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We have spent just over a year together, exploring corners of the market that might offer us a chance to earn extraordinary returns on our cash.
I've had a great deal of success with these methods across my career, discovering the overlooked areas of the financial markets where the mispriced companies exist that allow us to buy them and their assets for far less than they're worth, and where the big boys can't play.
I've used strategies like small banks under tangible book value, discounted closed-end funds, stocks below liquidation value, and a host of other strategies to earn far more than any index fund or mutual fund can hope to achieve.
Most of these strategies feature smaller stocks and only a tiny handful of qualifying opportunities at any given time.
That's precisely why they work as well as they do for us as individual investors.
You can't manage billions of dollars using these strategies, but you can turn your thousands into millions with them.
The Rules and the Truth
Today I'm going to kick off our 2020 strategies discussion with one that flies in the face of everything you have ever been taught about investing.
From day one, you're told to avoid companies with a lot of debt because of all the bad things that can happen to a business that owes a lot of money.
But the truth is if you add in a little common sense and some rigid rules about fundamentals and credit conditions, owning a small handful of highly leveraged companies would have made you five times as much money over the last 20 years as owning an index fund.
This works in part because the profits are divided among a much smaller pool of equity owners, so when the business improves, the equity value shoots higher than usual, giving stockholders enormous returns.
Be Ruthless and Prove Wall Street Wrong
With this strategy, we're going to look for companies that have lots of debt.
Specifically, we will limit the companies we consider to those that have a debt-to-equity ratio of over five.
What that means is that for every dollar of equity, there will be at least five dollars of debt in the capital structure.
These companies have to execute flawlessly, and we will take three steps to make sure they do.
- First, companies have to be profitable. It can be by just $1, but they must be profitable.
- Next, we will run the financial statements through a nine-point checklist to make sure they are financially solid and management isn't being reckless.
- Finally, I will use a credit scoring model developed by the world's leading bankruptcy expert to make sure there is little to no chance of the company experiencing any severe financial difficulty.
Only a handful of companies will pass through this rigid examination process.
On average, over the last two decades, there have only been eight companies that meet the requirements at any given time.
Every four weeks, we will run the checks again.
If a company is no longer profitable over the past 12 months, or fails either of the two checklists, you sell the stock.
You have to be ruthless about this.
I can't emphasize that enough.
No matter how much you like the stock or think the business will recover soon, you have to be disciplined and sell.
If it meets all the criteria at some point in the future, you can repurchase it.
With this much leverage in place, there's no room for wishing and hoping. Do what the numbers tell you to do at all times.
Right now, 16 companies pass all the tests, so there are far more leveraged companies with strong financials that are earning a profit than usual. That makes sense, given that the economy has generally been pretty good, and consumers are still spending.
However, once you buy these stocks, remember to be ruthless. At the first sign of deterioration, sell your shares.
A Company with the Right Fit
About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of "Max Wealth."