Orson Merrick: Building a Robust Investment Portfolio

Hello everyone, I am Orson Merrick. Chief Analyst and Senior Partner of UK Polar Capital Holdings Limited, with over 19 years of experience in investment markets. During this period, I helped clients by providing expert investment concepts and professional knowledge, as well as developed and protected their family and personal assets, giving them solutions to meet their financial goals. Today, I will share with you some of my personal experiences in U.S. stock market investing, as well as some precautions and my own investing logic when doing U.S. stock investing.

When I choose stocks or invest in stocks, I will focus on the fundamentals and technical aspects as a supplement. Fundamentals can help me screen stocks. For example, if I think a company has good fundamentals, I will first select that company and add it to my stock list. After selecting it, I will use technical analysis to determine when to buy, sell, increase, or decrease positions, as well as my stop losses and profit-taking points.
Next, I will share the fundamental and technical analysis of which data or indicators to look at, and then share them with everyone one by one.
Fundamental analysis
(1) Financial statements
Firstly, I would choose to look at the company's fundamentals. Warren Buffett and Peter Lynch belong to value investors, and their fundamental roles are relatively important when making value investments. Peter Lynch previously managed a fund called the Magellan Fund, which achieved an annual return of over 20% and achieved better returns than the market through stock selection for over 15 consecutive years.
Next, I will talk about the fundamental factors that I have seen in investing before. I will mainly focus on the three major financial statements: the balance sheet, the income statement, and the cash flow statement. Financial statements are one aspect that can be seen. The management, team, products, competitors, and potential market size of the company are all factors that fundamental analysis will refer to.
The next step is to analyze each factor that you are interested in. I won't go into too much detail on this topic because it will take a long time. Therefore, I will briefly explain the general idea to everyone.
The balance sheet focuses on the company's cash and accounts receivable. Through cash, we can see how the company's current liquidity is, and if there are debts to be repaid, whether the company has enough cash to repay the company's debts. It is best to combine accounts receivable with the remittance date, such as how quickly they can receive cash from their customers, to see the company's short-term liquidity situation. For example, if the company's payment collection is slow, it may drag on the accounts receivable aspect for a relatively long time, so the accounts receivable item on the balance sheet will be relatively large.
A problem that arises in investing is when a company takes a long time to recover its accounts or there are some payments that cannot be collected, which can cause the amount of accounts receivable to suddenly increase from one period to another. This is worth noting when looking at financial statements.
As for some traditional industries, if there is inventory, for example, if inventory suddenly increases from one period to another and the turnover period also becomes longer, we may go further to explore what causes the inventory turnover rate to increase. Is it due to poor sales, unsold products, or a backlog of some products that have not been selling well?
So we need to delve deeper into the story and reasons behind the numbers, which are related to the current and future development of the company. Like the balance sheet, I also place more emphasis on accounts payable. Does this company provide timely repayment to its suppliers? According to U.S. law, if there are issues with receiving payments from three or more suppliers, they can sue you to bankrupt the company. I have heard of such cases during my career.
It also depends on the company's short-term and long-term debt. Does the company have enough cash to repay the bank loan? If the company cannot repay the money owed to the bank, the bank can force the company to file for bankruptcy. These are some factors that I may focus on in the balance sheet, and of course, there are many other factors that I won't go into detail here.
In the profit and loss statement, I will look at the changes in the company's sales revenue growth over the past 3–5 years compared to the gross profit margin. Assuming we invest in Apple, its gross profit margin is around 50%, but it may have increased to 60% or decreased to 40% in the past one or two years, which are all factors that I value.
If it increases to 60%, then we need to delve deeper into the reasons for the growth. Apple itself has many products, including smartphones, tablets, and computers. Now, Apple phones should account for more than half of the sales. So we may ask whether it is because the gross profit margin of certain products is relatively high that has driven growth, or whether it is because they have achieved economies of scale through cost savings.
For example, if fixed assets are determined, their overall cost decreases as sales increase. Is it this reason, or is it due to the high gross profit margin of a certain product that has good sales?
Going further down are expenses, such as research and development costs, marketing costs, and some management expenses of the company. It is important to see if these expenses have undergone sudden changes. As a technology company, I may value whether research and development expenses are invested sufficiently to ensure the company has good market competitiveness. They invest a large amount of research and development costs into the company, which then enables the company to compete with other companies in their sector, hopefully keeping their product ahead.
There is also a cash flow statement, which can reflect fixed asset investments, financing, and depreciation.
The above is a brief introduction to the three major financial statements. If I invest, I will conduct a simple analysis and judgment. Actually, the most important thing is to look at the financial situation of the company, and we will take a rough look at the rest, which will not take as long as the financial statements.
For example, does the current management of a company have many years of experience in this industry? If the company is facing difficulties now, does the management have previous experience in reversing the company's difficulties? If he is an expert in a certain industry and serves as the CEO or core employee of the company, it may be of great help to the company's future development trend.
(2) Potential market for the company
If I invest in a listed company, I need to see how much market potential the company has in the future. For example, the current market value of this company is already one billion U.S. dollars, and its future market value may only be two billion U.S. dollars. If it has already accounted for 70%–80% of the entire market, it will be difficult for it to grow in the future.
But if the current market value of this company is 10 billion U.S. dollars, with a market share of only 20% and continuous growth, the company's development potential in the next 5–10 years will be relatively large, at least not capped in the short term, and the company can maintain high growth. But if the company itself has a market share of over 80%, the possibility of future growth is relatively small.
Industry trends are also an important factor. Everyone knows about the hot topic of artificial intelligence. If the industry continues to grow rapidly for the next 5–10 years and you want to invest in a company, even if the company is not a leader in the industry, you can still enjoy the investment return brought by the overall rise of the industry. This is a trend in the industry.
(3) Company products
The company's products may attract many users in the short term, and more and more users will continue to use their products, such as on Facebook. Initially, it was a social platform, but later on, the number of users on the platform increased, and the number of daily activities continued to increase. That is to say, firstly, the product itself is well done, which can capture the frequency of user use and increase the number and frequency of people using this platform. This can also be considered a factor that the company values in terms of product competitiveness.
There are also competitors and equity structures. I usually choose the leader in its industry as my target. Firstly, it prioritizes market share so that we are not threatened by the host company. Secondly, there are also some barriers to prevent other companies from entering, which will help them gain customers or market growth. That is why we chose the leader in the industry as our investment target.
Then, like the equity structure, for example, the major shareholder is a well-known investor or institutional investor in this industry. If large institutional investors are optimistic, then it may be more reliable for us retail investors to come in. If there are only some retail investors or small institutional investors in the company itself, there may not be many people who are optimistic about the company. It is important to carefully consider whether the company is worth investing in.
(4) Technical analysis
Just now, I briefly introduced fundamental investment analysis. Below, I will briefly introduce some technical analysis methods and the indicators that I will value.
I have previously written a paper specifically studying the effectiveness of technical analysis in the market over the past 150–200 years. We mainly tested three technical indicators, the first being the moving average line (MA), the second being the relative trend strength (RSI), and the third being the Bollinger line (BOLL).
My team and I tested the relevant data of companies whose stocks have survived since the establishment of the New York Stock Exchange. We then used these three technical indicators to test whether they could buy at the buy signal, sell at the sell signal, and finally see how the overall return was.
The specific details will not be discussed here. The final conclusion is that if RSI and MA are combined, the return is better than all other possible combinations of any 1, 2, or 3. So in the investing process, I always use the moving average and relative trend strength to judge.
Let me briefly introduce the concept of moving averages. For details, you can go online or read professional books. The moving average method uses the crossing of a slower MA with a longer look-back period with a faster MA with a shorter look-back period; depending on the direction of the cross, a buy or sell signal is generated. It’s a relatively simple method.
RSI is calculated using a mathematical formula to determine whether a signal is oversold or overbought when stock prices continue to increase. After the calculation, the numerical standard of RSI is generally between 0 and 100. If it is between 80 and 100, it indicates excessive buying and a tendency towards overbuying. This signal suggests that everyone should sell.
This is just a common concept, and it still needs to be considered relative to the trading volume of stocks or other technical indicators. When the trend of RSI is less than 20, it is equivalent to oversold. At this point, we buy, while when it is over 80, we sell.
The Bollinger Line was created by Mr. John Bollinger, who invented two standard deviations around stock price fluctuations. Based on fluctuations in the past 4 or 21 days, a range of stock fluctuations is calculated, called the Bollinger Line. It has upper, middle, and lower tracks. If it reaches the upper limit, it is generally considered a resistance level and can be sold at this location.
When we break through the upper track, we will use it as support and can buy at this support point. When we reach the bottom track, we believe it is a good support point for buying. If it breaks through the bottom track and continues to fall, it will be considered a technical disruption, and one will choose to sell at this time.
These are the three main indicators, and of course, they are not necessarily the best indicators. Of course, some people will also use well-known technical indicators, such as stock trading volume. I mainly use the moving average and relative trend strength as two relatively simple indicators to make judgments. You can find a book dedicated to technical analysis to take a look at the specific details, and we will not delve into it here.
(5) Stock selection ideas
I have several ideas for stock selection, dividing the stocks I have chosen into several categories. The stocks with high growth potential are cigarette butt stocks, which are very cheap in price, but I believe they are some stocks that have been underestimated by the entire market. Like some event-driven stocks, such as those with good fundamentals or high-growth companies.
A company is selling cheaply. For example, there was a Chinese concept company called Zhongdong Game, which had developed many good games and had its own IP. However, at that time, the market had a relatively low valuation compared to similar American game companies. At that time, I thought it was a cheap stock that was undervalued by the market. At the same time, its management team is also a veteran in this industry, with many years of experience in mobile game development and research and development. Therefore, there are not many companies in this industry that can compete with them in terms of technology and gaming, so we chose this company as a target.
High-growth companies. Give a few simple examples, such as the NVIDIA (NVD) GOPRO. NVIDIA is now quite popular. Initially, they made graphics card CPUs, mainly graphics card processors. They later conducted research on artificial intelligence, autonomous driving, and virtual reality. Its stock price nearly doubled last year.
Another company is called GOPRO, and some people who are interested in extreme sports may be more familiar with it. This is a sports camera company that specializes in producing sports cameras for extreme sports enthusiasts to capture some exciting shots during their exercise. At the beginning, it was widely promoted and loved by the market, and many people came to purchase their products. Although the company's stock price is relatively low now, when it first went public, it probably rose from around 20 to over 90, more than three times and nearly four times, making it a good case of a high-growth company.
Monopoly companies. Give two examples: one is Facebook, and the other is Google. Google is basically the world's leader in artificial intelligence, autonomous driving, and search, with a market share of over 60% or even 80% in the United States.
In terms of social interaction, Facebook's monthly active users have exceeded one billion. In terms of social interaction, they have a WeChat platform abroad that is similar to our domestic platform, as well as a friend circle function that can only send pictures. Facebook's own platform also has software that everyone can use to send text messages, and they are basically leading the world in social network layout. They previously acquired a VR company for one billion U.S. dollars, so they are also a relatively large company in the VR field.
Event-driven investment. Events such as Brexit in June last year and the November 9th election in the United States can be considered event-driven investments. Before this event, we would have some judgments about them, such as short selling gold, short selling European stocks, or short selling stocks before Brexit, because we believe that if we were to Brexit, the risk would still be slightly higher.
At that time, the entire market was not expected to leave before Brexit, so the market was on the rise. At that time, we made an expected judgment on this, and later we had some long positions in gold and short positions in a small number of stocks, which can be considered an event-driven investment case.
Privatization arbitrage or acquisition arbitrage. Give a few simple examples, such as TXU and Alltel, the former fifth largest mobile operator in the United States, which are all privatization arbitrage cases we have done. Merger and acquisition arbitrage, such as Tesla acquiring Sun City and Dell acquiring EMC, typically yields arbitrage returns of around 10% to 30%. Like mergers and acquisitions in the United States, companies do not have as much room for arbitrage. In a particular case, our judgments are not quite the same. These are a simple summary and introduction of how I categorize investments when I invest.
(6) How do I assess value?
Finally, let's briefly talk about valuation. I will do a simple valuation when making my own investments. I use several common valuation methods, the first of which is using analogies of past transactions. A simple explanation is, for example, how much a company paid when it acquired another company. For example, if I am investing in a company and comparing it with the acquired company, and these two companies have similar industries, users, or products, I can use it for comparison.
Assuming Facebook had previously acquired WhatsApp for approximately $19 billion, I may have a simple analogy when valuing Twitter in the future. At that time, it had users paying so much money. I could divide its total valuation by the number of users to obtain a simple ratio, and then multiply this ratio by the number of users of the company I am currently analyzing—Twitter or Weibo—to obtain a valuation.
Another valuation method is that I can compare a company with listed companies and similar companies in this industry. For example, dividing the stock price by profitability or the stock price by sales revenue yields a ratio. Then multiply this ratio by the profitability, net profit, or overall sales revenue of the company I want to analyze in the future to obtain a valuation.
There is also a slightly more complex one called cash flow discounting, which may be more difficult for general investors and slightly more complex for model construction.
Firstly, it requires high predictive ability for the company's future finances. The entire logic of discounting cash flow is to discount a company's future profits to the present and then obtain the company's valuation. This method is widely used in the entire investment industry, but it requires high requirements for model construction, financial analysis, and financial forecasting, which is not recommended for general investors. You can simply look at some valuation analysis reports.
Finally, let's briefly introduce how to build an investment portfolio on your own. We can use simple valuation methods ourselves, such as the two examples just now, to make a simple judgment on a company. Through our own model, we can imagine whether the company is overvalued or undervalued. When building an investment portfolio, you can sell high-valued companies, buy undervalued companies, and build a portfolio that you already have.
For the index, we have our own comparison and are bullish on the index, so that we can make the proportion of long positions slightly higher. If you are bearish on the index, you can take a short position. We can balance our own investment portfolio by adjusting the long-short ratio.