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Investment philosophy, portfolio, position sizing and valuing a business
As a long-term investor, I believe in buying and holding businesses run by great capital allocators, ideally forever. My investment ideas and values have been shaped by investors like Warren Buffett, Charlie Munger, Nick Sleep, Chuck Akre, and the books about them. I do not have an MBA nor did I attend business school; everything I have learnt has been from writings such as, Berkshire Hathaway letters, The Intelligent Investor, Common stocks and uncommon profits and Mastering the Market cycle. At this point I have read over 200 books in the past 3 years and have no plans on slowing down. In this post, I will detail my investment philosophy, which involves holding a concentrated portfolio of 10-15 stocks, hunting for businesses that create win-win-win relationships with their shareholders, stakeholders, and employees, and the art and science of valuation.
Portfolio as of 31st March 2023
Prosus (PRX) - 15.9%
Alibaba (BABA) - 12.4%
Micron Technology (MU) - 8.1%
Markel (MKL) - 8.0%
Amazon (AMZN) - 7.5%
Daily Journal (DJCO) - 5.9%
Meta Platforms (META) - 5.6%
Alphabet (GOOGL) - 5.6%
RH (RH) - 5.5%
Kelly Partners (KPG) - 5.0%
Salesforce (CRM) - 4.2%
FICO (FICO) - 3.9%
Fiserv (FISV) - 3.8%
Berkshire Hathaway (BRKB) - 3.6%
Charter Communications (CHTR) - 2.9%
Thor Industries (THO) - 2.1%
Investment Philosophy:
I believe in a value-oriented, long-term investment approach that involves holding a concentrated portfolio of 10-15 stocks. The idea behind a concentrated portfolio is to put most of my eggs into one basket and watch that basket very closely. I am looking for businesses that create win-win-win relationships with their shareholders, stakeholders, and employees, ultimately making the world a better place because their business exists. Unfortunately, it is not always possible to find a company that is undeniably a win-win-win company. For example, some would argue that Charter Communications or Meta Platforms would not fall under this description. However, I believe both companies do more good for the world than harm.
The businesses I am looking for must have a durable competitive advantage and be able to allocate the majority (ideally all) of the earnings they generate back into the business at high rates of return. I am looking for businesses that compound value on a per-share basis over time at a rate that is faster than the S&P 500 (my benchmark). I want to buy these businesses when they are selling at a discount to intrinsic value and hold the business for a long period of time, up until a point in which either the stock is egregiously overvalued, I was wrong, I no longer have conviction in the company's future earnings, or they are no longer able to compound at acceptable rates of return.
Although ideally, I would like to buy a business selling at a discount, it is far more important over the long term to buy right and hold on, as an outstanding business will create far more wealth when left to compound than buying a business that is less than stellar because it is trading at 50% of its intrinsic value.
Charlie Munger said:
‘‘over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return’’.
If I do my job and buy right, this newsletter will become very boring!
I believe that a good management team is the key differentiator between a good investment and an outstanding investment. Management needs to be incentivized and aligned to manage the business for the very long term and not quarter to quarter. I would like them to be significant shareholders in the business. Management should have a proven track record of quality capital allocation, ideally investing in the current businesses, making small asymmetric bets in creating new businesses; (spawners) that could ultimately be bigger than the current business in the long term. A recent study shows that 50% of the S&P profits come from business lines that were not the original business venture. They should be willing to disrupt themselves because ultimately if they don’t, someone else will, and buy back stock or sensible acquisitions when the opportunities present themselves.
Idea Sourcing:
The main way I source ideas is from the 13Fs of investors I look up to. These are normally, quality investors who have a similar framework to me, they will have a proven track record of beating the market, a concentrated portfolio, and a turnover of less than 10%. I see a lot of investors focusing on investors such as Michael Burry, and although I enjoy seeing his 13F each quarter, my time horizon is indefinite whilst those stocks are likely to not be there next quarter. In my opinion, the most important thing in cloning is to have a set of investors that you can be confident that they will be looking to hold a position for several years, if not longer.
It is important to note however this is just an idea source, I have no problem shamelessly cloning as Mohnish Pabrai would say, but I only clone the idea, not the conviction. This means I do my own deep analysis on the business before making any kind of purchase.
Position Sizing: The key to staying in the game
In a recent interview, investor Guy Spier spoke about the importance of position sizing. In summary he said that it is important to size your positions in a way that feels like the water is coming up to your knees rather than your neck or worse, fully submerged. In other words, you want to have enough in the game to make it meaningful, but not so much that you are at risk of meaningful impairment from a single stock.
I believe that it is far better to have positioned too small and missed out on the full effects of a 10-bagger than to have positioned too large and ultimately taken a permanent impairment. The most important thing about position sizing is being able to stay in the game while ultimately feeling as much of the benefits from your winners.
Position sizing is a complex topic and there is no one-size-fits-all answer. However, I believe that following Spier's advice and sizing your positions in a way that feels like the water is coming up to your knees is a good starting point. It is important to remember that the goal is to stay in the game and capture the upside potential of your investments.
I am comfortable with a position size of 6-9% of my portfolio at cost. I may on occasions exceed the upper end depending on the situation, I have no limit on the size a position can grow to, but once I feel that the water is getting to an area I am uncomfortable I may start to take some chips off the table.
High Quality Business
I believe a high quality business can be defined as a company that possesses the following characteristics:
The business operates in an industry with long-term growth prospects, rational competition, and a manageable pace of change.
The company has a durable competitive advantage that allows it to generate high returns on invested capital and reinvest that capital at a similarly high rate for long periods of time.
The business is built for long-term sustainability, with a strong balance sheet, manageable growth, and insulation from cyclical downturns to the greatest extent possible.
The management team is aligned with the interests of shareholders, with management also being shareholders themselves. The management team runs the business with a long-term outlook, investing in future opportunities and business lines.
Valuing a Business
Valuing a business is more of an art than a science. Warren Buffett says ‘’it's better to be approximately right, rather than precisely wrong’’. In theory, John Burr Williams’ book the theory of investment value summarises it perfectly: a business is worth the future sum of the future cash flows discounted back to the present using an appropriate discount rate." In reality nobody can predict with any certainty what a business is going to earn in 6 months time, let alone 10 years, and if they do, you should be finding them not reading this! An example of this is Amazon, nobody could have predicted that Amazon would be where it is today in 2001, but famous investors Bill Miller and Nick Sleep have held on for the ride since 2000 and have been rewarded with extraordinary returns as a result. Understanding a company's culture can make a huge difference to getting an idea of where a business may be headed over the next decade. Nobody could have predicted Amazon creating AWS, but understanding that Amazon's culture allows them to make lots of asymmetric bets on future industries would give you the confidence to know that a few of these bets may work and become huge winners over the next decade. This does not mean you can expect more AWS like businesses to come out of Amazon, nor could anyone of expected such a phenomenal business like AWS, but I am saying great businesses and the cultures behind them tend to surprise to the upside and as Warren Buffett says it only takes a few great ideas over a life time. When valuing a business I think using a reverse DCF is a useful tool, understanding what is assumed in the stock price may provide a clearer picture of any opportunities between what you believe the business is capable of achieving and how the market is viewing it.
Ultimately I want to hold a portfolio of businesses with the potential to generate large returns in the future priced at low expectations, knowing full well that only a few will work out as hoped and the majority of decisions will be no better than average, and on the odd case when I do find one of those outstanding businesses it is imperative that I distract myself from selling in every way imaginable.
I hope you’ll join me for the ride!
NOTE - This is not investment advice. Do your own due diligence. I make no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness, or reasonableness of the information contained in this report. Any assumptions, opinions and estimates expressed in this report constitute my judgment as of the date thereof and is subject to change without notice. Any projections contained in the report are based on a number of assumptions as to market conditions. There is no guarantee that projected outcomes will be achieved. Leeder capital is not acting as your financial advisor or in any fiduciary capacity.