Lesson 7: Generating Stock Ideas

Value Investing 101: introductory course

In a previous lesson, one concept took center stage: the Circle of Competence.
We looked at why it's essential for you as an investor to stay within your own area of knowledge.

To underline that again: if you want to increase your chances of success — in the stock market, in life, and in business — you first need to know where your circle ends. And then: stay inside it.

Today, we take the next step: how do you put this concept into practice? And at the same time: how do you take the first step toward selecting stocks?

Generating Stock Ideas

In a 1993 interview, Adam Smith — author of Supermoney — asked Warren Buffett how a small investor could find good ideas.
Buffett answered:

“I’d tell him to do what I did 40 years ago: learn everything about every publicly traded company in America. Over time, that knowledge base will pay off.”

Smith, surprised, replied that there were 27,000 publicly traded companies.
Buffett smiled:

“Start with the A’s.”

Everyone knows Buffett gets his ideas from reading annual reports. Today, CEOs hand them to him on a silver platter — but 60 years ago, he was just a small player figuring things out by reading every annual report he could get his hands on. And with great success.

You're now standing where Buffett once stood. But you have one big advantage he didn’t: technology.

No need to walk into a library. One click, and you have access to annual reports from hundreds of companies. So you might be wondering:

“Which companies should I start reading about?”

Buffett already gave the answer in 1993 — and he repeated it last year at Berkshire Hathaway’s annual meeting, when someone asked how he would invest smaller amounts of money.

Take a list of small caps — usually companies with a market cap of €200 million to €2 billion. I even like to go smaller, into so-called microcaps. And then:
“Start with the A’s.”

---

Want to narrow it down faster?

Start by filtering out companies you know are outside your Circle of Competence. Below, I’ll give you more methods to help generate ideas.

---

Avoid These Sources for Stock Ideas…

Good stock ideas rarely come from:

• TV or newspaper headlines

• Tips from friends or colleagues

• Your broker (who profits from transactions, not your returns)

Harsh? Maybe. But it saves you a lot of disappointment. Better approach: do your own research.

---

Screening: Your Path to Stock Heaven

While I’m not a fan of blind screening — because data can’t replace thinking — I am a big fan of smart screening. Use it as a tool, not a compass.

I use simple screeners as a first filter. And while I love quantitative models (quant investing, like Joel Greenblatt’s Magic Formula), you really need to know what you’re doing if you go that route. It’s not traditional value investing — so you’ll need solid diversification and strict rules.

There are great paid screeners out there. But you don’t have to pay right away. Tools like Finchat and Chartmill (affiliate link) both offer limited free versions, and — importantly — they let you screen for European stocks, which isn’t always possible elsewhere, and I have experience using them.

---

Three Steps to Screen Stocks

Step 1: Remove any preset filters and set your own, such as:

• Revenue growth (5-year): 5%–50%

• EPS growth (5-year): 5%–50%

• Net margin: 5%–75%

• Return on Equity (5-year avg): 15%–150%

• Debt/Equity: < 100%

• Market cap: > €50 million

• P/E ratio: 5x–25x

• Volume: min. 100 shares/day

Note: these criteria are strict. Sometimes they yield only one result, especially if you filter by a single country too. I now use looser filters, focusing either on quality or deep value. But when you're starting out, it's helpful to begin with strict, high-quality parameters like the ones above.

---

Step 2: Filter out companies outside your Circle of Competence

Cross off any business where you can honestly say: “I don’t understand this.”

---

Step 3: Look at five years of financials using the screener’s data

Look for trends in:

• Revenue growth (ideally rising and stable)

• Net margin (stable or rising; drops are red flags)

• ROE (stable or rising)

• Debt (preferably D/E < 1x)

• Free Cash Flow (FCF), with a focus on trends and FCF Yield (>5% is good)
  

---

The Best Ideas Often Come Unexpectedly

Sometimes, a screener doesn’t spark anything. But life does.

One time, I came across an article in De Tijd (Belgian business newspaper): “Picanol CEO Luc Tack refuses a salary.”

He had just saved the company from collapse and only wanted to take a salary once the losses were cleared.

The stock was trading at €2.90. I didn’t buy right away. But I kept following it.
In 2012, after two years of research, I bought my first position at €10.65. Later, I added at €27 and €45. The stock went above €106 before merging with Tessenderlo at a lower price.

Picanol wasn’t just a lucky shot. Other examples: Corticeira Amorim, Sipef, and more.

What helps? Reading. Staying alert.

Don’t be afraid to follow an idea. Sometimes, reading about one company leads you to a competitor or supplier that’s even more interesting.

---

Next Step: Read Those Annual Reports

Screener data is a good starting point — but real insight comes from the source: the annual report.

A lot of analysts collect piles of data. But more info doesn’t make your analysis better — it just makes you feel more comfortable.

Use a “Less is More” checklist. Focus on what really matters.

---

“Less is More” Checklist

• Do I understand what this company does?

• Is revenue and EPS growing consistently over 5–10 years?

• Will this company still be around — and more profitable — in 10 years?

• Does it have a sustainable competitive edge?

• Does management allocate capital well?

• Does the company need to keep investing just to grow?

• Does it generate more cash than it spends?

These questions help you assess whether a company is good, great, or gruesome — as Buffett might say.

---

Final Thoughts

Successful investing isn’t magic. It’s the result of solid work, knowing your limits, and recognizing opportunity when Mr. Market presents it.

With this approach — step by step, focused and structured — you lay the groundwork for sustainable returns.