To invest in equities with the highest risk-adjusted expected return, with no geographical, market capitalization or style constraints. Expected returns are quantified as the difference between the market price and the security’s intrinsic value. This strategy results in a bias to global value stocks.
Intrinsic value is calculated as the present value of future free cash flows using the appropriate discount rate. Trading comparables and historical multiples are also utilized but given less weight.
Investment process for long ideas
In 2018, I read the cash flow statement of every listed stock (globally). From that exercise, I creating an opportunity set of 620 companies from 36 countries whose free cash flow profiles are attractive to me. I monitor those 620 companies to identify long ideas. Because my focus is on the price paid for cash flows, long ideas generally emerge when there’s a financial crisis like Turkey in 2018, or excessive pessimism somewhere like Russia in 2018. The due diligence process involves learning everything possible about a business via its annual reports and competitors’ annual reports.
Investment process for short ideas
There’s no formal process, generally an idea emerges from the financial press that I want to investigate, or, I’m looking for a new long outside my core opportunity set and am disappointed by what I find.
The ideal long
- A business with a sustainable competitive advantage.
- That trades at a large discount to its intrinsic value.
- Because of extreme market fear or pessimism which will mean revert.
The ideal short
Beyond frauds, I like unsustainable business models (with growing debt and deteriorating debt-servicing metrics) with promotional management where there’s a disconnect between net income and cash from operations.
I understand Modern Portfolio Theory but I don’t abide by it. I’ve adopted Stanley Druckenmiller’s approach to portfolio construction:
My idea of risk control is a little non-conventional, I like putting all my eggs in one basket and then watching the basket very carefully … My concept was to put into those 2-3 ideas that I had the most conviction in. - Stanley Druckenmiller
This approach works because I don’t manage outside money and am indifferent to volatility.
Portfolio return objectives
To maximize absolute returns, unconstrained by any benchmark, on an opportunistic basis. I’m aiming for 30-50% returns per annum moving forward which I think is possible because I’m not constrained by institutional money or position-sizing limitations, and can take contrarian positions in under-followed micro-caps, in countries experiencing a crisis or too much pessimism. And, I’m getting better with time.
I’ve permanently left the corporate world to pursue investment research full-time. I live off market returns which have exceeded 20% per annum for the last five years and 37.94% this year. I passed Level III of the CFA Program in 2018 which completed my educational needs. More practical experience is my focus moving forward. I’m curious to see where things lead when I just read annual reports for the next decade. Here’s my latest brokerage account after changing countries from Australia to the United States. I’ve blacked out my account number.
Source: Interactive Brokers
Source of wealth
Borrowed money that I compounded in the market and repaid years ago.
I identify as aggressive. Excellent buying opportunities are rare and you have to be aggressive when they avail themselves.
- Warren Buffett and Charlie Munger: Whilst I don’t have access to company management, their espoused principles of buying companies with a sustainable competitive advantage at an attractive price, and then holding them for the long term, have influenced everyone.
- Stanley Druckenmiller: I see investing like poker; you have to bet big when the odds are in your favor. Stan’s record validates this approach, if you know what you’re doing.
- Jesse Livermore: Never use leverage.
- Howard Marks: I’ve always been fascinated by psychology, but Howard deepened my understanding of the market’s psychological underpinnings and interrelationships.
- Ray Dalio: I've adopted Ray's macro framework that incorporates: productivity growth, a short-term debt cycle, and a long-term debt cycle.
Liquidity constraints and market price action
I have no liquidity constraints. I’m indifferent to holding any stock for one day or one decade. I’ll sell when the price meets my target for intrinsic value. For stocks which I invest in, and have completed due diligence, I don’t see the market as a capable financial analyst whose opinion I should respect. As Warren Buffett says, the market is there to serve us not guide us.
Investment time horizon
I’m less time-driven and more outcome-driven. Whilst I’m regularly two years early on my contrarian ideas, sometimes the stock price rises in less than a year, other times it takes five years. The main variable for me is to maximize exposure to my favorite ideas. If I’m in my favorite ideas, then my time horizon is ‘as long as it takes’.
Holding equities for longer than 12 months reduces capital gains tax but taxes are a lesser concern to me versus being fully-invested in my favorite idea or ideas.
Investment lessons from my worst loss
By September of 2008, when most participants had lost enormous amounts of money in the Great Recession, I was up more than 200% for the year. The world was falling apart and I saw a way to make some more “easy” money. I expected the U.S. House of Representatives to pass the Emergency Economic Stabilization Act of 2008 on September 29 and global stock markets to bounce higher after this event. I went long Hang Seng index futures contracts immediately before the close in Asia so that there’d be no volatility affecting the levered position.
To my later horror, the politicians acted irrationally and rejected the bill 205-228 causing the Dow Jones to fall almost 7% in one day. The politicians passed the bill a few days later but it was too late, and I took some enormous losses that drastically changed the trajectory of my life.
I learned a lot of lessons from this: (1) don’t use leverage, (2) don’t expect politicians to act rationally, (3) embrace fallibility and humility, (4) invert your thinking to consider the opposite perspective, and (5) from a non-investing perspective, don’t think that you can trust or rely on anyone but yourself when the chips are down.
Procedural changes over time
I’ve become more rigorous needing to read everything available concerning a topic before making conclusions. I’m less bold/cavalier than I used to be and fear blind spots more, which we all have. And I spend more time inverting my views to consider the opposite side.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.