I've heard it said that a typical NFL game's outcome can be broken down to three pivotal plays. What this means is you can go back and review a game and there are usually three plays where if they went the other way the losing team would have won. Sometimes a game can hinge on less than that. The outcome of one play can change a game from a loss to a win, or a win to a loss.
It's my belief that most successful investments are similar, their outcome and success can be distilled down to a few important factors. If I can't simplify an investment to a small number of pivot points I will pass on the investment, because monitoring the company and estimating an outcome is too difficult.
Let me explain with a few examples. The easiest example is a net-net, or a company trading below book value. There are a lot of different things investors can research about the given companies, their margins, their competitors or their management. The first question I ask is whether the company is worth NCAV or BV? If it is then why isn't it trading there? If a company is worth their asset value then the next question is what will it take for the company to trade there? Most of it time it's just that the market needs to recognize value. After I've determined the company is undervalued and I need to be patient all I need to monitor is that business continues as usual at the company.
Distilling an investment down to a few pivotal facts makes following a company easier and also simplifies the selling decision. If I determine a company has an undervalued piece of real estate and suddenly the real estate is sold then it's time to sell. If I think a CEO is holding the company back and they're replaced and nothing changes then I need to sell.
My goal is to reduce an investment idea to a set of factors that if true would validate the thesis and result in a gain, and if false would invalidate the idea. Keeping an investment simple isn't just a matter of simplifying the investment idea, it also includes investing in simple companies.
Readers are aware that most of the time I invest in small companies, usually because that's where opportunities exist, but also because they're easy to understand. I have two annual reports on my desk from small unlisted companies, both are 15 pages or less. I can read and analyze the companies in a half hour at the most. One of them sends only an annual report, the other sends an informative letter quarterly plus the annual report. The time commitment for both of those companies is about an hour a year at the most. I can spend an hour a year and keep up with two companies that I'd like to own at a lower price, right now I own single shares of each to stay on their mailing list. I have a few dozen companies like these two. They send out short annual reports and it doesn't take many hours to keep up with them. I also like to scan through the OTC Markets financial reports page. I will open and read or scan the filings for any company that's filing within the past few weeks. I can usually read and keep up on dozens of companies without much time spent.
Finding easy to understand, easy to follow companies whose investments hinge on a few factors is one thing, fitting them into a portfolio is another.
Just as investors like to classify themselves as certain types, readers seem to classify me as well. I'm often thought of as a net-net investor, or maybe a low P/B investor, or a bank investor. I certainly invest in those types of stocks, but I don't limit myself either. I manage my portfolio in a somewhat unique fashion. It's hard to build a portfolio around one specific type of investment idea. What does a spin-off investor do when there are no spin-offs? What does a net-net investor do when there are no net-nets? I guess they'd sit on cash until those opportunities arose again.
What I have done is to divide my portfolio up into a number of different styles. Low P/B stocks, cash box stocks, net-nets, banks, quality companies I'd hold etc. My goal is to never let any of these specific strategies overwhelm the entire portfolio.
Dividing my portfolio allows me to diversify across strategies, and it also allows for new investments when one strategy starts to top out. Right now in the US there aren't many net-nets left, but that's fine, I have been finding cash boxes, some special situations and a few attractive banks. I'm still able to buy cheap companies even though there aren't net-nets abounding.
The last thing investing like this does is it allows me to compare and fit new investments into a framework of existing investments. If I'm looking at a bank stock I can compare the bank's relative value to the other banks I own. If the bank is more expensive than my current holdings I need to either know why it's worth holding or reconsider the position and add to an existing position. I do the same with all of the other types of investments I own.
To end this post I distilled my approach into a few simple bullet points:
- Follow companies that are simple to understand.
- Follow companies that publish short annual reports that are quick to read and easy to understand.
- Invest in multiple strategies, never let one overwhelm the portfolio.
- Compare new ideas to existing ones
With the above guidelines I'm able to manage my portfolio without spending a lot of time keeping track of what I own. I can dedicate most of my time finding new companies I'd like to buy.