Investing Alongside Great Capital Allocators: A Portfolio

Oct. 03, 2022 1:00 PM ETAMZN, ASML, CNSWF, CRM, CSU:CA, DHR, FVRR, GOOG, LFCAF, MELI, MSFT, RICK, SARTF, SDMHF, SPOT, TXN, VEEV, WSO, ZBRA, TDOC, PROSY, PROSF12 Comments

Summary

  • I'm focused on high-quality companies with growing free cash flows per share.
  • I group my portfolio into 4 buckets: Great capital allocations, Tech Leaders, (unprofitable) High-growth and short-term trades.
  • I want to own companies with great management so that I can sleep well at night and not worry about my investments.
Langfristige Anlagebilder, allmählich hoch gestapelte Münzen und Sanduhr

takasuu/iStock via Getty Images

I've been writing on Seeking Alpha for 8 months now, yet I haven't showcased my personal investing strategy. I recently got inspired by Three Wood Capital's article and want to talk about my portfolio and underlying portfolio as well.

About me and objective

I am a 23-year-old recent graduate in Business Informatics (a mix between computer science and economics), working as a software developer and author on Seeking Alpha based in southern Germany. I aim to build my financial freedom in my young years through long-term-oriented investing in compounding machines that let me sleep well at night. In my first year of investing, I went through a bunch of different strategies, until I found what works for me. Investing is a very personal journey, so what works for me might not work for you. I try to do a buy and hold and check strategy: I hold companies for the long term, but I do check on them frequently and sell if the thesis is not intact anymore. I want to try and keep my stock turnover at less than 20% of my positions per year and I am trying to concentrate my portfolio around 15-20 positions (16 currently) that I know well.

I try to buy companies from three/four different categories:

  • Great Capital Allocators: Companies with high-quality management with a track record of excellent capital allocation. The target size of 60% of the portfolio.
  • Tech Leaders: Technology companies with deep moats that dominate their respective industries and actively try to expand into new niches and businesses. The target size of 25% of the portfolio.
  • (Unprofitable) high-growth: fast-growing companies with a long runway of growth. These companies can be unprofitable at the moment while they scale their business. The target size of 10% of the portfolio.
  • Trades: any stocks that I do not aim to hold for a decade and more. The target size of 5% of the portfolio.

Capital allocation as a driver for returns

The main focus of my portfolio is on what I consider to be great capital allocators. I got heavily influenced by Chris Mayer's "100 Baggers: Stocks That Return 100-to-1 and How to Find Them" and William Thorndike's "The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success". Both books talk a lot about the importance of good capital allocation and how it can turn a mediocre stock into a great one.

What is capital allocation?

Capital allocation is what happens with cash generated by the business. Ideally, we want to own asset-light businesses that do not need to put a lot of capital into running the day-to-day operations of the company. This leaves us with excess cash that management can allocate in six different ways (in order of importance):

  1. Reinvest back into the business for organic growth.
  2. Acquire businesses that integrate well into the current operations with higher expected returns than reinvestment into the existing business would generate (acquisitions are generally riskier, so we need more upside).
  3. Buy back shares, if the stock price is below intrinsic value (poorly timed buybacks can destroy shareholder value).
  4. If there is money left over, pay out a dividend.
  5. Pay down debt if it makes sense (this can be a higher priority depending on the interest rate and leverage).
  6. Sit on the cash (this isn't really an allocation of capital, but rather a delay of the allocation).

A proxy to track management's capital allocation is the returns on invested capital a company generates. This should exceed its weighted average cost of capital and ideally consistently be above 15%. Buybacks are good indicators of the capital allocation capabilities of a management team. Below we can see an example of opportunistic buybacks from Zebra Technologies (ZBRA). We can see that the company bought back shares during the Covid crash and then did nothing for 2 years while the stock ran hot. After the price came down back to normal levels the company started to repurchase shares again.

Zebra Technologies Buybacks

Zebra Technologies Buybacks (Koyfin)

Skin in the game

Another important part of my strategy is trying to buy companies with good insider ownership, ideally run by the founder. So-called owner-operators often showcase more prudent capital allocation, because their own wealth is at stake as well. Capital allocation is often noticeable in earnings calls and conferences. I try to listen to how management talks, are they talking about cash flows or simply growing the revenue? Are they prudent with diluting shareholders?

Cash matters

At the end of the day, cash flows are what matter. That is why I look for companies that can grow their free cash flows (FCF) per share consistently and trade at a reasonable FCF yield. Below you can see the FCF yields of my portfolio companies. I try to buy companies around a 3-4% yield, but I am fine buying lower or higher if the growth rate is accordingly. We can also see that Amazon (AMZN) currently has a negative FCF yield. This is due to heavy reinvestment into the business over the last 12 months over $65 billion. I expect Amazon to produce plenty of FCF again soon.

Portfolio companies FCF yields

Portfolio companies FCF yields (authors model)

Staying motivated

Much like dividend investors often track their dividend income for each stock, I'm tracking the Free Cash Flow my stocks generate for me every year (keep in mind that I applied a random multiplier to the FCF number, as I do not disclose my total portfolio value). The analogy isn't perfect, because after all not all FCF is equal, unlike dividend payments. FCF used in bad acquisitions or expensive buybacks should be viewed very differently than FCF allocated by capable management teams. Tracking FCF massively helps me to stay motivated, because it makes investing more tangible and detaches the company from the stock price. I can only recommend any investor to do something similar that keeps them motivated to keep going, even in tough times like these.

Keeping track of the FCF to stay motivated

Keeping track of the FCF to stay motivated (Authors Excel sheet)

A breakdown of my portfolio companies

Below you can see my current portfolio, concentrated in 17 companies. I intend to hold all of these companies for many years, but I will always check up on them. Companies should prove themselves to you and show you why it's worth keeping your money invested in them. You can also see a picture of my portfolio composition by segment, which I'll talk about in the next segments and by region. I'll quickly mention every company and what they do (beginning with the highest weighting in each segment) and link my most recent article about them if I cover them on Seeking Alpha.

Stock Metal Investment portfolio composition

Stock Metal Investment portfolio composition (Authors Excel sheet)

Stock Metal Investment portfolio segments

Stock Metal Investment portfolio segments (Authors excel sheet)

Stock Metal Investment Portfolio country allocation

Stock Metal Investment Portfolio country allocation (Authors excel sheet)

Great capital allocators

My largest segment is the so-called "Great Capital Allocators" segment. This bucket consists predominantly of Serial Acquirers from different niches. I am a big fan of serial acquirers that consolidate an industry. These companies need to have great management because acquisitions can destroy a lot of value if done poorly:

Tech Leaders

My second largest segment is Tech Leaders. I will not go over all of them in detail, because most of them are very well-known companies like Amazon, Microsoft (MSFT), Alphabet (GOOG)(GOOGL) and Salesforce (CRM)(most recent article). I do have some less known tech leaders like Veeva Systems (VEEV), which is the dominating operating system and enterprise software provider with a great founder in the life sciences industry and ASML (ASML), which has a large technology moat with its EUV lithography machines, the most vital part of the semiconductor manufacturing process with a true monopoly. These companies have established a wide and expanding moat and keep creating new growth opportunities in adjacent business segments.

(Unprofitable) High growth

My last segment with current investments is (unprofitable) High growth companies. These companies do not share the same high-quality characteristics that the other two segments share, but are operating in promising niches as the leader with lots of runway for growth and margin expansion. All of my growth stocks need to have high insider ownership, I learned that lesson with my failed investment in Teladoc (TDOC). These are my high-growth stocks:

Short-term trades

I currently don't have any stock in my trades section, but this section is reserved for more short-term-oriented investments that I do not intend to hold for a decade. I normally don't do these kinds of investments, but I recently tried it with Prosus (OTCPK:PROSY), which went really well. This segment shouldn't exceed 5% of my portfolio.

Conclusion

I hope you got some inspiration from my strategy and portfolio. I'd love to hear your feedback and how you structure your own portfolio. Do you disagree with any of my approaches? Let me know in the comments below.

This article was written by

'Heavy Moat Investments', formerly known as 'Stock Metal Investment', is 23-year-old self-taught investor Niklas based in Southern Germany, who recently finished his bachelor of Science in Business Informatics and now works as a Software Developer, besides writing about his investments on Seeking Alpha and Twitter. The main investment themes in Heavy Moat Investments are great capital allocators, Spawners and companies with deep, widening moats. The only investment horizon that is discussed on this channel is long-term investments, preferably with decades of growth runway. Follow Niklas on his journey to financial Freedom.

Disclosure: I/we have a beneficial long position in the shares of AMZN, GOOG, DHR, MSFT, WSO, RICK, SDMHF, MELI, FVRR, SPOT, ASML, CNSWF either through stock ownership, options, or other derivatives. 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.

Additional disclosure: What do you think about my portfolio strategy? Does it overlap with yours or where do we stray apart? Let's continue the discussion in the comments. This is not financial advice.

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