Philosophy
I invest to secure my family’s financial future. I aim to compound at 15%, or to double every 5 years. Mathematically, the impact of this over a lifetime is breathtaking.
No asset class will compound at 15% over the long term, but carefully constructed portfolios can.
Active vs passive investing
Obviously, I believe in stockpicking rather than passively tracking an index. Statistically I am wrong about this - most active managers underperform after fees. But I have three reasons for picking stocks:
I enjoy it.
I think I can make stockpicking work. While it is difficult to have an informational advantage, I think it is possible to have a psychological advantage in markets. I am relatively good at anchoring to long term value in stocks I know well, especially when markets are being driven by emotions and misaligned incentives.
I don't think I can make passive investing work. The argument for passive investing assumes perfect buy-and-hold-forever behaviour, but when I own the index I trade emotionally around macro, and in doing so I interrupt compounding.
Investment edge?
If I have an edge it is rooted in two closely-related things.
One is time horizon. The market is sometimes very short term. By contrast, I find clarity on the horizon. I’ve owned my core compounders for 15+ years, and when I buy a new stock my investment horizon is always 5+ years.
The other is psychology. I have become reasonably good at developing a valuation framework for a company, buying when it is cheap, holding it for a long time, and selling when it is expensive.
Performance
You will notice I did not cite past performance as a reason for active investing. Simple maths says that my portfolios are bigger than market performance alone can explain, but I don’t measure performance for two reasons:
The information is not useful to me. I care about the future, not whether I could have been slightly richer or poorer if I had done something different in the past.
Measuring performance makes me a worse investor. It is an inherently short term activity and I find it alters my time horizon. It also introduces unhelpful emotions.
Instead I try to focus on what matters: optimising future returns.
Rules of thumb
I try to:
Be fully invested. Equity markets tend to produce positive returns over time, driven by nominal GDP growth and free cash flow. I'm no good at predicting market ebbs and flows, so it makes sense to be fully invested. If I am not, it is because I can't find individual stocks I like.
Capture occasional opportunities at scale.
Add risk in panics, even if it means selling things I love to buy things I love even more.
Stockpicking approach and process
I am a flexible generalist. I invest across markets, sectors, and types of company. I think this allows me to find opportunities in all markets, not just some.
I am a long term bottom up stockpicker. Macro matters, but I can’t predict it. My approach to macro is simply to try to be greedy when others are fearful.
I categorise companies into 5 mental models, which helps me understand why I own each one.
I have two golden questions: will the stock help my portfolio to double in 5 years? And do I understand why I own it and the risks I am taking? These seem very obvious, but I am not sure all investors apply them with rigour.
Most investors make predictions about the future. That’s hard. I prefer to understand what’s priced in. As a general rule, markets are good at pricing high-probability outcomes, but not lower-probability outcomes. Things that are reasonably likely to happen (but not certain) are often either very overpriced or not priced in at all. Avoiding the first and embracing the second has worked for me. I like stocks that have decent base case returns plus an underpriced option embedded somewhere.
I prefer accumulated knowledge over intense bursts of work. Broad deep dives - i.e., trying to learn everything about a stock at once - have a number of drawbacks. They take a lot of time, even if you’re not going to buy the stock; they often contain a lot of stuff that doesn't really matter; and (perhaps most importantly) I find I never have enough confidence in a new idea to allocate capital at scale. I prefer to accumulate knowledge on a company for several years, analysing results and calls, and doing narrow deep dives into the things that really seem to matter. Then, I have the confidence to buy in size when an opportunity appears.
I no longer build detailed financial models. These are essential if you’re trying to predict quarterly earnings to the cent, but very time consuming to maintain. I build simple valuation frameworks to understand what’s priced in for the two or three things that really matter.
Over the years I have developed a very specific portfolio structure that suits my strengths and weaknesses.
Funds
Most of my portfolio is in stocks, but I am happy to pay fees when funds:
have permanent capital;
do something I can't;
are clear on philosophy and strong on execution;
lever long term and cheap; and
trade at a discount.
“What were you thinking?”
I'll finish with my all-time favourite investing quote, which speaks beautifully to the role of psychology in investing and hints at how investors often blame management for their own emotional mistakes. Here is Scott McNealy, the then CEO of Sun Microsystems, on absolute fire in Business Week in April 2002:
"But two years ago we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes that with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?"