Long before I took the CFA curriculum into my hands and started watching Mark Meldrum (huge kudos!) on YouTube, I tried to start multiple businesses. In my humble opinion, there were no less than 20 attempts.
One of the most profitable enterprises was laptop flipping. Here are some reasons why this business helped me a lot in my investment approach and how it can help you.
We’ll use analogies between laptops and companies to make it easier to compare.
First of all, I had to decide how much money I needed to start with and what types of brands I wanted to flip. I could choose to work only with the most reputable ones, like MacBook and ThinkPad because of their liquidity. People buy it a lot and all the time.
It's all the same with companies. If an investor has a lot of money, he needs to pick the first 80-100 companies from the S&P 500 by market capitalization, because the more money he has, the fewer investment options are available to him.
Back then, I was young and started selling all laptop brands. But I quickly realized that I needed to get the most durable ones and buy them cheap. There are multiple characteristics to check: display, hardware, case, keyboard, touchpad, etc. And every model has its own weaknesses and problems. If a seller doesn’t know these things and just buys with closed eyes, he is at the risk of selling a bad unit to someone. The buyer will refund it, of course, and the seller will have a useless asset and an irrecoverable money loss.
If someone wants to buy a good laptop without issues, he needs to know what and where to check. It became very clear to me that it was almost impossible to know everything about all laptops, and I needed to specialize in particular brands and good-selling models.
I think you already see the analogy with a company analysis here. To buy a wonderful business, you need to understand the "known issues" and its "hardware." Or put it simply, understand what’s going on in the industry and where it’s going.
I chose to specialize in two brands (Lenovo and Apple). There was huge liquidity because they had reputable brands and a decent variety of models. I could have chosen Dell and HP also, but I decided to stay narrow and get more value from specializing than from quantity.
Then I needed to choose models. That was pretty simple. I selected the business segment from Lenovo (ThinkPad series) and all MacBook models since 2011. Putting aside all the trashy brands that fall apart after 3 years, with bad screens or dying HDD, I saved a lot of time to spend it on actual buying and selling rather than figuring out what might be wrong with a laptop.
This is so similar to companies. From almost seven thousand companies that trade on US stock exchanges, we have just 300-400 that deserve a true deep analysis because most other companies earn no more than the required cost of capital even if we don’t take the tax issue into account.
To get my profit, I needed to buy a laptop below the average market price. First, I needed to develop some skills in identifying profitable listings. For example, not every cheap listing was worth buying; sometimes it had defects that couldn’t be seen before the purchase. On rare occasions, I bought defective laptops because the price was so good that I could sell them for double the price after replacing some parts (turnaround businesses, yeah?), but it wasn't the general rule.
Second, I needed to be creative and utilize psychology. Sometimes people were too lazy and didn’t even write a model in the title of the ad, so I went through all the Lenovo items to occasionally find a bargain. Another way was to check for misspellings. I looked at MakBook, Macbok, Aple, etc., places no one would look at. If a person was so careless as to write the proper name, would he also check the right price of the laptop?
In the previous note, I talked about the importance of looking inside a company’s financials in order to find undervalued stocks. If everyone is buying large companies from newspapers, we need to look at companies with a market cap of under $1 billion. If everyone is selling large companies, we need to take a look at it now. Not the other way around.
Here we go into the most interesting part of flipping: profit. If we buy a laptop cheap enough, we can get a huge amount of money compared with the price we paid. Looking at my old accounting records, I had a high margin on ThinkPads (35%), but a low selling amount (10–15 units per month). With MacBooks, it was different. Margins were smaller (10%) because those laptops were always more appreciated on the market and price inefficiencies were rare. But the liquidity was way better, allowing me to sell 25–30 units per month.
As you can see, the profit was almost the same, but I stopped selling MacBooks after three months. Why? The answer is "Return on Invested Capital."
I needed to freeze just a tiny portion of my capital in ThinkPads and spend less time finding and selling them to get the same profit as from MacBooks. Furthermore, ThinkPads were more of a business laptop. Companies usually buy it for their employees and renew it every three to five years. So if you knew how to get it from a company, you could buy it really cheap and wouldn’t even need to compete with other guys on eBay.
Through Reddit, I started to concentrate on establishing business connections with system administrators of many companies. They were the first guys who knew when the old laptops would be depreciated.
But let’s return to companies. Buying stocks just because everyone is buying is not far away from betting. An investor needs to buy businesses that generate a profit. And the most efficient way to compute the attractiveness of a purchase is to measure it by the amount of money a company returns on an investor's "frozen" money. Of course, he needs to understand a lot of "known issues" and "hardware" about a company if he doesn’t want to lose the principal.
Eventually, I stopped my flipping business because I was finishing my bachelor’s degree and needed to concentrate on getting my master’s. But I didn’t stop implementing those two investment lessons--specialization and return on invested capital--later.