I’ve been a moderately satisfied brokerage customer at Zecco for almost 3 years. I was initially attracted to the broker for sole purpose: free trades.

At the end of last month, Zecco announced a significant change in their trading policy (emphasis mine):

“When Zecco Trading first launched in 2006, our focus was to deliver a good, solid service at a bare bones price. In the four and a half years since that launch however, our customers’ needs have evolved quite a bit. While investors today certainly value low commissions, they also demand a great trading service with a rich set of advanced features.

To better support this balance between offering remarkable value and continuing to deliver the innovative new technologies, tools and services that Zecco Trading customers require, we are modifying our commission structure. Starting on March 30, 2011, our new commission rates will be:

Equity trades: $4.95 per trade*

Options trades: $4.95 per trade, plus $0.65 per contract

With this change we are no longer offering 10 free trades per month. As before, there are no minimum balance requirements or inactivity fees to open or maintain a Zecco Trading account.”

While the new commission structure is reasonable, I’m disappointed in the news.

Broker History

I started out my investing career at Scottrade. For a discount broker, Scottrade had a nice interface, great customer support, and reasonable commissions.

However, with a small amount of starting capital, commissions – even $7 flat fee commissions – had a not-insignificant effect on the growth of my account balance.

While I consider myself a long-term investor, I am constantly adding capital to my brokerage account, meaning I’m often adding to positions every month.

In addition, after the first year, I started out getting into more special situations or workout investments. Scottrade, along with many other brokers, charges a “voluntary reorganization fee” for tenders or stock conversions.

The fee usually starts around $25, which can significantly cut into the profits for odd-lot tender offers.

So I shopped around for a new broker, and ended up with Zecco.

Zecco Experience

Support at Zecco could be much improved, especially with the email support option.

There is a reason why Zecco ranks very low in customer service surveys.

Phone support is much better, but I personally was transferred around to several departments before finding a knowledgable person around special transactions like a merger arb situation or going private transactions.

Let’s face it: Zecco had built up its business on the promise of free trades.

Over the years, the free trade aspect has been drastically modified:

• From 40 free trades per month to 10 free trades per month
• Then from a $2,500 min qualifying balance to a $25,000 min qualifying balance
• And now to no free trades at all

The company has added additional community features and mobile options to its product mix, but as a (somewhat) sophisticated investor, the only thing I care about is the commission rate and order execution.

Time for a New Broker!

The latest change at Zecco removes the last remaining reason for continuing with their service. While it is a pain to switch, I’ll be making the move before the end of the month.

What I’m looking for in a broker:

• Ability to trade penny stocks with little or no additional fee (a must)
• Option to trade internationally at a reasonable cost (Canada & UK to start)
• No ‘reorg charge’ or other fee for tender offers or other special situations
• Execution speed and ease of buying illiquid securities

I probably make 5-10 trades per month (often because I’m building up a position in an illiquid security). I’d like to minimize my transaction costs and open up my stock trading universe.

Please leave a comment below or drop me an email with your broker suggestions.

Selling positions is often harder than buying. It is all too easy to get married to certain positions and hold on for too long.

To improve my performance in this area, I’ve tried to avoid eking out the last few percentage points as an investment rises closer to my valuation range.

Undoubtedly, I had some flaws in my original analysis (investing is not an exact science), which means my range probably wasn’t perfect in the first place – sometimes it’s best to just move on to a new position.

This is Part 1 of the thought process behind two of my most recent sales.

Stryker Corp (SYK)

My blog currently focuses on microcaps so this giant ($25b market cap) medical company is a bit outside of the blog’s normal scope.

However, the recent financial crisis brought about an amazing opportunity to pick up wonderful businesses at historically low prices. SYK was one of those picks.

The company competes in the ultra-competitive medical device segment with companies like Zimmer and J&J. – think hip replacements, knee replacements, and other medical supplies.

The company is an amazingly stable performer, with sales rising from $5.4B in 2006 to $7.3B in 2010 without a single down year.

EBIT has improved on a similar uptrend, as operating margins increased up to the current 24%.

FCF has followed, growing from $892m in 2006 to $1.5B in 2010, for a current FCF yield of 6.01%

5 year ROE (18.59%), ROIC (17.65%), and CROIC (21.06%) are all outstanding, especially for a company sitting on $3.3B in net cash.

So Why the Sale?

When I purchased SYK in the summer of 2009, the stock was selling for under $40/shr, for an EV of approx $14B.

This translated into an EV/EBIT of 9x and EV/FCF of 10x – very low for a company that showed no signs of slowing down its growth in sales, profits, or cash flow.

The stock is up over 60% since that time and currently trades at an EV/EBIT of ~12.5x and EV/FCF of 14.4x (or 14.4x and 16.5x using 5-year average EBIT & FCF figures respectively).

My conservative DCF valuation provides a valuation range of $65-$70 per share.

While there is still a good chance that the stock is undervalued, the margin of safety has shrunk considerably.

Short-term, the new health care legislation will affect the profitability of medical devices makers, with a 2.3% excise tax due in the next 2-3 years.

Conclusions

Long-term, I think the stock will outperform (the baby boomers are a driving force: older baby boomers = higher demand for joint replacements!) but believe there are better, and significantly more undervalued areas, to place my money.

So I sold.

When I started out investing, I tried to keep a significant portion of my portfolio in these large stable names with a strong competitive moat (many would describe this as the new Buffett philosophy).

Today, I’m more comfortable hustling to find the microcap stocks that are significantly undervalued (the old Buffett philosophy).

Since I’m willing to put in the work, I sometimes make the decision to sell a great stock for the chance to earn even greater returns in another investment idea.

At least for now, I’m sticking with the old.

Part II – Stay tuned!

Disclosure

No positions

P.S. –  Rational Walk has a great summary of closing his position in Noble Energy (NE). I went through a very similar experience with NE – check out his summary for a great write-up.

As I had mentioned in my previous posts on the evolution of my value investment philosophy, I’ve recently been focusing more on microcap stocks trading on the OTCBB and Pink Sheets.

While many stock screeners aggregate data for most stocks on the OTCBB, Pink Sheets are not required by law to file periodic financial statements, making a screener less useful.

Despite this, many Pink Sheets continue to file audited financial statements and press releases.

Since many investors are unwilling to purchase these types of securities, this dynamic presents a great opportunity for the willing investor, as many of the securities are significantly mis-priced.

Buffett’s Approach

At the 2001 Berkshire shareholder meeting, Buffett talked about his approach to investment research:

When I started, I went through the manuals page by page. I went through 20,000 pages in the Moody’s industrial, transportation, banks and finance manuals — twice. I actually looked at every business — although I didn’t look very hard at some.

Since the opportunities in the broader market are drying up (at least for the fundamentally cheap stocks I’m looking for), I used this as inspiration to start my own research project into all of the businesses trading on the Pink Sheets.

I would look at every possible stock and decide whether it was worth further research.

As Buffett said, I wouldn’t look very hard at the majority of the available stocks, but I was hopeful that I would find a few gems.

On the OTCMarkets website – the go-to source for Pink Sheets securities – I started with the Symbol Information File for the entire company directory.

A recent check shows 20,730 individual securities, a staggering number.

Research Methodology

A significant number of these securities consist of stocks trading on the Grey Market – a security that “is not listed, traded or quoted on any U.S. stock exchange or the OTC Markets” and has no market maker – and therefore can be avoided.

Check out the list of OTC Market tiers to better understand the various levels of disclosure.

I also removed international stocks, setting them aside for further review later. (Right now, I continue to trade through Zecco, which does not provide exposure to international markets)

For the initial stage of this project, the focus was on U.S. common stocks.

Once the list was cut down, I started going through the list one-by-one.

I’d open up each stock quote page on OTCMarket and check out the latest price quote, stock chart, and company information. I’d look at the financials, and open up the latest 10-Q and 10-K.

I could usually tell within a minute or two whether the stock warranted further analysis.

Many stocks are labeled as development or exploration companies, outside of my circle of competence and likely not generating revenues.

A large portion were banks and other financial institutions, an immediate pass for me.

Others were shell companies, continuing their public disclosure in the hopes of merging with an entity in the future.

And numerous others had no identifiable business model or updated financial information.

Consistently negative profits, tons of debt, recent or repeated share dilution (a favorite among the penny stocks) are all reasons to cross the name off of the list.

The ugliest had literally billions of shares outstanding yet traded for only fractions of a penny.

While some investors might find value in these types of securities, I decided to just pass instead of looking at them very hard.

At the same time, many of the stocks were growing, profitable businesses with long histories, but ones that had decided that the costs and compliance of Sarbanes-Oxley and full SEC reporting were not in the best interest of the company or shareholders.

If the stock passed the initial once-over, I’d usually spend time reading the full annual report, the last few quarterly filings, as well as the proxy statement and any recent press releases or insider filings.

Only then, satisfied that it was a legitimate, worthwhile business, would I add it to the watch list for full due diligence at a later date.

By the Numbers – 3698 Stocks Later

Final Tally: 3,698 stocks

Roughly 15% of the stocks passed my initial 2 minute due diligence check.

Of the stocks requiring further due diligence, I broke them out into subjective tiers based on their overall business model, cheapness, insider holdings, etc.

All Tier 1 stocks required additional due diligence and number crunching to identify actual investment candidates.

To date, maybe 20-30 companies made it as candidates on my immediate watch (or buy) list.

30 out of 3698

.8%

Conclusions

There is no doubt that there are still incredible bargains out there for investors who are willing to put in the effort to comb through the undiscovered corners of the market.

A few examples:

• A business with 50 years of history trading at 1.5x EV/EBIT & less than working capital
• A sub $50m stock that grew revenues through 2008/2009 with an average FCF yield of 27%
• A $300m in sales company selling for 0.65x book value, with positive net income for 9 out of 10 years

It was an incredible exercise, and definitely helped my confidence in evaluating companies through their financial statements alone.

In these stocks, the simple things matter – profits, cash flow, positive equity – and I’ve found that I prefer it that way.

It took me almost 2 months to complete this initial review, but it is a quest that never ends. I need to go back through the Tier 2 & 3 stocks for a second pass.

Final Thoughts

In a 1993 interview, Buffett talked again about his recommendation for investors who are starting out with small sums of capital and searching for undervalued opportunities.

Adam Smith: If a younger Warren Buffett were coming into the investment field today, what areas would you tell him to point himself in?

Warren Buffett: Well, if he were doing – if he were coming in and working with small sums of capital I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities and that bank of knowledge will do him or her terrific good over time.

Smith: But there’s 27,000 public companies.

Buffett: Well, start with the A’s.

3,698 stocks later.

From A – Z.