Refocusing My Quality Investment Portfolio

Summary

• I am a 24-year-old investor aiming for financial freedom through long-term investing in companies with good management and growth potential.
• I made changes to the portfolio, buying stocks such as UFP Industries and Ulta Beauty, and selling stocks like Microsoft and Alphabet.
• I am open to suggestions and eager to learn from others about portfolio construction.

Olivier Le Moal

It has been almost half a year since my latest portfolio update on Seeking Alpha, so let's get started. To check out my prior portfolio updates, click here: First portfolio article and second portfolio article.

About me and objective

I'll quickly summarize this because I already talked about this in my previous article:

I am a 24-year-old Business Informatics graduate from southern Germany who works as a software developer and author on Seeking Alpha in my free time. I aim to achieve financial freedom through long-term investing in companies with good management, dominating their industries and having significant growth potential. I hold companies for the long term, check on them frequently, and sell if the thesis is no longer intact. I aim to keep stock turnover at less than 20% of the positions per year and concentrate my portfolio around 15-20 positions.

In October, I aimed for a 60% allocation to Great Capital Allocators, 25% to Tech Leaders, 10% to high-growth and 5% to trades. I now aim to have even more in the Great Capital Allocator basket(which I define as companies with high-quality management and a track record of excellent capital allocation) and less high-growth stocks (which are often unprofitable and highly valued) and tech leaders. I learned that it feels much easier for me to own stocks that aren't on the cutting edge of technology. For example, I much rather hold Texas Instruments (TXN) in its boring Analog semi-market than exciting Nvidia (NVDA).

Tracking the portfolio

In recent months, I started to closely track a few KPIs, which I believe do a good job of evaluating the portfolio. I calculate all these in my valuation spreadsheet, but the values aren't updated too frequently, maybe a few times a year. These KPIs are weighted averages, so each company's position size is accounted for. Let me explain why I choose these:

• Free Cash Flow yield: I chose the FCF yield as the basis of my valuation. I believe that Free Cash Flow per share growth drives returns over the long run, so I want to track this metric.
• Owner Earnings yield: OE yield is an enhancement to the FCF yield, which I believe smooths out a few things and makes it more representative. I adjust FCF for Stock-based compensation expenses, add back growth capital expenditures (this often has to be estimated) and adjust net working capital changes, primarily changes in accounts receivable/payable and inventories.
• Expected Growth: This is a conservative estimation for each company based on management long-term guidance, industry growth projections or if nothing else, extrapolating past growth (if it seems reasonable).
• Owner Return on Invested Capital: OROIC is my version of ROIC. I use my calculated Owner Earnings as a basis instead of NOPAT. I calculate the invested capital part of the equation with and without Goodwill.
• Insider Ownership: I prefer businesses with owner-operators with large ownership in the business. Bonus points if it is still founder-led.

Portfolio KPIs (Authors KPIs)

Changes since the last portfolio update

Since my last update, I continued to narrow down the portfolio by focusing on my best ideas and removing expensive or low-conviction stocks. I bought the following stocks:

1. UFP Industries (UFPI) manufactures and sells wood end products. The company is moving away from commodity products, with over 60% of sales in value-added products. It is well-managed and at a cheap valuation.
2. Ulta Beauty (ULTA) is a beauty products retailer that has sold off in line with other retail stocks in the last months. It has a history of generating very high ROICs and is trading at its cheapest historical valuation.
3. Carlisle Companies (CSL) manufactures and distributes roofing solutions. It used to be an industrial conglomerate that continuously sold off its weak segments and now is a roofing pure play with high ROIC.
4. AO Johansen (AOJ) is a Danish distributor of electrical and plumbing supplies. The company is founder-led and has ~30% market share in Denmark. It invested heavily into automation in the last years and trades at a very compelling valuation.
5. Ashtead (OTCPK:ASHTF) has an oligopolistic position in the equipment rental market in the U.S. together with United Rentals (URI). It's an industry where the big will get bigger and both companies are well managed.

I also sold out of a few companies:

1. Microsoft (MSFT) is a great company, but I wanted to focus on smaller market caps. Furthermore, it is already dominating its industry and trades at a high valuation, requiring a lot of growth. Almost all growth has to come organically, as M&A is very tough and buybacks aren't that helpful at the current 2% FCF yield.
2. Alphabet (GOOGL): A similar reason to Microsoft, but it trades at a cheaper valuation and is not the same quality as Microsoft's business.
3. Zebra Technologies (ZBRA): I underestimated the cyclical nature of the business and overestimated its ability to go from hardware sales to a higher proportion of software/service sales. Napco Security (NSSC) has a similar investment case but does a much better job of generating high-margin revenue from its hardware. Sadly, my timing was quite bad here and I reinvested the money from Zebra before Napco crashed 40%. I wrote more about the situation here.
4. Veeva Systems (VEEV) is a great business, but I'm not too fond of the capital allocation. It is very asset-light but keeps hoarding cash. It trades at a high multiple, so buybacks don't make much sense. M&A isn't much of a factor for management and they don't have debt to pay down. They should just dividend it out.
5. Sonova Holding (OTCPK:SONVF) is a good company, but I noticed it did not grow in conviction after owning it for a year. The valuation also isn't great and I generally see better risk rewards in other stocks.
6. Sartorius Stedim (OTCPK:SDMHF): Similar reasons to Sonova. It is a good business, but I don't need it in my concentrated portfolio. I reinvested the money into its competitor, Danaher (DHR).

Heavy Moat Investments portfolio (Excel)

Above you can see my current portfolio. I like all the companies in my portfolio right now. Still, if I were to consider selling, it would probably be Nemetschek (OTC:NEMTF) or UFP Industries, just based on the small position size and relatively low conviction compared to the other companies.

I hope you can get some inspiration from this article and strategy. How do you construct your portfolio and do you have any suggestions for me? I'm still young and eager to learn, so let me know in the comments below.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of DHR, TXN, NSSC, ADYEY, UFPI, ULTA, ASML, AMZN 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.

This is not financial advise.

Comments

[Dan Fronzeil]

Have to admit you are the one analyst on Seeking Alpha that seems to think very much like I do, with similar theses and investment goals. Although unfortunately for me, I've started my investment journey 15 years later than you, but better late than never. I've learned a lot from your articles, everything resonates with my own way of thinking. And I can confirm based on my own experiences - owning companies that make you sleep well at night is the most important. Some innovation risk is prudent too in my view as missing new trends can be painful to watch, but not more capital than you're willing to lose if things don't pan out.

[Heavy Moat Investments]

@Dan Fronzeil thank you and indeed it is never too late.

[KFYY]

@Dan Fronzeil

So, what are your top 5 positions in the portfolio?

And what do you plan to buy during the next 12 months?

[Dan Fronzeil]

@KFYY Top 5 would be TPL, TTD, KNSL, SEDG, MAXN. I own very many software, semiconductor and other tech stocks, but in smaller quantities because there are so many. I want to reduce the number of companies I own, so I'm in the middle of portfolio reconstruction/rebalancing right now, doing as much research as possible to find all the best stocks that will help me sleep well at night (90% of portfolio) plus about 10% of riskier disruptive innovation stocks.

[feltner]

Hello
I am Danish and think you have made a good choice buying A & O Johansen at these historically cheap valuation metrics for the compampany. It is currently trading below its historical average valuation.
A professional danish portfolio manager who has a model portfolio in the Danish shareholders' membership magazine has it in his model portfolio.
A model portfolio consisting of shares listed solely on the Danish stock exchange, and that focuses on industry winners and quality companies according to his own statement, and which since 2004 has given an average annual return of 19% and has beaten the Danish stock index benchmark.
A & O Johansen has been in his model portfolio for most of the years, and is still there.
Another danish stock that he has just added to the model portfolio that is currently trading below its historical average (Just like A & O Johansen) is Novozymes B and according to him with good growth prospects for the future.
Novozymes is a much larger company whose shares are also traded on the German and American stock exchanges.
Novozymes is a world leading company engaged in the production and sale of industrial enzymes, microorganisms and biopharmaceutical ingredients.

[KFYY]

@Heavy Moat Investments

If you are from Germany, what is your opinion about TUI AG?

What is the probability that it's share price will go up 300% in the next 24 months?

TUI cleaned it's balance sheet after COVID, now it is starting to improve the profitability.

[Heavy Moat Investments]

@KFYY No opinion on TUI, I do not see it as a high quality business so I am not interested. Tough business model in a world where most people just book vacations online. I can't be helpful here.

[KFYY]

@Heavy Moat Investments

Still, they sell vacations for more than 20 billion Euros per year. There are many people who prefer TUI, especially in Germany.

[pomps909]

Ahhhh to be 24 and investment savvy! You are clearly on a strong path. I have a strong inclination to pay attention to ROIC and appreciate your enhancements to this measurement.

Having over 30 years of professional experience, much of it focused on maximizing capital investments - I have an appreciation for how prudent capital deployment unlocks growth.

I'm curious about your largest holding (DHR) - and the factors involved in how you got there? I own the stock and have been dollar cost averaging with some of the recent weakness. I feel the current pressure is due to expected weakness in top line growth with COVID no longer being a spring board so to speak.

Being recently retired, my allocations are heavier toward income. I set and follow strict allocation guidelines at macro level so I'm balanced between equity, income & safer treasury holdings.

A couple things that may be helpful. I pay very close attention to FCF/Debt ratios and look very closely at how companies manage debt loads.Debt is not a terrible thing when managed properly but can act as anchor when businesses face other challenges. I also personally do not carry cash. There are too many liquid investments these days that offer 5%+ interest with high levels of safety. In my daily funding accounts I do keep a few month buffer of cash - but in brokerage accounts there isn't a penny that's not sitting in liquid investments. Easy to move out of these when other new opportunities present themselves.

Best of luck to you!!!

[KFYY]

@pomps909

So, what are your top 5 positions right now?

[Heavy Moat Investments]

@pomps909 I missed that comment, but I'll reply now. Thank you for the compliment first off!

I wrote a few articles on Danaher, you might want to check those out. I first bought a tiny position in 2020 and have very aggressively bought throughout 2023 from a 1% position to 14% or so now. The continued focus on improving the portfolio towards high growth industries with secular growth is compelling and management is one of the best to do it.

I agree, debt is very important and I always include it in my investment process. I don't like levered companies, it is a popular reasons why great companies fail.

[pomps909]

@KFYY As I noted, I'm heavily slanted towards short term treasuries at this time - about 60% of my portfolio is held in monthly paying treasury and bond funds - mostly in SGOV; USFR; with smaller allocations (3-5%) in JPST; VUSB; VCSH. For equities - I'm at or close to a 2% full position in the following - RTX; AEP; VZ; JAA; EPD; AEM; PR; EQT this is amongst about 70 total equity holdings.

All of the above equities mostly are income plays with many also being undervalued. Hope this is helpful!

[Maxlzzp]

50/50 split between a Dividend and Growth ETF. Rebalance when prudent.

[Uncorrelated]

@Heavy Moat Investments thanks for publishing this article and describing your approach. Focusing on well run companies with good financial results and (hopefully) competitive advantages or moats can never be wrong, although as you say they might not always be "exciting" :)

You did not say much about your own goals for your investments/assets so my advice is in that area. A company may have good financial strength and results, but might not be a good investment for you as owner of their debt or equity. I thought hard about my specific goals for my taxable and non taxable investments and wrote things down to guide me in making choices. One good approach is like a pyramid with your "vision statement" (ha ha but it's a real thing) on top, this is your highest level strategy or "what do you want your investing life to look like". For me, it is "never run out of money" (I'm retired now so mine will be different than yours). Compare this to the old approach of "sell up to 4% of your assets every year and hope that you don't run out of money before you die". That one vision statement drives a lot of lower level goals and objectives. Yours might be "build a big enough nest egg so I can retire at age 50 if I want to" or "so I can buy a boat and become a pirate" or whatever. The pyramid idea is just that any investment you make should support one or more specific objectives, and that objective should support a specific goal, and all your goals should support your vision. Or call it your investing strategy, or your ultimate dream or whatever you like.

For example, at the next level down I have "never sell anything to pay my bills or expenses, only sell to improve investments (take capital gains, get out of a losing position etc)." That leads to lower level, supporting goals like "find investments that pay dividends to cover my expenses" which of course means I have to have a good handle on my expenses and "minimize taxes to reduce expenses" which, in the U.S., might mean "investments that pay tax-qualified dividends" or municipal bonds that can be federal and/or state tax-free. Your goals at your age probably include focusing on no-tax/low-tax growth instead of income right now. My objectives for my IRA (tax-advantaged retirement account in the U.S. which I am not allowed to spend yet without paying a penalty) are totally different than those for my taxable account as they should be for most people. These low level goals are where you filter for how much risk (drawdown, volatility, however you like to measure risk) you are willing to accept, timing (how soon do you need the gains and/or dividends from this investment?), tax issues, diversification and things like this. I won't draw from my IRA for at least 10 years, so everything I buy in it has a 10-year planning horizon (unless something goes wrong with the investment and I need to sell it sooner) so if a good company is having a bad quarter, I don't care. Not true for my taxable account.

When you get down to this level and you are evaluating the financial health of a company, you can also say "do the dividends pay me enough, and keep my taxes low enough" or "does the mix of share price growth and dividends meet my annual return required to be a pirate by age 50" etc etc.

Maybe you are already doing this, but I think a lot of people aren't that clear with their specific goals as an investor and they just think "is that a good fund/company" maybe looking at total return, or dividend yield. The right way to think is "is that a good fund/company which also meets this very specific investing goal of mine".

Hope this helps and best of luck! You are doing a great job already for somebody of your age.

[Heavy Moat Investments]

@Uncorrelated thank you for this great comment. I did share this about my goals in the first portfolio article " 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."

As you said, income is not a focus for me right now. I expect that this will take care of itself with time. All my companies generate great cash flows, so I'll see some start to pay a dividend through the years (like Napco, who initiated a dividend this year) and others continue to raise the small dividend they already pay.

I like the pirate goal, but as a metalhead I'd prefer to become a viking :P

The pyramid idea is a good one. Right now for me it is all about maximizing the KPIs, while not taking on large risk with speculative companies.

[skehoe]

I like your portfolio metrics. If you haven’t already, look at smith fund run by Terry Smith. His extraordinary results validate your plan.

[Heavy Moat Investments]

@skehoe Thanks, Fundsmith has a good portfolio for sure.

[Carlos T Baez]

Based on historical factual cyclical data we are ready for a natural economic/financial reset that no matter what anyone says or does cannot and will not be avoided. Mother Nature can be manipulated/delayed but NEVER, NEVER denied. Ever since 1971 when I first started trading every time that I have defied Mother Nature's cyclicality, I have regretted it. I have learned and benefited from sticking with company's stocks that everyone depends on to live and survive. Fossil fuel energy is here to stay for at least the next 30 years, and buying the formidable generals within that group at a major pull back price which will happen within the next 12 to 24 months, will be rewarding. The same thing with health care, food and related processing/cultivating companies. Utilities, Transportation etc. Every single thing that we can look at, touch, smell, wear, sit on, ingest, throw, catch, read, type has and will continue to have fossil fuel energy. The pills that we take are encapsulated in oil/chemical related packages, they have to be transported, they have to be rapped etc. No matter how many wars we are having, what the fed is doing, what Wall Street is saying doing everyone has to get up in the morning and brush their teeth, eat/drink something and drive and/or be driving to work and/or to the church where they help people financially. My Economics professor taught me that whether the economy is booming or totally destroyed the next sectors do well. When the economy is at its peak everyone is eating, drinking, celebrating, travelling, they get sick and die. When the economy is at its bottom everyone eats more to substitute the lack of other pleasures, they drink more to drown their sorrows, they get sick and die. This has happened since the dinosaurs declared war on Monther Nature.

[Dow500k]

@Carlos T Baez nice tin foil hat

[notyouagain]

@Dow500k
Tell us what was wrong with any specific thing he said.

[KFYY]

@Carlos T Baez

Great comment!

Why do you believe energy companies will go down during the next 12 to 24 months?

What are your top 5 positions in your portfolio now?

[NunoG]

Thank you for sharing your thoughts and knowledge. Congratulation for such a fine job.
The only stock of your portfolio that I would certainly avoid is MELI. I will definitively look into AOJ-B.CO

[Heavy Moat Investments]

@NunoG Any particular reason why you'd certainly avoid MELI? Political risk?

[Random Logic]

The most important investment writing I ever read was "Worldly Wisdom by Charlie Munger 1995-1998"
www.studocu.com/...

There's a lot to chew on in this and I found it fascinating. I think its amenable to your approach. Even now as I glanced over Munger's musings to post this, I'm reminded that I need to review it all over again. There are two parts, IMO, that are most vital and I will provide excerpts:

~The trick is getting into better businesses.
We have really made the money out of high quality businesses. In some cases, we just bought the whole businesses. And in some cases, we just bought a big block of stock. But when you analyzed what happened, the big money has been made in the high quality businesses.
Over the long term, it is hard for a stock to earn a much better return than the business, which underlies it earnings. If the business earns 6% on capital over 40 years and you hold it for 40 years, you are not going to make much different than a 6 percent return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you end up with one hell of a result.

~Make a few great investments and sit on your assets
There are huge advantages for an individual to get into a position where you make a few great investments and just sit on your ass: You are paying less to brokers. You are listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded.

The one comment I would make on your investing criteria is that FCF yield is more an issue of when to buy, that is when it is less expensive, and not a matter of what to buy. The latter is more important. After all, as is said, price is what you pay, value is what you get.

Good luck! It seems to me you're on the right path.

[Heavy Moat Investments]

@Random Logic Thank you for the thoughtful comment. 100% agree with the first comment and that's why I try to hold on to high ROIC companies. I don't have the discipline to make just a few investments, but I try to retain my high conviction stocks in my portfolio for a long time. Actually similar to how Berkshire does it: Make more frequent transactions in the small positions and hold onto the large positions.

I agree, FCF yield is my way of valuing a company. I have it as a KPI to have a quick glance at Quality (ROIC), Growth (expected growth) and Valuation (FCF/OE Yield).

[Random Logic]

@Heavy Moat Investments I don't have the discipline to limit myself to just a few names, either, but the more important thing is the long hold period as you said. I compensate for the higher number of names by limiting the investment level with a few of them down to the "pets" level where I get less (usually far less) than 100 shares but find the industry they're in to be interesting, e.g., IMAX, GVDNY, MATX, REMYY, MHGVY, and TSRYY for instance.

BTW - I own ULTA and a little TXN and hoping to get more of the latter in a downturn.

[Small Cap And Special Situations]

Nice work on this, Heavy. I'd be interested in seeing an article on AO Johansen if you ever feel inspired to do so.

[Heavy Moat Investments]

@Small Cap And Special Situations Thank you. Unfortunately, AOJ isn't available on Seeking Alpha, so I doubt it'd get past the editors. I might publish an overview on my substack, if you want to follow me there too: heavymoatinvestments.substack.com/...

[LorenzM]

@Heavy Moat Investments I was very interested in AO Johansen as well, but found really bad customer reviews. Any insights on that?

[DannyRule1]

You have a bright future in the investing game. I wish i had your knowledge at 24. Keep the the good articles.

[Heavy Moat Investments]

@DannyRule1 Thank you for the kind words Danny! Next one in the pipeline is BRO, should be out later this week.

[199chamber]

I appreciate the stocks you listed with moats. At my age of 66 I decided to stay away from individual stocks as they have become a little too risky for my taste. I was wondering if you have ever looked at etfs that invest in moat strategies. Those I have looked at are JQUA, MOAT, QUAL and SPHG. If you have or even haven't looked at these would you care to share about them?

[Heavy Moat Investments]

@199chamber Thank you for your comment. Great decision to focus on ETFs. I expect to de-risk as well once I plan to fund my retirement from investments. Sadly buying US etfs often is not too easy in Germany, at least with my broker. Many don't comply with regulations we need to have here.

I haven't looked into moat efts yet, I do however own one ETF: MSCI World Quality Factor. It does go in a similar direction, with a focus on companies with stable profitability and high returns on equity.

[199chamber]

@Heavy Moat Investments thanks I'll take a look at that

[Engineered Quality Investments]

I think you’ve done the right thing my friend. I wish I could have your portfolio, I love it.

4% fcf yield, growing 12% and 22% roic sums the quality to perfection hahah

I’m sure you’ll outperform the market, good luck!

[Heavy Moat Investments]

@Engineered Quality Investments Thank you my friend!