I’m building my portfolio to compound over the next several decades and protect against downside. This means I have to take a long-term approach, it also gives me the advantage of being able to take some risk. Pursuing this goal, I make primarily three types of investments:

• Established compounders

• Multibaggers

• Value plays

While established compounders are often multibaggers as well, I’ll outline how I think of the two categories differently from a risk-reward aspect, returns, and company size.

Established Compounders

These will tend to be larger, more established companies. They will have a long track record of growth and strong rates of return. But, this also means a lot of that strength is priced in, so the return from multiple expansion and company growth is lower.

The returns will still be strong and over my hurdle rate, but I don’t expect a multi-bagger within a few years.

So why invest in these companies?

If you’re investing for the long-run and want some security in your portfolio, knowing you can grow at a good rate for years, these are perfect.

They will experience downturns, of course, but they’re much less risky than the multi-baggers I will discuss. In my opinion, you don’t need as great of a margin of safety, but the growth baked into the stock price also can’t be too high.

For me, these are companies like:

Texas Roadhouse - Beloved restaurant chain that has returned 15.5% annually since 2004. Not a high-growth sector, but they have a very clear growth pipeline with existing and emerging restaurant brands.

Constellation Software - Proven ability to find high-return areas to deploy capital, 34% CAGR since 2006. Trades at a premium and primary area of growth is becoming limited.

Berkshire Hathaway - High downside protection, strong capital allocation, but low growth potential.

Amazon - Has several established businesses that are market leaders. They have displayed an ability to innovate, but are already so large that you shouldn’t expect high double-digit returns.

Note that these aren’t taking into consideration current prices.

Multibaggers

For me, multibaggers need to fit a few criteria:

• Small - generally small-cap or mid-cap stocks

• Low valuation - ideally a P/E under 10, but higher can be okay too

• High ROIC - although I’m seeking companies that have room to grow and improve, I generally want to see that >10% returns on capital are already achievable

• Strong tailwind - either their overall market or specific service needs a reason to grow fast and eventually gain attention

Wanting multibaggers to be small is pretty obvious, the smaller the company, the more likely they are to have room to grow. Another unrecognized aspect is that smaller companies often don’t have much analyst coverage. Less analyst coverage means less knowledge and projections around the company, and thus lower valuations. Also, when the stock eventually does get coverage, that will help push their multiple expansion.

Low valuation is important because returns come from not only underlying company growth, but also the market recognizing the company’s potential. This is what magnifies returns. One of Buffett’s greatest investments was in Apple in 2016. At the time, Apple was trading at a 12-13x P/E, today they trade at 39x, that is a 3.2x from multiple expansion alone. Adding the earnings growth and share buybacks, Apple is an 8-bagger over the past 10 years. In contrast, if you buy a stock at a 30x P/E the strong results are already baked into the price, and you won’t get much further expansion. This is why it’s important to buy at low multiples to achieve multi-baggers.

Strong tailwinds are very important, especially if they’re not fully recognized by the market yet. Whether it’s growth of annual fires, domestic construction, or housing shortages, tailwinds make growth easier and give the sector more investor interest over time. This helps expand the P/E multiple, provides a growing pie rather than relying on solely stealing market-share from others, and can be massively impactful on share price if you catch it early.

For instance:

Sterling Infrastructure’s share price is a 20x in the past 5 years. Their P/E was 10-12x in 2020, the company was in the middle of a turnaround and the markets they were entering were all expanding. Sterling’s operating segments profited from the large federal infrastructure bill, high-demand for homes, and the growth in domestic manufacturing, e-commerce, and data-centers. The level of growth and margin expansion would not have been possible in a stagnant or shrinking market.

See below for my write-up on their turnaround:

Value Plays

I don’t participate in these as much anymore because I don’t think the effort and risk is worth the return. If I notice an egregious mis-pricing and am interested in it, I may take advantage, but I have found myself spending less time with these.

Generally, for a value play to come about, there has to be negative press around the company or market. This will push prices lower than they should be, which also lowers risk. If you think the market will rebound in a timely manner, you can recognize a very strong return.

I took advantage of this during the banking crisis when SVB fell. See this post for a discussion on my investments in PacWest and Timberland Bancorp:

You can also find value plays in stronger companies. For instance, Meta and Netflix, which have both experienced significant declines and sharp rebounds in years past.

Below, you can see Netflix’s stock dropped in 2022 from near $700 to $170 in half a year! If you had invested at the bottom, you would’ve experienced a 2x in the next six months, and over a 5x in the next 2.5 years!

The beauty of these types of investments is you don’t need a rock-solid thesis on the next 10-years, you just have to believe the market is overreacting. Despite the end of COVID and emergence of competitors like Disney and HBO, Netflix had an incredible market position and brand among consumers, they weren’t going anywhere.

Conclusion

I pursue small-caps to achieve large returns at a higher risk, and invest in proven compounders to secure some of my wealth. Value plays can also be great if you’re interested and have a non-consensus opinion.

I believe a diversified approach is a useful one for the average investor with a long runway and I will aim to provide more recommendations of strong picks in the future.

Read full disclaimer here

It has been a while since I wrote a post. I have been busy with my studies and have not been able to allocate as much time to actively researching new and old positions. My schedule has freed up more recently, so I have been inspired to pen a new post.

This sabbatical has given me time to reflect on my past investments. Though they are all higher than the price I purchased them at, I do not believe that is a positive metric for the quality of my decision-making. Especially since most positions are less than two or three years old.

Woes of Overpaying

One that has been on the top of my head is Dino-Polska. I was sucked into the frenzy and love for the stock and believed that nothing could go wrong. They were portrayed as this unique player in the Poland market that found their niche and gave them a competitive advantage. The risks appeared miniscule or unlikely, and the prospects for continued growth appeared beautiful. A high price was made to seem worth it for the potential for expansion across the rest of Poland and surrounding countries.

What I failed to see through this fog of ecstasy was how a high price is risky, no-matter the company.

Risk of High Growth Projections

Sure, you can cite PEG ratios and other growth dependent valuations. But, that doesn’t disregard the fact that the higher the growth rate you estimate for a company, the more room there is for them to miss that projection.

A growth rate of even 20%, but especially 30%+ is incredible to achieve (and sustain!) for even smaller capitalized companies. If you base your purchase price on such high expectations, it can become dangerous.

John Huber has reflected a similar sentiment:

I agree that even though paying 50 times earnings would have worked very well for FAST shareholders in 1989, I’m not interested in going anywhere near that type of valuation, because I don’t want to rely on my dubious ability to predict the future that far in advance.1

Buffett seeking 8%+ for investments versus the 30% or more some investors seek, are two completely different levels of risk. It does not matter the company size or prospects, 8% growth is incredibly easier to predict and achieve versus 30%.

There are of course people who do this successfully: VC, growth-equity, etc. But it is incredibly hard, variable in success rates, and necessitates incredibly deep insight into the company and industry, something very hard to attain as a public market investor.

Back to Dino Polska

Yes, I still hold Dino Polska, and my position is profitable, but I still view my purchase as a point of weakness. I felt like I “had to have” DNP in my portfolio, which is just flat wrong. Don’t ever fall in love with a stock, it can only hurt you and blind your judgment.

The risk of rose-colored glasses is encapsulated by one of my favorite quotes, I’ve heard it mentioned by the likes of Howard Marks and Milton Friedman:

“It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.”

- Mark Twain

Why I Didn’t Sell

I still hold DNP because I don’t believe that you should automatically sell a company once you realize you might have spent too much.

If you believe something fundamentally changed in the company, you should sell. But, if you think you paid a little too much, freaking out and immediately selling is not the solution. Especially if that feeling of being wrong was brought about by a drop in stock price.

Rather, you should reevaluate the situation and see if your money is better kept there or allocated to another opportunity (opportunity cost), including either the realized loss implications, or the tax implications from a realized gain.

The beauty of public markets is also the danger: the incredible speed in which you can make portfolio changes once you realize a past decision was poor or a new opportunity is better.

My Weakness

I would say one of my great weaknesses as an investor is my poor ability to envision the bear case for companies I view as fantastic. Sometimes it’s hard to tell if this is due to the quality of the companies or rose-colored glasses preventing a truly fair evaluation of a company’s prospects.

On the bright-side, not looking at my portfolio much in the past two quarters has incredibly surprised me with the performance of the companies I am invested in. (And with a lot less stress than I would have had if I was checking every day!)

To Check or Not to Check

The question of checking prices of stocks, I own or want to buy, has been bouncing around my head for years.

On one hand, I fall into the camp of thought that you should not constantly check the share price of your portfolio. It often causes excess worry over every little fluctuation and drop.

This then leads us to our human tendency to seek causality, aka narrative bias. We search far and wide for why the stock price dropped (or shot up), thinking, “there must have been something! A strange comment on the earnings call, some new competitor, a new government policy, something!!” But, often times it is just good old Mr. Market going through his manic-depressive phases.

On the other hand, these depressive market phases can also serve as a great way to grow your position of a company you believe in, given you’re aware of the price swings. If you are very in touch with what you value one of your portfolio holdings at, when there’s a 10% drop, you can pounce on it.

It is this tough give and take that I don’t believe I will ever fully solve. You either sacrifice some peace of mind by constantly watching every stock fluctuation, or you don’t pay attention at all and miss chances to add on to your portfolio (or trim if egregiously overpriced).

I believe the ultimate position to be in is more of a stoic approach to stock prices. You don’t care of the daily fluctuations, you just care where that falls in relation to your intrinsic valuation, because you are confident in your analyses and conclusion. I believe this is what makes the greatest investors. For many, it is probably an inherent character trait, but I think it can also be trained. Indoctrinate yourself into the Buffett philosophy.

Thanks for reading, see you next time.

Investment Philosophy

In this post, I figured I would go over my investment philosophy as it has developed further and changed throughout the past year.

Inspiring Characters

Who are my biggest inspirations? Nick Sleep and Qais Zakaria (Nomad Investment Partnership), Peter Lynch, Warren Buffett, Charlie Munger, and Phil Fisher.

How have they influenced me? They have strengthened my tilt towards focusing on companies that have a strong potential to grow and are dominant in their industries. From Buffett, I have learned the power of a strong brand name and of course the importance of a “moat”. Peter Lynch and Phil Fisher have helped me see the growth side of things, where it is okay to pay a higher price (albeit reasonable) for a company that has a good chance to compound at higher rates. Sleep and Zakaria’s letters have shown me a lot through their investing journey, going from value oriented investors to huge proponents of quality and position concentration. And, Charlie Munger has provided a view into how the joy of learning from various disciplines can also make you a better investor (Michael Mauboussin is also a great source on this).

Through these people, among numerous other sources, I have formed what I look for in companies.

The Main Points

What do I look for in a company?

• A company with a proven business model and profitability

• Management who are proven capital allocators

• Future growth potential (often with an industry tailwind)

• Superior competitive position/differentiated offering

• Fair valuation

• Easy to understand growth drivers

• Good company culture

None of these things sound revolutionary, and they aren’t. I feel they are rather simple on paper. But, in my mind, how I weight each of these points is constantly shifting, a much more complex web. I find that defining your investment philosophy is only a tiny step. The test is whether you can stick to them, but also know when to break them. Additionally, the best way to truly get better is practice, studying as many companies as possible and finding what you do and don’t like. No two companies I invest in are the same or have the same prospects, the investment process in quality companies contains high levels of subjectivity.

My Biggest Struggle

Valuation hands down.

The adage goes, “price is what you pay and value is what you get”, but how do you determine the true value of a company? Trick question, you can’t.

You can give your best estimate, but it will likely be nowhere near true. When Buffet and Munger were haggling over a couple million dollars trying to buy the Buffalo Evening News, did they have any clue that within ten years its annual profit would be much more than how much they paid for the company? Or, that a few decades later the internet would come out, and regional newspaper advantages would slowly be decimated? No, they had no clue.

Sure, you want to find how much cash a company will produce “from now to judgement day”, but how do you actually even come close to an unbiased estimation of that, even finding the true earnings power is sometimes hard.

Furthermore, there’s research and disputes in how much valuation matters if the company grows revenues and profits at a high rate. But, should you even rely on a high rate? How much does margin of safety matter? What is your discount rate? Should you even do formal excel models at all? It’s a constant battle that people struggle with, and I do immensely.

This conundrum ties into the next section:

Understanding Growth Drivers

One of the points I find key for me is understanding where growth can come from. This is part of Buffett’s idea of simplicity and circle of competence. Although as most young people, I am decently tech-savvy, I am by no means an expert in the technology space (especially software). Furthermore, I overall find it hard with some of these companies such as SaaS companies to map out how much they will grow and where it will come from. It often relies on past earnings trends and belief in management, who are you to say this chat service company will get 20% or 0% growth next year. That’s why I’ve decided to not pursue some such as Text S.A. because I simply couldn’t tell you what would happen in a fast-pace, highly competitive, little differentiated, and constantly changing industry. And it is why I love companies that have tangible store locations, where I can map out how each store addition will add to profitability.

Recently, my valuation and growth estimation methods have varied by company. I find it useful for brick and mortar type businesses such as restaurants or grocery stores to map out the return on capital on a store level and how many stores they would need to open for a specified growth rate. This helps me see if these stores are worth reinvestment and how far the current cash will go for reinvestment and growth. But in some others it can be a guessing game. That’s why I like either companies with tangible locations as the profit source, those with a view into future earnings (contracts/backlog), or strong companies in markets with high expected growth rates overall. I’ve also found it useful to use reverse DCFs as a quick check into what the market is pricing in.

Company Culture

This has also been a struggle of mine, largely in debate on how much it always matters. There are some companies such as Texas Roadhouse where it is indisputably a competitive advantage, but others such as Dino Polska (bad reviews at lower levels) where I’m not sure if it matters as much. Of course, you want employees to enjoy their job and have an upbeat environment, but it’s also sometimes hard to get a good gauge of what the true standing is.

I feel that it goes with reviews of most types that people are way more likely to leave a bad review if they’re slightly unhappy, than a good review if they are pleased. People who enjoy but don’t love their job may not think of reviewing their company, but someone who feels at all scorned by management (even if the employee/customer was in the wrong) will raise hell. People may never consider reviewing the company that built their home if they are content with it, but one broken pipe or installation delay, and it will be bad review galore. There is also a common habit to complain about the business without even reaching out to them first. Many will try to right the wrong immediately. This is why I feel that outstanding reviews (employee and customer) are often a good sign, but bad ratings aren’t always as telling.

Capital Allocators

I feel this one is regularly touted in investing circles (for good reason), but sometimes overused without understanding what goes into it or how to find one. What I look for in a company and their management in terms of capital allocation skills depends on the opportunities. For a company that needs to just sustainably open up new stores of a similar type, it’s a little more straightforward, especially if they have a proven track record. This type is great, and I’d be happy to invest in these companies (as long as they understand basic concepts like return on capital and opportunity cost). But, there are others who are on another level, Phil Fisher’s “fortunate and able” management. They can spot tangential (or sometimes completely unrelated) markets with great potential and execute it successfully. These are people like Buffett, Mark Leonard, or Dick Smith at General Cinema. They intensely understand the importance of return on capital, hurdle rates, and opportunity cost.

Nonetheless, every CEO and Chairman should know the options for capital deployment and which to choose and why: reinvestment, acquisitions (few are good at this), dividends, share repurchases, and paying off debt.

Differentiated Offering

This one is of course important as it is what makes them unique compared to the competition. For example, Nvidia’s offerings, the combination of GPUs, CPUs, CUDA, and NVLink, offer a complete cohesive solution for their customers. Arguably, no other company has the offerings that they have with the level and years of development behind them, the incredible man-hours that went into CUDA and the community around it is one example. These differentiations are usually entrenched and hard for the competitors to catch up. Another good example is Texas Roadhouse’s above average food quality control and company culture. It is entrenched in the positions and systems they have set up and a culture that has been built and grown for thirty-one years (I highly recommend Kent Taylor’s autobiography). Much of their top management has been with the company for decades as well and are committed to the mission. That’s not something Outback could implement overnight.

This is a complex point where you could argue that some things do or don’t fall under this based on what your definition of differentiated offering is. For example, maybe a software company (such as early Microsoft) doesn’t have a particularly unique product, but it has become the market standard and there’s no reason people would switch. Then, over time, competitors die off and they obtain a near monopoly. While the product itself may not have had much differentiation, the position and utility it had within the market could have been. Same goes with Costco, from the outside perhaps a Costco may not seem too different from a Sam’s Club, but their pricing discipline, how they treat suppliers, and returning value to customers could have been a unique process power, also their scrutinizing cost management. It’s important to not just look at what a company does, but how they do it. In some industries this is easier than others. You can have a better grocery store than competitors, but it’s mighty hard to sell better crude oil than your competitors, but you can do a better job finding and selling it.

That’ll be all for this post, if you have any comments or questions, feel free to leave a comment below or shoot me a message.

Disclaimer: The information contained in this report is not written or intended as financial, tax or legal advice. The information provided herein may not be relied on for purposes of financial decisions. You are encouraged to seek financial, tax and legal advice from your professional advisors. Investor’s Odyssey may hold positions in any of the companies discussed.

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