Here is a screenshot of my portfolio as of January 18th, 2019:
I wish I could report that the notable change in my total portfolio holdings of about $4.2 thousand, or 31.6% from my previous update a few months ago was due to my superior stock-picking ability. The bulk of this gain came from portfolio infusions through winnings various competitions I participated in during my first year in college; optimistically, perhaps this can be viewed as a great return on my investment of time. Because of these infusions, it’s difficult to compare my portfolio to S&P returns but allow me to make it easy for you: I didn’t beat the market. In fact, I estimate that I slightly underperformed, in large part due to my concentrated investment in YY (approximately 32% of my total portfolio). The stock dropped approximately 40% from my original purchase price in large part due to trade war tensions between the United States and China (which don’t affect YY’s business, I should add). Nonetheless, I was able to average down my position dramatically.
I don’t say this shamefully; in fact, the probability of underperforming the market in a given year even if you are endowed superior stock-picking ability is fairly high. Warren Buffett underperformed the market about 35% of the time while he ran the Buffet Partnerships in 1960-1970. Allow me to reproduce a sentence I wrote in a previous post:
“This short-term gain (over the course of 2 months) does not excite me in the slightest. Tomorrow I may be drowning in red ink; the vacillations of the broader market (and consequently my stocks) do not interest me nor do I attempt to forecast my gain over any time period… The only claim I make with these businesses is that they will outperform the broader market over a period of many years.”
I’ve kept my promise so far, so it seems. What I do regret, however, is my portfolio turnover, that is, how much time I spent buying and selling different stocks. In my last portfolio update, my portfolio consisted of 7 stocks, only three of which you see here today. To be fair, three of the seven you don’t see here today were classified by me as short-term investments in which there was extreme mispricing; nonetheless, to reiterate Buffett’s forth law of motion:
“For investors as a whole, returns decrease as motion increases.”
Reflecting on this, I’ve created a sizable cash position (over 30% of my portfolio) that will be utilized only in the best of opportunities as they present themselves. Too many investors cannot stand the fact that “cash in the bank isn’t earning anything.” This thinking leads to imprudent and hasty decision-making in hopes of having a high invested position, and many investors fail to recognize that earning 0% is better than losing your money in a foolish investment. True opportunities are extremely rare, and if one is finding a “great” investment every other day, their standards are too low. I’m happy to keep this cash position for many years, and I’m in good company: the best companies in the world often have high cash positions to take advantage of opportune times (examples include Berkshire Hathaway, Baupost Group and Apple).
Picking Good Companies and Making Good Investments
The titans of finance may disagree with me, but I firmly believe that a 10-year old with a basic arithmetic background can choose five great companies as well as a finance graduate. In fact, the 10-year old may be a better company-picker because he/she won’t be distracted by all the noise the finance major learned in college. In fact, after taking my first finance class, I had a disturbing revelation: in the whole semester, we calculated measures of risk and expected return on different stocks/portfolios yet not once did we talk about the fundamentals of the company in question. In fact, risk and expected return is exclusively a function of its past stock price movements.
One may also logically argue that a publicly traded company is not fundamentally different than a private company; the only real difference is that the private company does not offer daily quotes of what the investing aggregate believes is its value. Therefore, shouldn’t calculations of risk and expected return of private and public companies be similar? Well, it turns out that traditional finance theory has not concocted a way to quantify risk of a private company (yet a year after it IPO’s, suddenly the risk is straightforward).
But I digress. Anyone can find great companies and determine with reasonable accuracy whether their current price is appropriate in light of its business prospects (the latter might require some specialized knowledge that a 10-year old doesn’t have, but it’s not unbearably complicated). If that is the case, why do so many smart Ivy league graduates fail to generate decent returns? The reason is that finding good companies and making good investments are two different things: finding good companies is straightforward, almost a science, while making a good investment has a behavioral component that dumbfounds even the smartest money managers. The interesting and profitable conclusion from this information, however, is that in their education, most investors focus on the easy part (finding good companies) and fail to develop the emotional vitality required for good investing. An interesting observation: there are classes in The Wharton School dedicated to both finding good companies (FNCE 207, corporate valuation) and making good investments (FNCE 239, behavioral finance). All of the sections of Corporate Valuation are filled to the brim, and there is a long waitlist to get into the class. Behavioral Finance, on the other hand, is half-empty. More interestingly, Corporate Valuation is rated as the more difficult class, even though the greatest investor in the world, Warren Buffett, says otherwise:
“Investment problems, they’re easy. It’s the human problems that are the tough ones.”
Because of the insistence of academics, students and practitioners of finance, I have decided there is an oversupply of individual company analyses; for this reason, you have not been seeing much of them on this blog. I prefer to focus on the more difficult portfolio management aspect of finance; nonetheless, I’ll provide a quick description of my many investments and my abridged rationale. You can find my TSCO analysis here, YY here and NVR here.
Enovo International is a subprime lender, that is, they provide loans to those who typically get denied credit at traditional financial institutions. In one sentence, it’s a bank that services those with bad credit. At first look, this seems like a terrible business; however, these loans are priced such that Enovo still makes a profit on defaulted loans. Its two big competitors are CURO and Elevate Credit, but Enovo is the largest. The name of the game here is the interest rate spread between the liabilities of these companies and the earnings power of their assets (i.e. loans). For example, if Enovo gives me a $100 loan at a 90% APR, it must fund this loan through its own loan; say it borrows $100 at 15%. Assuming I pay the loan in full, Enovo receives the 75% spread annualized (less any operating expenses for servicing this loan). Thus, the APR a company is able to provide is entirely dependent on its cost of financing; companies with a low cost of capital will be able to lower the APR of their loans or earn a higher spread on their existing loans. Enovo’s cost of capital is about 9-10% today, which is fairly lower than its competitors (Elevate, for example, has a cost of capital above 10%). The idea is that as Enovo continues to grow, there are a few value-adding factors at play: (1) operating expenses will decrease as a % of revenue through economies of scale (there are little incremental expenses of servicing a new loan), (2) cost of capital will decrease and certain loans can be funded with equity and (3) more competitive pricing can help gain market share. Finally, there are some macro factors that can facilitate this process. Traditional brick-and-mortar payday lenders are going out of business because of regulatory upheaval, leaving a lot of white space for fin-tech like companies such as Enovo which have lower operating expenses. Moreover, recent regulations favor those lenders who can lower their APR the most, and Enovo is one of the frontrunners on this front.
Triple S-Management (GTS) is primarily a property and casualty insurance company in Puerto Rico that traded at above $40; after the hurricanes hit, the stock fell to ~$15. The question we should ask ourselves is: can GTS stay solvent and achieve profitability after paying for these new liabilities? This is a very difficult question to answer, especially considering that there are dramatic regulatory changes in the region as well. However, some things to consider is that in the life insurance segment, GTS has the exclusive right to use the Blue Cross Blue Shield name in the country and controlled over 40% market share. Moreover, while the company is reporting earnings of about $50m, certain adjustments indicate that its true earnings (equity-method investments) are closer to $70m, relative to a market capitalization of ~$400m when I purchased it.
Graham vs. Buffett
Most adherents of value investing will distinguish themselves in two camps, the Graham followers and the Buffett followers. The Graham followers will buy any company as long as it meets one criterion: absolute cheapness with the ability to at least double from its current market price. According to them, a well-diversified portfolio of such cheap companies should outperform the market. Buffett followers, on the other hand, place emphasis on the quality of the company, and only buy great companies and good prices. Some go insofar as saying one can buy a great company at its fair, or intrinsic, value. Personally, I do not try to place myself in any of the two camps. As Charlie Munger says:
“All good investing is value investing.”
In fact, in his early days, Buffett bought extremely cheap companies regardless of the underlying business; his most well-known purchase, Berkshire Hathaway, in 1962 was such an investment (back then Berkshire Hathaway was a textile manufacturer). And it wasn’t until only a few years ago where he advocated buying great companies at fair prices.
It’s dangerous to constrict your opportunities because you steadfastly adhere to a very specific philosophy. Facebook may be a great investment at $60, or 10 times earnings, but according to Graham followers one should only buy companies trading for less than book value. Moreover, a company trading for $5 with $8 net cash per share about to undergo a quick liquidation may be a great short-term investment, but the Buffett followers would never touch it because it doesn’t have a “durable competitive advantage”. As Seth Klarman advocates, it’s important to have a flexible mandate, that is, be open to investing in many types of situations as long as you’re buying something for less than it’s worth. There are too little opportunities for great investments and a great many people looking for them; one should not squander these opportunities just because they only look at small cap stocks, or tech stocks, or distressed debt, etc. To give an illustrative example, after the tech bubble in 2000, what might you guess were the best performing assets in the subsequent two years? The answer is commodities. Those who weren’t looking were never be able to profit off these developments. Those who did didn’t have sexy investments to talk about during cocktail parties, but at least they made millions.