In today’s blog, I’ll answer some questions that came in response to my tweet. I got a lot of questions, some by email. More than 9 pages worth altogether! So, I won’t be able to answer them all here. Maybe I’ll do a part two. (Maybe I’ll experiment and answer them in a video). And some of the questions sent deserve a full blog post. Anyway, thank you for sending in your questions. There were many, many excellent questions.
Let me preface my answers by saying: These are just my views and I offer them humbly. There are many ways to climb the mountain. Other people may find success with different strategies and ideas.
With that, let’s get started…
How do you know when you're wrong?
I got a lot of questions basically asking this (when to sell, etc.). I think selling is the hardest thing to do well in investing. And I don’t know that I have anything particularly fresh or new to say about it.
One thing I’ll say is it helps to write your thesis down. Clearly articulate why you own a certain stock. Use bullet points if that helps. Don’t have too many. Maybe just 3-5 key points that are essential. You don’t want to get lost in details that don’t matter much. And you want to give your businesses some room to disappoint you now and again. Owning a business for a long time means you’re going to own it during a stretch when it isn’t at its best.
But if the long-term thesis is still intact, you’re probably better off holding on. When the reason you own something is no longer valid, it’s probably time to move on. Writing it down gives you a way to help keep yourself honest.
Selling is hard. Embrace a strategy that has you do less of it! I'm only half-kidding. For a great piece on "the art of (not) selling," I can't recommend this enough by Chris Cerrone at Akre [Click here].
Another way to think about it is to invert the question. Reasons not to sell? Thomas Phelps in 100 to 1 in the Stock Market offered the following:
My stock is “too high”
I need the realized capital gain to offset realized capital losses for tax purposes
My stock is not moving. Others are.
I cannot or will not put up more money to meet my margin call
Taxes will be higher next year
Number 4 is kinda funny. Kids, don’t use margin!
If a business meets all of your criteria except one or two, do you still invest? How do you decide? Can you share any examples?
To the first question: No, with a qualification. I have some key filters that every idea has to get past. Among them, significant insider ownership (skin in the game) and low financial leverage. So, if the business doesn’t meet these two, I don’t go any further.
But no business is perfect. Sometimes there are tradeoffs. I own Brown & Brown, for example, which has the lowest return on invested capital in the portfolio. I’ve kept it for several reasons, one being that it reinvests most of its cash flow so that overall returns are good enough. And also it has been a low risk, low worry kind of name. It just sort of plods along building free cash flow per share every year, like a bricklayer building a wall.
I’ve owned it since the inception of my fund in January 2019, when I bought my first shares for $27 per share. Today, they are $73. So far, so good. I’ve enjoyed some multiple expansion, but the business has performed well, too. Earnings per share, to take one measure, were $1.22 in 2018 and this year consensus is $2.65. They will have more than doubled in 5 years.
How would the portfolio you manage for Woodlock differ from what you own today if you were ONLY managing your own money?
I love this question. My answer is it would be no different. Also, I have most of my money in my fund, by the way.
If I think about it some more, one way it might be different is that I could buy more illiquid names if it was just my own money. As a practical matter, though, I don’t think it matters much. For one thing, it’s not like I have a bunch of illiquid names I’d love to own. And two, it’s not as if illiquidity necessarily has kept me out in the past. I'm invested in Teqnion and that’s relatively illiquid. If I really love an idea, I can find a way. It’s a little more work than if I was just running my own money, but do-able.
How much drawdown are you willing to accept before you change your decision about an investment you made?
I don’t know. I don’t think about it that way. Looking back on experience, I can suffer quite a bit. I have had some wild ups and downs already in just the 5 years running the fund. I rode Topicus from C$60 to C$142 and then back to C$60 - that’s about a 57% drop from peak to trough. I never touched it during the whole time, though I did add a bit when it got back to ~C$60. (And bought more earlier this year). Today, Topicus is about C$100. I suffered a similar drop in Evolution, from peak to trough. I still own both.
The key is that both businesses were performing during the entire stretch. In fact, just looking at the business results you would never guess the drama going on in the stock market. When the business is sucking and the stock is getting hammered, it’s a lot harder.
The environment matters, too. It’s easier to hold on when everything is in the crapper. It’s harder to hold on when everything else is going up except what you own. Still, it’s critical to focus on the business.
In short, I try not to let the price action dictate what I do.
Can you please explain your thought process behind your portfolio construction strategy?
Where I am now: I like 10-12 businesses. I don’t push anything past a 10% weight. But if the stock appreciates beyond that, I let it run. The reason I don’t “overweight” a single name to 20% (or something like that) is because in my experience I never get that right. Invariably what I overweight underperforms and what I make a 3% position doubles. So after seeing that happen again and again over the years, I decided to even out position-sizing a bit more – at least to start. It’s worked better for me.
Otherwise, I try to be aware of certain exposures: industry, geography and currency. I don’t mind significant concentration if the idea (or ideas) are strong enough. For example I don't mind having 25-30% of the portfolio in VMS (i.e., Constellation, Topicus and Lumine) or Swedish serial acquirers. But maybe not 50%. Meaning, I wouldn’t actively put that much capital toward one exposure, but over time the portfolio could get there via appreciation if a certain set of ideas outperforms a lot. That would be a good problem to have.
I guess the point I want to make is I’m not managing to any pre-arranged pie chart, where so much is in X, so much in Y and so on. I don’t bother with the traditional categories people use (like market caps, value/growth, etc.)
Do you trim a position if it reaches a certain size?
No. I’m not a fan of doing that, though I know some people are good at trading around positions – trimming here, adding here. I don’t think I’m good at that. It requires getting a lot of things right again and again, plus there is a distasteful tax drag.
My portfolio will be more like an unruly garden over time. Some positions will come to dominate. I think that’s where the outperformance will come. I also think of Robert Kirby’s coffee can portfolio and the lessons learned there. Click here for that classic.
What is your perfect work day?
A perfect work day one where I have plenty of time to read and think, get outdoors, learn something new, eat a good meal, talk with a friend and laugh. That's pretty much a perfect day, work or not.
Any particular habits/changes to your environment that have had a sizable positive impact?
Years ago I used to read through three or four newspapers a day. I used to consume a lot more media - weeklies, monthlies, etc. I cut all that out. There is just way too much noise.
I’ve been much more thoughtful about what I consume. You are what you pay attention to. Attention is a precious gift. And so many things are competing for yours. Don’t give your attention to just anything.
How many companies are in your watch list or investable depending on price? Any particular business model/sectors that you gravitate toward?
Hard to say, because I keep several lists. I have a bullpen, where I keep names I am looking at actively. There are only a couple there right now. I have a more general watchlist, where I keep names I like and have at least done some light work on. There are maybe 40 there. But I have other specialized lists, too, such as “Swedish serial acquirers” that I use to track certain sectors or groups.
I guess, looking at my portfolio, one would have to say I gravitate toward serial acquirers and VMS businesses (which are also serial acquirers). That wasn’t planned. It’s just the way things have evolved. I like the resilience of these models. I like the focus on reinvestment and returns on capital. There is also good alignment in the ones I own; they are run by talented people with skin in the game.
I also seem to gravitate toward businesses that benefit from a tangible network (i.e., built around land). Copart and Old Dominion Freight Lines have competitive advantages built, in part, around ownership of an extensive real estate network that is impossible to replicate.
How do you source ideas?
Lots of questions around this. I wish I could say something definitive. But it seems like I get ideas from all over the place – sometimes from a screen, sometimes by talking to other investors, sometimes by random chance.
Is there a book or resource (blog, letter…) that has significantly influenced your investment philosophy?
This is another question that came up a lot. I learned a ton from Buffett and Munger, of course. And from Peter Lynch’s books. And from Chuck Akre, who is the investor who has most influenced my investing style. (I didn’t always invest the way I invest now. It’s been an evolution. I started much more in the Ben Graham, deep value camp and slowly made my way over here).
I also like to cite Martin Sosnoff’s book Humble on Wall Street and Silent Investor, Silent Loser. Not because we are similar investors; we’re quite different. But he really got me thinking more about “skin in the game.” I read his books relatively early in my investing journey and that key lesson has stuck with me. (Sosnoff wrote: “My experience as a money manager suggests that the entrepreneurial instinct equates with sizable equity ownership.” I’ve never forgotten it).
I happened to stumble on this compilation of quotes from Silent Investor. It’s entertaining at a minimum. Click here.
In your experience, what is the most important trait an investor should develop for long-term success?
Patience. The ability to sit on a great business for two decades is a superpower worth cultivating. It’s how 100 baggers are born.
An excellent business without skin in the game or a good business with a lot of skin in the game?
I’ll take good business with a lot of skin in the game. I just put such a high priority on incentives, maybe too high. I want that skin in the game. Which leads to the next question…
What is the most overlooked task in an investment research process? Why do you think it’s important and why do investors tend to ignore it?
I think reading the proxy (in the US), which discloses stock ownership and incentive plans. It’s like Munger says, “show me the incentive, I'll show you the outcome.” If a management team's bonus plan has sales growth as a target, guess what they are going to? And do you want that?
How do you know you have a business with a long term competitive advantage?
You never know for sure. Clues would include stubbornly high returns on capital over a number of years, which indicate the business has something that resists competition. Market share gains are another clue. I’d say these are two big ones.
Do you have any tips to spot when a CEO is lying or putting makeup on a pig so to speak?
Hard to tell. I’m thinking of Seinfeld’s George Costanza: “It’s not a lie if you believe it.” There are half-truths and other gray areas. I would say when a CEO relies on buzzwords and corporate speak, he or she may not be lying but they aren’t saying much you can rely on either.
I would not rely solely on what a CEO said. Any investment thesis has to rest on a variety of evidence. The hope is that a balanced due diligence would uncover lies and warn you off. If a CEO talks about a great culture, but employee turnover is the highest in the industry, that’s a red flag.
What are your thoughts on margin of safety?
One thing I will say here that is maybe different than what you usually hear: Quality of the business is also a source of margin of safety. Most of the time, people think price and price alone is your margin of safety. But owning a great business can bail you out of a valuation mistake over time.
Look at Copart, for example. Ten years ago, it was trading for a split-adjusted price of less than $4 per share. Today it is $45. It was much more important to be right about the business than worry too much about the valuation back then. You could be off on the valuation and still come out okay, as long as the valuation mistake was not too egregious. Business first, valuation second.
How do you avoid doing too much work on an idea & losing objectivity? Is there a tradeoff between going wide & going deep?
I’ve spent lots of time researching ideas that I never bought. I’ve flown to foreign countries, met with CEOs and not bought the stock. It’s just the way investing works. You have to enjoy looking at businesses, just for the sake of learning. It’s part of the adventure. It’s fun. And go into it with the idea that whatever knowledge you gain may not pay off for years - maybe never!
But what about an idea I already own? Can I lose objectivity? Probably! I think you have to keep testing it against your thesis. It’s a tricky problem. And yes, I think there is a tradeoff between going wide and going deep. I’m a one-man band. There are only so many hours in a day. So, I have to pick and choose my projects. I am more on the deep side of things than wide. But it works for me, because I only need 10-12 names. And I’m not turning over my portfolio much. (So far this year, turnover is zero).
If you were to be even more concentrated and own only 3/4 of the stocks from your portfolio - which stocks would you own?
Am I close?
Ha! That’s not a bad trio, actually. That is a resilient bunch. I included this question because it reminded me of the converse: if you had to sell one stock in your portfolio, which would it be? I think about this. Just in case something new comes up that is super compelling, at least I’ve given some careful thought about what to swap out.
With all the knowledge of 100 baggers at hand, is it necessary to seek investments beyond the US 🇺🇸 & Canada 🇨🇦?
No. I like to, but I’ve always had a global orientation. I’ve traveled all over the world and I’ve always taken an interest in other countries and cultures and been fascinated by different markets. So, it’s natural for me but don’t feel you have to follow my example. The US and Canada have plenty to keep you busy!
Okay, so that’s enough for one day. Thank you again for all the wonderful questions. I know I left a lot of them unanswered. I will keep all of them and maybe answer in another mailbag edition. Maybe a video. And a few of them gave me ideas for future blog posts.
I hope you enjoyed the Q&A!
Published September 12, 2023
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