employ investment strategists, economists, investment managers and analysts that generate tremendous amounts of research.

In addition to these sources, you can access any number of the following sources:

1. Individual corporate reports (press releases, quarterly and annual financial releases, etc.) as these are tremendous sources of information on the individual companies and their areas of operations.
2. Trade publication, magazines and websites. Almost every sector of our society has its own magazine (Accounting, Medicine Pharmaceutical, Nursing, Real Estate, Construction, Engineering, Aerospace, Aviation, Telecommunications, Actuaries, Pension Administrators, Insurance, Banking, Investment Advisors, Investment Analysts, etc.). They all have publications that write to a specific audience about industry trends and changes within the industry. These can be great sources for your investment research.
3. Government publications and websites. Governments collect and publish massive amounts of data (Statistics Canada, Canada Mortgage and Housing (CMHC), Bank of Canada, the U.S. Bureau of Labor Statistics, Federal Reserve Banks, Bank of International Settlements, European Central Bank, etc.).
4. Think tanks write and publish reports on a whole array of topics (The Fraser Institute, The Canadian Centre for Policy Alternatives, Brookings Institute, Economic Policy Institute, etc.). Think tanks are no different than those in the investment industry or any other publishing entity; they each have their own goals and motivation for writing and publishing articles. But as long as you understand their interests, their research can help investors in with their investment decisions.
5. Foreign news agencies. Begin reading foreign news websites to gain a more balanced perspective of industry and world events. You may not realize it but European, British and Irish newspapers research and write about Canadian businesses and events. Their perspective does not always agree with the views of their Canadian and American counterparts. In fact, most times the foreign news services will follow North American events in greater detail and for longer periods of time than we find with North American news agencies.
6. Independent and Subscription services. There are a large number of independent investment services available to investors. Some offer their opinions and recommendations for free and others require a subscription be paid. For example, one of Canada oldest investment advice services 5i Research and The Investment Reporter.  The subscription service Canadian ShareOwners organization also provides its own specific approach to the buying and selling of individual growth investments.
7. Charting Sites. In addition to InvestingForMe’s charting tools and IFM Quotes, there are a number of excellent charting sites that specialize in providing only charting services (for example, big charts which is a division of MarketWatch). Remember, when searching for charts on shares trading on Canadian exchanges, you need to add “CA:” before the symbol for most charting services based in the United States.
8. Real-Time Market Data Services. If investing is a hobby or passion consider subscribing to a real-time data service like IFM Quotes and Perimeter Bondview. Real-time data services can provide you with up to date news and data as it occurs. The depth of economic and corporate information can prove to be invaluable for active investors.

Remember: One of the biggest mistakes Canadian investors can make is to only follow and read research that helps to reinforce their own investment decisions. This is termed Reinforcement Bias and we all have it to varying degrees.

It is human nature to befriend people with similar likes and dislikes, similar social values, similar habits and hobbies, etc. In addition, we also tend to gravitate to writers and research that is agreement with our own thoughts and conclusions. As a result, we keep reading more and more like-minded literature and ignore the opposing opinions. This bias leads us to over-estimate the validity of our own assumptions and conclusions. The more self-reinforcing literature we read the more certain we become about our analysis and conclusions. Reinforcement bias leads to most investors being blindsided by the market events. Investors too often and too easily dismiss opposing opinions as misplaced, erroneous, incomplete or just plain wrong.  So when researching investments, try to keep an open mind and be aware of the biases present in the article and within you as the reader. You should not only be searching for information that reinforces your decisions, but also information that is counter to your decision.

Remember:  When you begin researching individual investments, use your written IPS as your guide. Your IPS will help you to narrow and concentrate your time and effort on the investment options that fit with your portfolio design. The IPS will help to ensure that each of your investment decisions is supportive of your investment portfolio and your financial goals and it will help to ensure that each individual investment within your portfolio has a specific purpose or job.

Check out Step 11: Monitor, Rebalance and Adjust the Investments as required