How To Spot A Good Company Before It’s Overvalued

IMPORTANT: Please read the disclaimer before continuing.

Hey everyone, it’s Kelvin here.

After holding classes for my community recently, I received many messages saying that it was hard to find undervalued companies.

From there, I started reflecting on some ways to spot a good company before it becomes overvalued.

Then, I remembered this very interesting theory that I knew would help all of you, so here it is!

Back then when I was picking up my Chartered Financial Analyst level 1, I came across this term called Mosaic Theory. 

So what is this Mosaic Theory? 

Based on CFI, the definition is:

The mosaic theory is an approach to financial security analysis that involves the analysis of a variety of resources, including public and non-public material and non-material information, to determine the underlying value of a security.

Sounds difficult to understand? Fret not. 

A Quick Illustration

To help everyone to understand this theory, let me show you an example.

(For the purpose of this, I will use a fictitious character named Kelly.)

Kelly is a beginner investor who wants to find a good company she can invest in. She then chances upon Company A and decides to research more about it.

Company A is an e-commerce company and all of its customers transact via its online website and mobile application.

But when Kelly started to analyse the financials of the company. It shows that the revenue declined for 5 years and the company was bleeding a lot of money.

As a result, company A’s share price was an all-time low.

At this point, she almost wanted to give up on her research on this company.

But before doing so, she started to use a free tool called Similarweb.com to check the web traffic of the e-commerce company.

To her surprise, the site showed a recent spike in the company’s web traffic during the past month, but the company had not reported its financial report.

She thought to herself, “Wait a minute, this company could stage a strong recovery…”. 

So Kelly wanted to be creative in her due diligence. 

She drove down to the office building of Company A and stayed there for a few hours each night. She checked the company’s working hours, which are from 9AM to 6PM.

However, she noticed employees leaving their office between 9PM to 10PM. So, it seemed that everyone was putting in extra time.

She returned the next day to observe the traffic in the parking lots. She observed that there were other executives from other companies visiting Company A. 

She identified them as executives from Lululemon, Nike, and Adidas. 

With that information, Kelly proceeded to do her valuations.

She figured out that with a strong recovery in web visits and the possibility of new brands on-boarding, this company could be worth 80% higher than the current share price.

The next morning, Kelly proceeded to invest in the company. 

Two weeks later, Company A put out a press release stating that it has brought on 15 new brands to its e-commerce platform. Some names include Nike and Adidas.

The stock immediately rallied by 90%! 

If you are a regular investor, this would usually be the first point when you hear of this company – and it is usually also already over-valued.

So what can we take away from this?

What Kelly did was not illegal. She did not possess any material information.

Instead, she pieced the information together by using alternative data points. She was making a highly probable bet using the Mosaic Theory. 

In short, the mosaic theory is the usage of a variety of information and coming up with a view of what’s about to happen to the company. 

For investors who are relying on financials solely, their analysis would always fall short in comparison and lack a variant view. 

Creating An Edge Using Mosaic Theory

In today’s world, we have tons of free resources to aid us in our research. 

SeekingAlpha. Morningstar. Tikr.com. Marketscreener.com. Finviz.com. Webull App. 

The list goes on. 

Our edge is no longer in plucking out information from financial statements. 

Our edge is not even in interpreting the numbers as well.

For example, if you’re analysing Meta (formerly known as Facebook), there are probably hundreds of analysts who are performing the same role as you. Some of them hail from top schools such as Harvard or Stanford. 

How are we going to value-add to what they have already presented to Wall Street? 

Perhaps, this edge may still persist in research of small to medium companies where there is a serious lack of coverage. 

To be a great investor means you develop a variant view… and with time, be proven right. 

To get ahead of others, you need to derive unique insights by piecing valuable information and reading between the lines. 

Insights are grouped into two groups – qualitative factors and quantitative factors. 

Qualitative factors refer to the characteristics of the business.

This could refer to the culture, people, and management team of a company. It refers to non-numerical qualities or observations that cannot be quantified.

Quantitative factors refer to information that can be counted.

This covers aspects such as key performance indicators, financial numbers, number of staff, and others. 

Both go hand in hand. 

An Example

Sea Limited (NYSE:SE)

For full disclaimer: I am a shareholder of Sea Limited.

Sea Limited runs a gaming publisher called Garena and an e-commerce company called Shopee. 

Since Shopee is an internet company, there are many ways to obtain information. 

There are many methods that are proprietary to members of my investing community called Growth Investing Mastery. However, I’m sharing some methods which are publicly known to many.

You could use job openings, app rankings and website visits.

Any increase in those indicators would point towards better results. You may not be able to quantify the actual percentage of increase but directionally, you know it is growing.

For example, head over to Shopee’s LinkedIn page and you can see 3,015 job openings. 

Over time, monitor the job openings. If it is increasing, it means the company is gearing up for expansions and it is busy recruiting talents to support the growth. 

For App rankings, you may visit Google Play store or Apple Store. You want to see the app position maintaining or improving.

For website visits, use website traffic monitors such as Similarweb.com.

When you have a lot of alternative data sources pointing towards sustained growth, you will find it easier to develop your conviction in your company. This allowed me to build a big position in Sea Limited.

Once again, the concept of mosaic theory tells us there are many art forms in gathering information.

By fixating our research on traditional qualitative and quantitative formats, we are severely handicapped.This puts us at a serious disadvantage against resourceful and creative analysts.   

Summary 

Mosaic theory is all about pattern recognition. 

Reading more earnings calls, analysing more companies, identifying what makes companies successful are all steps to develop our pattern recognition abilities.

The power to see certain possibilities before others is a powerful skill for any investor.

The world has changed so much within a short period of time. We are living in a world filled with datapoints.

It’s our job to source for those details then drive powerful viewpoints that the broad market does not see. This creates superior returns. 

I also think luck plays an important role. For Sea Limited, I have many friends who are existing staff of Shopee. My position gives me an outsider access to understand the culture of Sea well. 

There are many ways to create luck. Make more friends, be genuine, support each other.

The world is also becoming more collaborative. No longer are days where you can hide behind your computer screen and hope to make superior returns constantly. It’s important to get out there to meet people. 

Collect datapoints, filter them through our lenses and we would make better investing decisions.

And only then can you invest in the best growth companies in the world.