In late summer 2000, I agreed to participate in a feature Microsoft’s MSN Money had planned. This was my introductory journal post for that feature, a way of introducing myself more fully to readers. I had been writing for MSN Money since 1997 as Value Doc, which is why I was included in this feature.

This is remarkably similar to what I think today, with some notable tweaks. I am planning a multi-part series of Posts covering how I pick and analyze stocks today. That will start next month. Right now I am focusing on writing up a few posts on stocks I like now.

I was 29 when I wrote this.

Background

This is the story of how a born finance guy took a detour through medicine before getting on back on track as an investment manager. Born in New York, I mostly grew up in San Jose, California – the capital of Silicon Valley. Out of 522 people in my high school class, two became lawyers, two became doctors (including me), and the rest are probably working in tech.

On a high school career guidance quiz, I tested into becoming an accountant, which matched my love of numbers but did not appear to match my ambition at the time. In typical high school fashion, I set upon doctoring as a noble and ambitious profession. Weary of the Bay Area but quite happy with California, I set off to UCLA and choked down a pre-med curriculum while majoring in economics. After graduating, I was torn between my interest in going to business graduate school and medical school – but medicine ultimately won, and I headed for Vanderbilt School of Medicine in Nashville, Tenn. I guess I figured I could always do an MBA later. I underestimated my commitment to medicine – seven years later I was still doing it.

Over the years, I continued to study and practice investment in common stocks. I had discovered Benjamin Graham and Warren Buffett and become enthralled. My investment library swelled to over 50 texts – twice as large (in number, not weight) as my medical library. By 1996, I had realized that I certainly was not going to need an MBA to understand successful business and investment practices of the past and to create those of the future.

During early 1997, I created a finance web site that espoused rational valuation principles and practice amid a growing internet-related stock bubble. That led to a side career as a freelance financial journalist for sites like MSN Money. In time, even with my time constraints, I came to realize that I had researched the companies about 10 times more thoroughly than any of the analysts I interviewed. In fact, I came to view sell-side analysts and their bosses as often relatively simple when it comes to their investment conclusions.

The freelancing stopped in early 1999 as I buckled down to study neurology at Stanford University Hospital and to develop my new, more popular valuestocks.net site, which won nice reviews in Barron’s, in The San Francisco Chronicle, and on CNBC. (Twice, the site was chosen Best of the Web in stock picking by Forbes.) I left medicine on June 30, 2000 to develop Scion Capital, LLC. I was fortunate to catch the interest of Joel Greenblatt, the legendary value manager who headed the Gotham Capital hedge fund. In short order, both Gotham Capital and White Mountains Insurance Group (NYSE: WTM) acquired portions of Scion Capital.

I expect to run Scion Capital for a long, long time, and I will always hold one goal dearest. That is, to be conservative yet creative in the successful allocation of capital for maximum return.

My strategy isn't very complex. I try to buy shares of unpopular companies when they look like road kill, and sell them when they've been polished up a bit. Management of my portfolio as a whole is just as important to me as stock picking, and if I can do both well, I know I'll be successful.

Weapon of choice: research

My weapon of choice as a stock picker is research; it's critical for me to understand a company's value before laying down a dime. I really had no choice in this matter, for when I first happened upon the writings of Benjamin Graham, I felt as if I was born to play the role of value investor. All my stock picking is 100% based on the concept of a margin of safety, as introduced to the world in the book "Security Analysis," which Graham co-authored with David Dodd. By now I have my own version of their techniques, but the net is that I want to protect my downside to prevent permanent loss of capital. Specific, known catalysts are not necessary. Sheer, outrageous value is enough.

I care little about the level of the general market and put few restrictions on potential investments. They can be large-cap stocks, small cap, mid cap, micro cap, tech or non-tech. It doesn't matter. If I can find value in it, it becomes a candidate for the portfolio. It strikes me as ridiculous to put limits on my possibilities. I have found, however, that in general the market delights in throwing babies out with the bathwater. So I find out-of-favor industries a particularly fertile ground for best-of-breed shares at steep discounts.

How do I determine the discount? I usually focus on free cash flow and enterprise value (market capitalization less cash plus debt). I will screen through large numbers of companies by looking at the enterprise value/EBITDA ratio, though the ratio I am willing to accept tends to vary with the industry and its position in the economic cycle. If a stock passes this loose screen, I'll then look harder to determine a more specific price and value for the company. When I do this I take into account off-balance sheet items and true free cash flow. I tend to ignore price-earnings ratios. Return on equity is deceptive and dangerous. I prefer minimal debt, and am careful to adjust book value to a realistic number.

I also invest in rare birds -- asset plays and, to a lesser extent, arbitrage opportunities and companies selling at less than two-thirds of net value (net working capital less liabilities). I'll happily mix in the types of companies favored by Warren Buffett -- those with a sustainable competitive advantage, as demonstrated by longstanding and stable high returns on invested capital -- if they become available at good prices. These can include technology companies, if I can understand them. But again, all of these sorts of investments are rare birds. When found, they are deserving of longer holding periods.

Beyond stock picking

Successful portfolio management transcends stock picking and requires the answer to several essential questions: What is the optimum number of stocks to hold? When to buy? When to sell? Should one pay attention to diversification among industries and cyclicals vs. non-cyclicals? How much should one let tax implications affect investment decision-making? Is low turnover a goal? In large part this is a skill and personality issue, so there is no need to make excuses if one's choice differs from the general view of what is proper.

I like to hold 12 to 18 stocks diversified among various depressed industries, and tend to be fully invested. This number seems to provide enough room for my best ideas while smoothing out volatility, not that I feel volatility in any way is related to risk. But you see, I have this heartburn problem and don't need the extra stress.

Tax implications are not a primary concern of mine. I know my portfolio turnover will generally exceed 50% annually, and way back at 20% the long-term tax benefits of low-turnover pretty much disappear. Whether I'm at 50% or 100% or 200% matters little. So I am not afraid to sell when a stock has a quick 40% to 50% a pop.

As for when to buy, I mix some barebones technical analysis into my strategy -- a tool held over from my days as a commodities trader. Nothing fancy. But I prefer to buy within 10% to 15% of a 52-week low that has shown itself to offer some price support. That's the contrarian part of me. And if a stock -- other than the rare birds discussed above -- breaks to a new low, in most cases I cut the loss. That's the practical part. I balance the fact that I am fundamentally turning my back on potentially greater value with the fact that since implementing this rule I haven't had a single misfortune blow up my entire portfolio.

I do not view fundamental analysis as infallible. Rather, I see it as a way of putting the odds on my side. I am a firm believer that it is a dog eat dog world out there. And while I do not acknowledge market efficiency, I do not believe the market is perfectly inefficient either. Insiders leak information. Analysts distribute illegal tidbits to a select few. And the stock price can sometimes reflect the latest information before I, as a fundamental analyst, catch on. I might even make an error. Hey, I admit it. But I don't let it kill my returns. I'm just not that stubborn.

In the end, investing is neither science nor art -- it is a scientific art. Over time, the road of empiric discovery toward interesting stock ideas will lead to rewards and profits that go beyond mere money. I hope some of you will find resonance with my work -- and maybe make a few bucks from it.