My Investment Focus
I am a disciplined investor who believes that applying strict mathematical logic, sound financial principles, and thoroughly backtested strategies in a systematic and non-discretionary process will enable me to beat the market. I invest mostly in US microcaps that exhibit strong growth potential, have high-quality financials, and are underpriced.
The Securities I Choose From
The universe of stocks that I choose from is defined as broadly as possible, and includes over 4,000 stocks. Conceivably, I could choose some mid-cap and large-cap stocks, but those very rarely come out on top in the stock-picking system I’ve designed.
My Investment Process
I use a research platform called Portfolio123. There I have developed a ranking system based on over forty factors. Several times a week, I look at the top-ranked stocks and compare them to my holdings. I then increase and decrease my positions based on their ranks, and buy additional highly ranked stocks as need be. I also take into account liquidity and bid-ask spreads, putting less of my money into stocks with heavy transaction costs.
A lot of thought and experimentation goes into choosing the factors I rely on. I use some standard metrics, and a great variety of them; but I’ve also devised quite a few valuable metrics of my own. And I’m constantly tweaking my system as I develop new ideas for improvement or discover potential flaws.
I only use limit orders when buying and selling stocks. I place them before market open and if they don’t get filled, I adjust them through the course of the day.
Ideal Long Ideas
There are dozens of things that I look for in a long idea. But here are the ten most important ones:
- strong operating income growth;
- the industry the stock is in (I’ve classified them into groups and favor those most sensitive to the metrics I use, but I also take into account industry momentum);
- steady sales growth—not too high, but accelerating;
- low market cap;
- low but increasing volume;
- good sentiment indicators (estimate revisions, recommendation changes, earnings surprises);
- low share turnover;
- strong EPS growth (both estimated and GAAP);
- high forward earnings yield; and
- low price to sales (both estimated and actual).
My Approach to Valuation
When looking at the price of a stock, I think it’s important to compare it to other companies in the same industry. I do so with a variety of ratios: price to expected earnings and sales, price to actual sales, price to free cash flow, price to R&D expenses, price to tangible book value, and so on. But I also look at the stock’s enterprise value (unless it’s a financial or real estate company), and in those cases I compare it to other stocks in general. I use enterprise-value based ratios with unlevered free cash flow, gross profit, and long-term debt.
My Approach to Portfolio Risk
I use a performance measure called the omega ratio to measure risk-adjusted performance, and by designing my portfolios using that measure, I lower my risk. Omega basically takes the sum of a portfolio’s positive excess returns and divides them by the sum of its negative returns, so any time a portfolio’s return is worse than the median market return, it drastically lowers omega. Using omega as a performance measure thus ensures that your portfolio has as few periods as possible with low or negative returns. In addition, I favor stocks with low share turnover, which lowers my beta a lot. Although I invest in microcaps, the beta and standard deviation of my portfolio has been consistently far lower than that of IWC, the microcap ETF, while my returns have been far higher, with fewer and shorter drawdowns.
My Portfolio Return Objectives
I really only have two: to beat the market, and to make as much money as possible. I’ve been very successful at this so far, maintaining a CAGR of over 40% for over three years. My return in 2016 was 45%, my return in 2017 was 58%, my return in 2018 was 14%, and my return in 2019 so far is 15%. My objective is to keep this up despite the fact that I have a lot more money to manage than I ever have before.
The Investors I've Learned From
James P. O’Shaughnessy, Joel Stern, and T. Rowe Price. O’Shaughnessy’s approach not only has always made instinctive sense to me, but he has provided innumerable practical examples of how to carry out a thorough investment analysis. Basically, O’Shaughnessy posited that one could find out what factors have worked in the past and could then use that knowledge as a basis for a systematic analysis of stocks. This is precisely my approach as well. Joel Stern, on the other hand, came up with two of the best financial metrics I’ve ever seen, free cash flow and economic value added. He started with rigorous accounting analysis, and really understood what drove company profits and growth. His insights into cash flow and the cost of capital are priceless. Lastly, T. Rowe Price recognized that one could invest successfully in growing companies without ever considering what they cost. Price has been overemphasized in investing, whether you’re looking at fundamentals or using technical analysis. The inspiration of T. Rowe Price has allowed me to think of price as a secondary consideration. For me, a company’s quality comes first.
For me to invest in a stock, it has to have a moderate bid-ask spread and a minimum median daily dollar volume of $30,000; it also has to cost more than $0.50 a share. I buy and sell stocks three or four days a week.
Investment Time Horizon
Some stocks I keep for months, others I sell within a month. My median holding period is about two months.
100% in equities. I usually have one or two stocks in which I invest 8% to 12% of my portfolio; my other positions are smaller.
My Hardest Investment Lesson
It took me close to two years losing a huge amount of money while the stock market was rising before I realized that buying and selling ETFs based on technical analysis was a surefire way to go broke. At that point, everything changed for me.
How My Investment Process Has Changed Over the Last Few Years
Since I had the epiphany, late in 2015, that the best way to invest is
- a) to examine every single purchase from as many angles as possible
- b) to do so systematically rather than by discretionary means, and
- c) to do so using a ranking system rather than screens,
my basic investment process hasn’t changed much. The biggest changes have been
- a) the realization that reliable backtesting should always be done on a much larger portfolio than the one you plan to invest in;
- b) using variable portfolio weighting rather than putting the same amount of money into each stock;
- c) selling only when I need money to buy a better stock;
- d) using divided universes and time periods in backtesting;
- e) using good risk-adjusted performance measures like the omega ratio;
- f) employing innovative value and quality measures that are starkly different from what I used at first; and
- g) allowing projected transaction costs to influence portfolio weights (i.e. I put less money in stocks with big bid-ask spreads than I do in stocks with more modest spreads).
My marketplace service, The Stock Evaluator, provides you with a weekly comprehensive ranking of over 4,000 stocks, and tells you what I'm investing in now too.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.