How I Invest

As investors we are always looking to learn and find insights from others in our field. This may be in the form of reading their books and letters, watching their interviews, viewing their 13F filings, etc. However, WHO we are learning from is equally as important as what we are learning. But how do we know if we are surrounding ourselves with the right people? This question is what I will do my best to answer in this post regarding my personal investment style. 

So to start, you’d be forgiven if you deduced by the name of the website or by the Mount Rushmore of investor quotes throughout that I am a “value” investor. Someone who buys statistically “cheap” stocks. But the truth is I don’t view myself in that way. I am simply an investor. To quote Buffett, “what is investing if it is not the act of seeking value at least sufficient to justify the amount paid?” Thus the term “value” as a precursor to “investor” is redundant. And if Buffett’s opinion isn’t sufficient on the matter here’s one from Charlie Munger, “All intelligent investing is value investing, acquiring more than you are paying for.” Instead of viewing investing through the “value vs growth” framework, I use an “investor vs speculator” framework. In my opinion, an investor might buy an asset that looks statistically cheap or statistically expensive so long as they believe that it is truly undervalued and they are therefore buying below its intrinsic value. However, a speculator has no view on the value of the asset they are buying.  

So as an “investor” how do I actually invest? Well I have two types of investments I look for, core positions and special situations. In terms of the core positions I have 5 primary attributes that I look in an investment: (1) I look to invest in high quality businesses (2) that are run by honest, competent, and aligned management teams (3) that offer products or services in geographies that I understand (4) that are still growing and therefore I can own for a long time (5) that I can make an investment in at an attractive valuation. Another way of putting it is that I take a private equity approach to the public markets. This is not a novel idea, but in reference to the attributes that I look for: I only buy the types of businesses that an intelligent buyer in a private transaction might buy (attributes 1, 2, & 3). In order to realize as much value as possible I look for businesses that I can own for many years and that are selling below their intrinsic value (attributes 4 & 5). An additional advantage of taking a private equity approach to the public markets is that prices fluctuate much more drastically in public markets, thus allowing me to make investments in some of the highest quality businesses in the world at superior prices to that of the private markets. Also, if I change my mind and determine I was wrong about the investment I can exit the position quickly.

If you have read your fair share of investing books or listened to portfolio manager interviews, this list probably won’t surprise you, and it shouldn't. I am looking for what most people are looking for in an investment. No one has ever said “Im looking for a real dog of a business that I can pay a lot of money for.” However, just because people say they are looking for the same qualities in a business, doesn’t mean everyone’s portfolio looks the same. Actually most portfolios of noteworthy investors are quite varied. Just look at some of the most successful investors’ portfolios and you will see drastically different industries, number of holdings, weightings, etc. So does that mean some of them are lying about what they are looking for? No, not necessarily. I liken it to every parent thinkings their children are the cutest, it’s simply personal preference. 

Of course the 5 points I touched on above are just a condensed statement of how I invest. Each of those points has a long list of questions that I make sure I know the answer to before making any investment in a business. But instead of boring you with a long list of checklist questions I will instead briefly clarify some of my statements from above.

Attribute (1) High Quality: When I say “high quality business” I essentially mean that I am looking for a business that is highly cash flow generative and possesses some sort of competitive advantage that allows it to earn high returns on capital. Also known as a moat, force, power, barrier, etc. Whatever industry the business is in, it must possess something that I can point to that explains its success in the past and what will make its success enduring in the future. Along with cash generation and competitive advantages that allow it to earn sustainably high returns on capital, the businesses are usually in secularly growing industries and possess a sound balance sheet.

Attribute (2) Management: This point is pretty self explanatory. No-one is looking for a business that is run by liars and crooks, but unfortunately for investors these crooks aren’t wearing bright orange jump suits. As a small private investor I don’t have access to management. So I instead read as much information about them and watch as many interviews of them as I can in order to aid my judgement process.

Attribute (3) Circle of Competence: One might think that this point is another obvious one. Who wants to own a business they don’t understand in a geography they aren’t familiar with? If most investors thought about it that way their answer would probably be “no one”. But investors don’t view investing that way, and therefore invest in things they don't understand all the time. They do this for many reasons, but the most common is diversification. Many arguments have been made on both the pros and cons of diversification, so I won’t engage in them here. I will just simply say as someone who has been investing actively for years. I have yet to amass sufficient knowledge on hundreds of businesses, period. Let alone enough businesses that meet all of my requirements for investment at any one time. I prefer to stick to what kinds of businesses and geographies I understand (which honestly isn’t very many), instead of investing by checking sector or geography boxes.

Attribute (4) Growth: One major advantage of owning a productive asset like a businesses as opposed to a non-productive asset like gold, crypto, currencies, or other commodities is the potential for growth. Imagine that you purchase 1 ounce of gold and 1 share of stock in a business that is growing earnings at 15% per year. You then put them both under your mattress for 5 years. At the end of that time you will still have just 1 piece of gold (it may be worth more, maybe less); however, with the stock you not only still have the original 1 share, but you have doubled your initial investment’s annual earnings, and therefore assuming a constant multiple you have doubled your investment. Plus you also have the dividends that the business distributed over that 5 year period, as well as a potentially larger share of the business if they used any of their earnings to repurchase shares. As someone who invests for the long term the combination of capital appreciation, dividends, and a larger piece of the pie, is potentially a very valuable asset.

Attribute (5) Valuation: So what is the business worth and is that currently an attractive price? I will start by saying that valuing a business is extremely subjective and thus everyone will arrive at different answers. Buffet would often say that if he and Munger were to compare their valuations of Berkshire they would certainly arrive at different numbers. I personally take many factors into account when valuing a business and I use different valuation techniques depending on the business in question. I try and find the best tools for the job and stay flexible when doing valuation work. This is in opposition to many market participants who use one or two metrics to value entire businesses and call it a day. This I believe is what led to Phil Fisher’s statement of “The stock market is filled with individuals who know the price of everything, but the value of nothing.” I do my best to know the value before I invest.

Of course I can still be wrong when making an investment that checks all 5 of my boxes, but if I feel confident based on all 5 attributes that my principle is secure and the upside is high I will invest. This doesn’t happen very often. I would guess the average is 1-2 new core investments per year. A note worth mentioning is that in order to find these investment opportunities I almost am always making a contrarian investment. Meaning that at the time of my investment the business is very disliked by the majority of other investors and especially the media. Although this type of contrarian strategy does make the investment decision slightly more difficult by having to determine which of the numerous negative details matter over the long term and which don’t, it is almost a guarantee that negative sentiment will be present at the time of my investment due to my valuation requirements.

Last but not least, I will discuss portfolio construction. Im not going to delve into the details in this post, I will save that for another time. But I will just quickly mention how I think about sizing positions. Once I have done all of the work of researching a business and its time to make the initial investment, I want to make the position large enough to accomplish three things. The first thing I’m looking to accomplish is to make sure that the position is big enough to scare me into diligence. What I mean by “scare”, is that if the position is too small I wouldn’t feel the need to learn as much as I should before making the investment. However, if the position is a large one, well then now I’m sufficiently “scared” into doing my due diligence. The second reason is that I want to make sure that if I have really done all my research and am correct, I will be compensated for that work. Again, if I make it too small of a position, even if I’m right it wont make much difference to my overall returns. The third reason is that it helps limit the number of businesses that I own at any one time. I attempt to follow the industrialist Andrew Carnegie’s advice of “put all of your eggs in one basket and watch that basket”. This limited number of holdings also insures that I am investing in my best ideas and am not becoming a “closet indexer”. The simple framework that I follow for portfolio construction is around 8-12 core positions that range from 5% - 20% each. These core positions are often held for many years at a time. 8-12 core positions isn’t a magic number or anything like that, it just fits with my position sizing goals of 5% - 20% with smaller special situation positions mixed in.

In addition to the core positions I also have smaller special situation positions of around 1% - 2% weighting. Like the core positions these investments are also quite rare but higher risk, which tends to limits the number of them that I do to a couple a year. They will typically involve some sort of situation like a merger, acquisition, spinoff, liquidation, bankruptcy, restructuring, or simply an extremely disliked asset. The key element that I look for in these special situations is higher asymmetry and shorter duration. For example i’m NOT interested in a merger arbitrage situation where the upside is +5% if the deal goes through but if the deal fails the downside is -25%. I’m looking for the inverse of that, I want the potential upside of the investment to be multiples of the downside risk. I usually expect the situation to resolve itself (one way or another) within a 1-2 year timeframe. Occasionally I will look to buy these securities via an option contract when it makes sense to do so, which adds to the asymmetry if i’m right on the timing and outcome of the situation, but the downside is still limited to just the premium paid. 

I apologize for the length of post, but I have made this post about as concise as I could and still cover the basics of how I invest. Each of these points made could be a post all of their own, and maybe one day will be. Hopefully it has been helpful for you to see how I invest and made it clear as to whether you want come back for more.

Thanks for reading