Investing Strategy
Creating a strategy is key to investment discipline and long-term success
There are many types of investors, but there’s one common goal we all have in common. The endgame is to become financially better off, these goals are usually driven by personal standards in which one wants a better life for him/her self or in my case, to create generational wealth I can pass down to my children.
As a self taught investor, I’ve made mistakes in the early days of my investing journey. These mistakes where driven by poor judgements, a lack of understanding and a lot of speculating. This approach was reckless, but if I could go back in time I don’t believe I would change a thing. These lessons learnt, and I believe many investors experience this during the start of their investing journey, are worth the financial loss. In my personal experience, these losses moulded me into the investor I am today and I believe many reading this can relate.
In this article, my aim is to show my subscribers and followers my investing strategy that’s helped me gain investing discipline whilst also footing the foundation for what I hope will help me reach my goals in the distant future. This strategy isn’t bulletproof by any means, but hopefully it keeps me on the right path to financial success.
My Philosophy
Avoid risky companies: non-profitable businesses, with too much debt, in unpredictable industries.
Own around 15-20 ABOVE AVERAGE businesses with long term growth prospects and great economics.
Once a business has passed all criteria, assess its intrinsic value and always demand a margin of safety. Remember the market is a manic-depressive entity. Use this volatility as an advantage.
Think like a business owner.
Hold for the long term.
Avoid risky companies
This first filter is intended avoid total loss of capital. My goal is to preserve and grow my capital with the least amount of risk. I try to invest in businesses that are predictable and with a bright future. This eliminates many start ups and companies in hypergrowth.
Growth investors will argue that I will never find a 100 bagger with this strategy. This is a true statement and by using this method I will be eliminating many 100 baggers from my investing universe. I accept this in advance. I have no doubt, there will be investors 10 years from now celebrating their gains in stocks that would have 10x or even 100x from today. Unless there’s clear economic/qualitative advantages in these businesses, the fact of the matter is that these investors on their purchase date where speculating, a lot of luck and a higher risk tolerance would have been the drivers here and I’m unwilling to travel down that path.
1. Unprofitable Businesses - Businesses that are unprofitable usually need cash from outside investors or creditors until the business reached a stage where it can fund itself. During these unprofitable years, there’s a higher likely hood of share dilution. I would prefer to wait these early years out and purchase when businesses are more financially stable.
Too much debt - The capital markets can be unpredictable. Companies with too much debt to fund its operations are more at risk of being unable to service the debt during periods of higher interest rates or economic downturns (especially cyclical companies). Higher debt levels means higher interest charges which depress earnings, another hurdle for management to grow EPS, a key driver of shareholder returns.
Unpredictable industries - As a cautious investor, I tend to seek businesses that are mature enough within an industry that is consolidated into a few major players. What I mean by “unpredictable” are industries in their early innings with dozens of businesses battling for market share (Solar and Cybersecurity come to mind). As a retail investor I have no idea who is going to be the industry leader a decade from now and due to this I pass. Another example here are industries that are common for technological change (Semiconductors). These uncertainties allow me to easily pass on such investments.
These simple principles have allowed me to stay away from fanboy stocks, not once have I had FOMO this year with many high growth businesses reaching new highs and achieving multi-bagger status. Instead I believe I’ve purchased excellent businesses that are leaders within their out-of-favour industries. Over the long term the market is a weighing machine.
Own around 15-20 ABOVE AVERAGE businesses
Diversification is an important factor, after all we don’t want all our eggs to be in one basket, and on the other side of the coin we don’t want too many baskets. The main goal of diversification is to minimise their exposure to unsystematic risk. Many studies have shown that around a 20 stock portfolio spread across multiple industries should give all the diversification an investor would need.
Excerpt from Giverny Capital 2016 Letter to shareholders
“In fact, we consider that a portfolio of about 20 securities is the right balance between having a minimum diversification level to reduce company-specific risk while also having few enough companies to improve the odds of beating the market indices.” Francois Rochon
Different asset classes also diversifies an investors portfolio such as real estate and bonds but as this article is focused on stock investing I won’t dive into these.
There is no correct answer to what’s considered fully diversified. I believe its all about the investors risk tolerance, time horizon and knowledge. Personally I like to have between 15 and 20 companies. This number allows me to be able to consistently monitor and understand all the businesses I own.
The key word here “ABOVE AVERAGE”. This is an important factor in my stock selection process.
What does it mean? Above average would indicate businesses with good quantitative economics and fundamentals, on the qualitative side which are harder to access are good management, higher quality products/services, barriers to entry, pricing power.
These can all be classed under one word. “MOAT”. Businesses with these characteristics will have some sort of competitive advantage. These advantages “if analysed correctly” should protect the business to some degree during economic downturns, and at times can come out the other end even stronger.
Here’s some screening metrics I use to eliminate what I consider below average companies from my selection process.
5 year revenue Growth +5-10+%
Operating income growth +7-12+%
ROIC >15%
Operating income margin >20%
Net debt / EBITDA < 3
What filters would you add here? Comment below.
Margin of Safety
The three most important words in investing “Margin of safety”.
Its fairly simple, you buy businesses below their intrinsic value with enough room for error in your analysis that even if you are wrong, you have that buffer to protect you from meaningful losses, yet many investors seem to ignore this simple concept.
“The best investments have a considerable margin of safety. This is Benjamin Graham’s concept of buying at a sufficient discount that even bad luck or the vicissitudes of the business cycle won’t derail an investment. As when you build a bridge that can hold 30-ton trucks but only drive ten-ton trucks across it, you would never want your investment fortunes to be dependent on everything going perfectly, every assumption proving accurate, every break going your way.”Seth Klarman
This simple concept will never be obsolete. We have to face the fact that the future is unknown and our analysis and forecasts of the future, will in probability terms be incorrect, by how much is unknown, this is why obtaining a margin of safety is so crucial.
The amount of acceptable MOS can vary on the predictability of the business. If cash flows are more or less certain, we can demand a lower MOS than a business with a lot of cyclicality, competition or prone to technological changes for example.
The intrinsic value of a business is personal to the investor, its never a precise number. Many variants alter the IV, such as growth rates and discount rates the investor inputs into their models. I find being conservative during my modelling has guided me well and ill continue down this path. Afterall its better to underestimate than overestimate.
Think like a business owner & long-term focus
Stocks are shares of ownership in a business enterprise. Buffett stated he believes stockholders should think of themselves as "part owners" of the business in which they are investing. This mindset allows investors to make more decisive decisions and also to focus on the long-term prospects of the business. Whenever I purchase a business, I always have the intention of a long-term holding period and I focus on the fundamental drivers of intrinsic value growth. Below are a few of my favourite quotes from legendary investors.
“I made the following inverse reasoning when I was young: What do those who beat the market do differently than others? I went ahead and read everything I could get my hands on about Peter Lynch, John Neff, Ben Graham, Phil Carret, John Templeton, Philip Fisher, and of course, Warren Buffett. Although Peter Lynch could have 500 stocks in his portfolio while Phil Fisher only had six, both shared the following fundamental approach: they viewed shares as fractional ownership in real businesses.”
Francois Rochon
“Whenever Charlie and I buy common stocks we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale. Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate. When investing, we view ourselves as business analysts — not as market analysts, not as macroeconomic analysts, and not even as security analysts.”
Warren Buffett
Both “Thinking like an owner” & “Holding for the long term” go hand in hand. You can’t implement one without the other.
I’ve always thought the best way to learn, is to learn from the best. All the most legendary investors obtain this “Owner” mentality and I certainty implement it into my investing approach.
This article isn’t intended for investment advice, rather, its to be transparent with my investing framework with my followers. By creating a strategy with what to work off, an investor can stay consistent and in my experience avoid poor investment decisions, both key factors to investment success.
Thankyou for reading.
DInvests
(DRGInvests) on X.
Disclaimer: I can’t guarantee the accuracy of the information provided in the newsletter. All statements express personal opinions and information gathered online. Any estimates, forward looking statements and assumptions made in this newsletter are unreliable. Any information in this newsletter is for educational and entertainment use only and should not be taken as investment advice.