One of my cochamim (wise ones) in the investment arena is Francis Chou. Recently, he taught a class in Toronto and outlined the principles for investing in CRAP companies. CRAP is an acronym for Cannot Realize A Profit. His investment results have been excellent and I was interested in how they were generated.
The beauty of CRAP companies is that they are so inexpensive. For anyone with a bargain mentality, these companies have an overwhelming allure. However, it doesn't take long to lose money in one of these investments and that is no fun. Chou states that losing money in some of these investments is part of the process. The purchase of CRAP companies involves "a shotgun approach rather than a rifle approach."
Chou screens through thousands of companies, looking for the companies with the highest drop in price. In the course of this process, Chou believes that he can only value about 20% of the companies. These are only valued in a general way. He quotes Buffett as saying that guessing the exact weight is not necessary; just knowing they're fat is enough. The valuation of the other 80% he describes as "inconclusive."
Within these conclusive companies, he "shotguns" for 60% accuracy. But, he does so with at least a certainty of 80%, not a 60% level. Because of the accepted limitations in accuracy, he avoids purchasing more shares in a company when it drops in value. He simply accounts these drops as likely to be in the 40% where he missed it, often takes the loss and moves on.
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