The GCI Member's Manual


Warren Buffett coined the phrase 'owner's manual' to describe a document that appears on the Berkshire Hathaway website and has been included in the company's annual reports since 1996. It explains in crystal-clear prose exactly what Berkshire Hathaway does and therefore how its shareholders should think about their investment. The choice of words is deliberate: Buffet wants his shareholders to think of themselves as co-owners in a joint endeavour, rather than transient holders of a tradable security. This is how Buffet regards his own relationship with Berkshire's investments in listed stocks. Terry Smith, founder of Fundsmith (and a former stockbroker of mine during my fund management days), has also adopted the same idea. Both documents are well worth reading.    

As well as wanting to keep good company, it struck us that a similar 'member's manual' would be helpful for both existing and new readers of GCI. We use the word 'member' here, rather than 'subscriber', because it implies togetherness and a shared purpose, similar to Buffet's concept of a Berkshire shareholding representing a 'partnership'. We all want to manage our money as well as we can and benefit from holding great small cap stocks in our portfolios. However as individuals we each differ by temperament, goals, net worth, risk tolerance... the list goes on. So it is important we are all on the same page in understanding the context that GCI is written in and how it looks at the world - hence this manual. 

What we do to help you invest

Each month we interview an average of 20 companies - more during results seasons and fewer in holiday periods. It works out at 250 a year. I hope my near 40 years' experience as a professional investor means that I know what questions to ask - so we never sit back and listen to management's presentation. Rather we ask questions that we believe address the most important issues facing the company. This privileged access to CEO's is something that most private investors do not have. There might be the odd exception, but virtually every stock written about in GCI will have been interviewed recently and is a share I can hand-on-heart say I know something about. We will never give a view without having done the work beforehand.      


I enjoy writing and try to choose the words in GCI carefully in order to put our views and opinions into context. That's important since we all have different requirements and approaches in our investing, as noted earlier. So GCI will occasionally be forthright in its views on a stock or theme - but only occasionally. That's because there are only so many ideas that warrant conviction: most stocks sit somewhere on the spectrum that has 'conviction buy' and  'conviction sell' at the extremes. Hopefully we can add value to your decision-making by saying where we think a stock sits on that spectrum: so it is important to take on board all the nuances when we discuss a company, rather than blindly acting on the bald recommendation.



That's because 'buy', 'sell', and 'hold' are quite blunt instruments when expressing a view on a share - XYZ plc might sensibly be a 'buy' for one investor but unsuitable for another. We also discuss around 20 stocks per issue with three main recommendation pieces, regardless of whether the stock market might be high and ripe for a fall, or at a low point and primed for an upward move. Indeed, part of our job is to bring new ideas and names in the small cap universe to you attention - that's why we talk to so many companies, rather than just focus on a few favourites. Don't blindly put buy-rated stocks into your portfolio therefore - read the context to get a full picture. Maintain a watch list and do some further research by reading the annual report and a company's stock market announcements.  


Our starting point in evaluating stocks is the fundamentals. Is this a good business and are its fortunes improving or deteriorating? Then we make a judgement on valuation. Is the stock cheap, dear, or about right when we consider what its fundamentals offer. So a stock could be a 'buy' because we really like the company and can live with the valuation; or it could be a buy because the fundamentals are OK but the valuation is very attractive. The conviction buys referred to above occur when the planets align: a good business is seeing an improving outlook and its stock is valued cheaply. 


Time horizon and liquidity

Short-term trading opportunities occur all the time and there's nothing wrong with taking advantage of these. However it goes without saying that equity investment is a long-term exercise and GCI takes this longer view in its assessment of a share's merits. That's partly down to the Editor's temperament, but largely it's because it provides more value to our members. We are trying to identfy stocks that can do well over the months and years rather than just days or weeks. We are thinking particularly about the next two years when we discuss a share - that is a good time horizon to have in mind when thinking about an equity investment. We do of course comment on near-term timing; but what happens over the next few weeks can prove more of a random walk than a reflection of a stock's fundamentals.


As an aside, I have owned Next shares continually since 1998. I have added and taken profits along the way, but have always had a holding. It can be very hard to run winners, but it's worth it (my original buy price was 473p; at the time of writing the price is £60 and I have received almost £23 in dividends per share). On the other hand, I still bear the mental scars of selling my ASOS holding for a nice turn at 70p in 2005, rather than taking a long-term view! 


When I was a fund manager there was pressure to perform on a quarterly or even monthly basis. As private investors we have much more freedom. We can hang on to favourite long-term holdings during sticky patches and equally we can cut mistakes for a quick loss, without having to explain ourselves to a Chief Investment Officer or board of trustees.


We are also smaller than institutions which means we can get on board a micro-cap share much more easily. Often an institution won't bother looking at a stock until it's above a size threshold, or it will have to wait for a placing for the opportunity to buy a unit size. That gives us a significant advantage over the professionals and is why we cover micro-caps as well as the more mainstream names in our universe. 


Pictures (in this case stock charts) can be worth a thousand words. And while we would never deal purely off a chart, a clear technical picture can often be the clincher in decision-making. So we will usually comment on the chart pattern when writing up a stock. Similarly we like to see director and institutional ownership. The former because it aligns management with shareholders. The latter because institutional backing makes it easier to issue fresh equity to strengthen the balance sheet or make acquisitions. 



Like skinning a cat, there are plenty of different ways to approach the problem of valuation. No single one is going to be right all the time, so it's important to remain pragmatic and flexible.


In general we look for stocks that offer growth at a reasonable price - 'GARP'. Growth because that's why we invest in equities - to share in the growth generated by successful enterprises. The 'reasonable price' bit is self-evident. We don't want to overpay because even great companies can be poor investments if you pay too much for them. On the other hand an obsessive focus on value can also be dangerous - many deep value stocks are 'cheap' for a good reason and can trap you in a poorly performing business. 


To judge whether a share is offering us GARP we usually relate the p/e ratio to the growth rate - as a rule of thumb, if this 'PEG' ratio is less than 1x then the shares are cheap. Clearly the lower the better, but plenty of other factors also need taking into account - balance sheet, cash generation, dividends, management, quality (which incorporates financial ratios like margins and return on capital, as well as subjective factors like competitive position). 


These numbers help, but the process is not mechanistic. We are using our experience gained over almost 40 years in the stock market to judge whether all these factors add up to a buy, sell or hold.    


This is not investment advice... 

Although I have spent most of my working life as a regulated individual, I am no longer registered with the FCA and GCI is not an FCA regulated publication. That means we do not provide investment advice. Our commentary reflects our personal views which are passed on for your general information. These views are given in good faith, draw on our long professional experience, and are the result of research - but any conclusions we draw might not be appropriate for your investment needs as an individual GCI member. 


We also get things wrong - it's the nature of the beast. So please do take professional advice and undertake research in order to understand your investment goals and risk tolerance. Getting the right asset allocation for you as an individual or family is crucial. Small cap stocks happen to play a relatively big role in my personal portfolio, but one size does not fit all and your circumstances might make it appropriate to have a small exposure to the sector. Likewise the GCI Portfolios are not designed to be models which should be replicated by our members - they exist to illustrate the challenges and opportunities in managing a small-cap portfolio.     


Why small cap investing is worth the effort

If you have got to the end of this manual then you must be convinced investing directly in equities and specifically in smaller companies is worth the effort! Of course we all hope to make super-normal returns by taking advantage of the opportunities in the asset class. But there is an overriding reason why it's important in my view - it is about taking control of your personal finances, and about acquiring freedom and choice as a result.


Sadly, fewer of us nowadays can rely on guaranteed occupational pensions. We have to teach ourselves about investing because financial education in schools is non-existent. Indeed, ignorance about the stock market is bizarrely worn as a badge of honour by many interviewees in the personal financial pages! Investing in equities early in life and allowing returns to compound over the years and decades is the best route I know to obtaining financial security and freedom.


Good luck with your investments.