How I invest and why
I’m sometimes asked how I invest and why. Are you a value investor or a growth investor? Here are some ramblings on my investment style.
Of course, no one approach is perfect for everyone. I’m at the point where I need to make a decent return to get by — but I have enough invested that I don’t want to lose it, and downside protection is first and foremost. Berkshire Hathaway, $BRK, is a great holding for me. The downside is small, but if it meets my projected return, it will probably be enough to get by on. There may be something that will have a higher upside, but (at mid-2020 prices) there are very few if any stocks that I project as having a better worst-case return. (If you know of some that have a similar lower-bound return with a higher expected return, please let me know!)
While I used to look for the highest expected return, I have come to appreciate Ben Graham’s “margin of safety” more and more (cf. Chapter 20 of his book The Intelligent Investor). I now seek the “highest expected return with a margin of safety on the real value of my portfolio.” After the US Federal Reserve’s 2020 printing of money, however justified in response to the Covid-19 pandemic, preserving my after-tax spending power is of primary importance. Since I don’t have enough assets simply to preserve my assets without earning a decent real rate of return, I’m not a fan of holding gold or any other non-earning assets without a clear path to appreciation. Similarly, given the low interest rates, taxation, and potentially significant inflation, I’m not a fan of the long-term fixed-income assets available.
So am I a value investor? I’m a value investor in the sense of seeking to buy an asset below its intrinsic value. But I am not a value investor if defined as a price-to-book-value factor in a Fama-French type model. If that factor seems cheap to me, I’d consider buying it, but I have no expectation of any return based on that factor; its historical outperformance may have simply been due to chance alone.
I define intrinsic value as the (discounted) future net cash flows available to shareholders over the life of the company, including the reinvestment of any distributions made. That’s the mental model that I use in evaluating a business, although I often don’t use a detailed discounted cash flow (DCF) model. But the mental model is useful to me. I also strive to have a “margin of safety,” at least at the portfolio level; usually I try to have the margin of safety in each stock as well. Sometimes that means that a stock I purchase may not gain much, but there’s not much chance of losing a lot of money and there is a potentially big upside. Or, sometimes it’s just a “boring” company with slow and steady growth. As I see it, reliable growth can definitely be part of the margin of safety.
Of course, I look at the portfolio as a whole. That’s what I’ll be living off of. I try not to get too concentrated in one sector or event. At current $BRK prices, a large position in Berkshire Hathaway makes sense to me with the remaining stocks as 5-10% positions, most initially closer to 5%. If I get more positions than that, I can’t keep up with the 10(k)s, proxy statements, quarterly earnings calls, evaluating the business and management on an ongoing basis, etc. I’d love to have just 10% positions in a few long-term compounders, but I just haven’t found enough to fill my portfolio. So you could say that I have a GARP bias in theory. But most companies with excellent growth prospects don’t seem to me to have a margin of safety right now.
Good company management is very important to me, preferably with incentives well-aligned with shareholders. I do get very nervous, however, when there’s a shareholder or group with a majority of shares; I’ve seen too many instances of minority shareholders bought out at too low a price.
As you may have noticed above, I am somewhat eclectic in the places I look for stocks. Right now, I see the US market as pretty highly priced; there seem to be some microcaps better priced, although there’s a lot of trash too in the microcap (and nanocap) space. Let me know if you see any good microcaps! My DMs are open on Twitter at @BradleyDSchultz . Finally, it appears that there are more good stocks right now outside the US, especially in small companies in developed markets, but I struggle to evaluate those (and would prefer not to invest in high dividend stocks with withholding taxes, as most of my investments are in tax-advantaged accounts where I can’t get the tax credit for foreign taxes paid). Of course, I’ll consider a really good stock, with a rationale for why markets are overlooking the company.
In the meantime, I’ll continue looking for companies with good business models; good, shareholder-oriented managements; with little downside; at fair or better prices – wherever I can find them.