My Investment Strategy & Philosophy

Summary: I am a GARP (growth at reasonable price) investor focused on buying stock in companies under $2 billion market cap with long growth runways.

What I look for in a stock:

  1. A company with a compelling product/service but currently small market share, with a clear opportunity–and more importantly, the resources–to take significantly more market share.
  2. Business has pricing power and a competitive advantage. I avoid race-to-zero commodity/commodifiable businesses. I prefer businesses that value-add to commodities because they can distinguish themselves through branding, better design/implementation, and enjoy some pricing power.
  3. Under $2 billion market cap. There are some distinct advantages in investing in smaller companies as opposed to larger ones which I outline in Advantages of Micro Cap Investing. And while $2B is not micro cap territory, it is still small cap, and this filter narrows my focus while not narrowing down my opportunities too much. This filter only applies during the research stage and my first purchase; if the stock grows above $2 billion market cap, I am willing to add to my position, even if the market cap is, for instance, now $8 billion.
  4. Typically U.S. based. I understand the laws, politics, and culture much better in the U.S. than any other country, not to mention I can visit locations and sample products from the U.S. much easier than say, a product/service that only exists overseas. Being able to sample products allows me to better form an opinion on how the product/service benefits the end user, and goes a long way towards understanding the investment opportunity at hand, and building conviction. Of course, if all my U.S. stock ideas have been exhausted, then I am willing to search for opportunities in other countries.
  5. Undervalued. Specifically, current market price undervalued relative to my calculation of terminal value.
  6. Competent management team; no red flags.

Risk Management:

  1. Cash only, no margin. This allows me to sleep at night even if I am down 50% on a position, because I know that my broker cannot take me out of my position; I can weather the storm and hold the stock for as long as I believe in the narrative I have outlined, and I can ignore Mr. Market. (See Volatility Does Not Have to = Risk).
  2. Although a position is allowed to grow past 20% allocation as the stock price rises, I do not allow the principle position to take up more than 20% of the portfolio. Unless the stock is at an absolute bargain price that I don’t believe will last long, I tend to scale into positions rather than buying all at once. There has only been one instance where I went over 20% and that was for PRPL, as I had a very strong opinion about it and covid pandemic had sent the entire market sharply down.)
  3. Do not purchase options. Options add unnecessary decision layers to the process. You either want the stock or not.
  4. Do not short stocks. It is more rewarding to be a buyer and an owner. Much has been studied about the opportunity cost of shorting versus being long.
  5. Appraise conservatively to build a margin of safety, and if the calculated upside is still many multiples above the current market price, then I know that I am looking at an investment opportunity that has asymmetrical risk:reward. (Great example: PRPL. You can argue that it is a $70 stock, but I used conservative inputs in my model to come up with a $32/share valuation; and seeing that the market price was ~$11/share, I bought it (and ended up buying more when it went into the single digits, bringing my cost average to $9/share. As of this writing, PRPL is trading near $40/share.)
  6. If I can’t imagine the business existing or being necessary 10 years from today, then I pass. I’m sure my assessment of this won’t always be right, but so far I’ve saved myself a lot of grief with this filter alone.
  7. I avoid ideas where the upside will only last for a limited time; I am looking for “permanent” growth.
  8. Build core position when stock is out of favor or in decline (buyer’s market.)
  9. Pass on average ideas, even if those average ideas might make a little money. Trust that the big fish will eventually swim by for me to net. The worst thing that could happen is to be reeling in a small fish just as the big fish swims past.
  10. Find bears and understand their view points. Attack your own stock constantly and see if you can defend it with facts.
  11. A gut check I ask before every stock purchase: “If this stock were to plummet 50% the moment I buy it, but for no fundamental reason at all, how would you feel about the stock now–would I still have conviction in its growth prospects?”
  12. During the research process, I avoid the opinions of other analysts and investors until I have learned enough about the company to distinguish faulty opinions from informed opinions.
  13. If a friend or colleague is pitching a 10X opportunity that I have a feeling will work out but don’t really understand the mechanisms of, I pass. I don’t care if they get rich and I don’t. I understand that there is a great peril in allowing short-term, lazy-thinking, shortcut-seeking habits to run my decision making that will eventually cost me lots of money in the future. Stick to principles.
  14. Don’t feel pressured to make money on everything. Define your circle of competence and stay in it. Be okay with saying “I don’t know” and passing on an opportunity. Passing on average ideas helps bring you closer to great ideas sooner. Be okay with congratulating others on winning big in a stock that was out of your circle of competence, and moving on, rather than questioning your entire strategy because you didn’t have as high of a return as someone else. Stick to what works.

Exit Parameters:

  1. If I find a new opportunity that is much more superior to a current opportunity, I exit the weakest current opportunity to free up space for the new one.
  2. If I see cracks in the growth narrative, or if reality is beginning to deviate negatively from my original expectations, then I exit the position.
  3. If I have hit my price target but the stock keeps going up and I am unsure when to sell, then I manage the exit using a trailing stop, using an ATR indicator as a guide (yes, I am willing to turn into a technical trader with my fundamental investment.)
  4. If the stock is down big, and it’s warranted and due to a disastrous fundamental reason, then I exit the position, take the loss, and move on. My philosophy here is that regardless if holding may allow you to take a smaller loss, the best thing is always to exit and reset as soon as possible so that you can move on without any baggage. The more days and weeks you attempt to hold on to a stock that’s clearly a loser, the more it weighs down on you and affects your decision-making, morale, and research.

Avoiding Analysis Paralysis:

  1. After my initial research, if the stock checks out on all my main filters and value is “popping out” at me, I buy a small position to keep me motivated to finish off the more intricate parts of the research (e.g. finer modeling details, etc.) Similar to setting a pack of wolves loose on yourself; the more you see the stock in your portfolio and realize you don’t know every single detail about it, the more motivated you become to complete your research.
  2. If I am unsure, even after doing enough research to have already made a decision, I pass and stop looking for anymore information. I will not sit around trying to justify a stock I don’t really understand, or a stock I can’t see myself tuning in for every conference call, etc. It’s much easier to avoid a bad stock during the research phase than to have to sell off the losing stock later.

The cornerstones of my investment philosophy:

  1. Remember, it’s a company, not a lottery ticket: As a businessman who comes from an entrepreneurial family, I know better than the run-of-the-mill analyst that it takes time to grow a business. This means that my time horizon has to be years, not months or weeks, if I want to enjoy big gains from my investment.
  2. True Fundamentalist: Ignore the idea of capital gains during your research. Instead think about the cash flow the company can make if they successfully execute their growth plan; put a price on that cash flow, and if the current price is many times lower than that appraisal, then you might have something on your hands. Basically: buy the cash flow the company generates, not the capital gains you think the stock may or may not produce. (It’s always great when a stock goes up, and in the long run stock prices do anchor to earnings power, but try to discount it completely during your research and think of the company’s value only. Do not rely on the market to save you. Pretend that the stock market will shut down for the next 3 years–will the company be bigger, better, when it re-emerges after those 3 years?)
  3. Go for multi-baggers: If I’m going to hold a stock for 3-5 years (or perhaps even more), then I want to be compensated with above average returns. I don’t want 60% gain, I want 200%, 300%…1,000% gains–as much potential upside as possible.

My investing role models:

  • Philip Fisher
  • Warren Buffett
  • Benjamin Graham (specifically for Chapter 8 and Chapter 20 of The Intelligent Investor)
  • Charlie Munger for his GARP influence on Buffett
  • Peter Lynch

Last Updated: 2/12/21 (My internal checklist is much more concise and chunked, but I was lengthy here to give more detail on my thought processes.)

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