This is the first of a series of posts that will detail my reasoning behind a new equity investment portfolio, launched October 1, 2012. Montaigne Capital is named for the great French writer, Michel de Montaigne, whose humility and talent for ironic contemplation of the limits of our knowledge serve as both inspiration and guide to the fund manager.
In the spirit of Montaigne's wise formula - "Que scais-je?", or "What do I know?" [medieval Fr.], here are the principles that guide my analysis and stock selection.
1. Avoid what I do not understand, or could understand but lack the time to study in sufficient depth.
With few exceptions, I will not be seeking opportunities in industries such as Restaurants, Semiconductors, or any other industry where I will never be able to acquire an advantage. I simply don't know much about these industries and do not have the time, insight, or industry connections to in any way remedy my disadvantage.
2. Hold off from investing even when I think I understand where value lies but believe that my degree of certainty is less than 90%.
My approach will be guided above all by the avoidance of risk and the desire for the highest possible chance of significant outperformance. I seek as far as possible a complete set of favorable, risk-mitigating circumstances - superior ROIC, management competence, pricing power, financial strength - that will maximize the chances of creation of value.
3. Find the right entry point.
While trained as a value investor, I recognize that timing matters as much as valuation and that having a variant perspective can destroy one's overall performance. Some of my best picks will be great companies that are not cheap. Others will be mediocre companies that are benefiting from a market inflection. Still others will be poor performers whose price is so cheap relative to their prospects that I believe I can make money with them. And occasionally there will be companies which will benefit from political decisions or events which I believe are 90% certain to occur.
In all cases, I will be looking for an unusually high degree of CERTAINTY that my all-too-fallible judgment is unlikely to be very wrong in this particular case. This means that I will create some basic, high-level investment theses every few months, based on my perceptions of fundamental shifts in industry and market conditions, political configurations and cultural and social trends.
4. Don't try to be brilliant.
I don't claim to have created a superior new methodology, or even to be wise enough to select one methodology above all the others. I mix and mash up what seem to me to yield my high degree of certainty, and go with it.
The great investors are wise enough to be simple, and I have never lost so much money as when I was trying to elevate my analysis above everyone else's. I also know that I lack the patience of an investing saint. Accepting that near-term performance is important to me, I accept the corollary, that I must be willing to join the crowd at the beach where the best waves are - so long as I can go a (little) bit ahead of the other surfers, stay up on my board, and catch a nice ride. My goal is not to be brilliant to make a nice return, and move on.
So, to end this post, here are my key investment theses and related top picks for the next 6 months based on a combination of high confidence in companies' expected financial results, favorable entry points, and, not leat, prominence/visibility to other investors at some point during the next few months:
Thesis #1: Obama and the Democrats will trounce the GOP this fall.
Picks: CECE, RGR.
1. CECO Environmental Corp (NASDAQ:CECE). I am 95% certain that the incumbent president will win in November and that his party will have sufficient momentum in the Senate and House elections so as to maintain their core policies in two key areas: the environment and healthcare.
My own opinions on these two areas notwithstanding - as if it mattered to anyone, I view the current administration as too timid in one area and too radical in the other - it is clear to me that there is a >90% chance that a leading maker of air pollution control products and services, with over 3,500 customers across more than a dozen diverse industries, will encounter a benign market climate in the next four years. CECE's fundamentals are strong, its valuation attractive, and I will buy it if it dips below $8.50 in coming weeks.
2. Sturm Ruger (NYSE:RGR). As with CECE, my opinions as to the wisdom of our gun policy are not relevant here; all that matters is my certainty that when Obama is re-elected, we will see gun sales increase and investor demand for gun stocks increase. I will buy RGR below $40.
Thesis #2: US consumers will continue to spend on bread and circuses: low-end entertainment, discount stores, smartphones at the expense of other household budget items.
3. Walt Disney (NYSE:DIS). Rock-solid, cheap, next to no chance of underperforming due to the diverse strength of its businesses, its management strength, and my belief that a period of scarcity and stagnation will benefit "bread-and-circus" branded consumer companies.
4. Ross Stores (NASDAQ:ROST). Same as DIS, above. I don't pretend to understand retail, but ROST's return on invested capital and growth trajectory are solid. Not cheap, but a reliable performer and an investment story that everyone understands. Buy below $63.
Thesis #3: Cheap natural gas and the drilling boom will drive higher multiples of currently-cheap oilfield services suppliers and chemicals producers.
6. C&J Energy Services (CJES). I have high confidence in the earnings potential of oil company suppliers, and CJES is one of the gems in the sector. Attractive entry point below $18. Also keen on Halliburton (NYSE:HAL) at current prices and potentially OYO Geospace (new name and ticker symbol - Geospace GEOS) if it dips below $105.
7. LyondellBasel (NYSE:LYB). Very keen on chemicals companies, like LYB's valuation, clear path forward, financially strong now. Low risk and significant upside at current prices. Also looking closely at Chemtura (NYSE:CHMT) and Omnova (NYSE:OMN), but need greater confidence in my understanding of these companies' fundamentals.
Thesis #4: Healthcare technology advances create one-off opportunities in smaller-cap stocks with strong revenues.
8. Female Health Company (NASDAQ:FHCO). Stellar all around, huge growth opportunities, attractively priced.
9. MediData Solutions (NASDAQ:MDSO). Clinical trials software and data management platform provider - very attractive business, scale economies, pricing power, strong position, growing market. Solid; look to buy if it pulls back to the $35-36 range.
Additional disclosure: Trigger orders for buying the following stocks: CRUS, T, RGR, CJES, MDSO. May initiate a long position in the next 72 hours in CECE and FHCO as well.