My portfolio is beautiful. I like what I own, I want to own more of it, and it’s been difficult for me to find any ideas lately that I like better than what’s already in there. Here’s to hoping my portfolio performs as good as it looks to me right now over the next few years.
Since I’m so in love with my portfolio right now, I find myself wondering what is it that I like so much about this collection of ten stocks. Why do they look so attractive to me?
I think the answer is that I understand these investments. I know what I own, I know why I own what I own, and I’m comfortable with the mix of businesses and their prospects.
I’m so comfortable with this mix of businesses because they mostly fall into two styles of investing that I understand and suit my personality perfectly: net asset value plays and growing pies. Along with these two core styles, I also have a small amount of money in what I’m calling “speculative tuition,” and of course, everything I do is very likely to have a cloning aspect along with it. Let’s break down my current style of value investing.
Net Asset Value Plays
I’m a simple guy. Give me a Caniac, a Diet Coke, and a Real Housewives of New Jersey episode and I’m living heaven on Earth.
How do they make this chicken finger so perfect on the inside but so crispy on the outside?
Why did Teresa come in so hot? She was in such a bad mood from the time she showed up. Will all the girls wear her fitness line at the softball game?
Since I’m such a simple guy, it makes sense that I’d be attracted to net asset value plays. What’s a net asset value play? To me, they are when you purchase a business for a price that is much less than the net value of their assets minus their debt. It’s simple.
Ring Energy has $1 billion of net of debt reserves at $70 oil, I bought it for an enterprise value of $500 million, and the result is that I made $500 million the day I bought it. I bought something for less than its worth.
Pedevco has $150 million of net of debt reserves at $70 oil, and I bought it for an enterprise value of $70 million.
Seritage has real estate net of debt worth $25 to $35 a share, and I bought it for $11.
And so on.
Is Ring really worth $1 billion? Will I really make $500 million?
Is Pedevco really worth $150 million?
Is Seritage’s net real estate worth $35 a share?
I’m a simple guy, I’m not good at advanced math, and the answer to these questions is that I don’t know.
Ring’s net assets could be worth $700 million, or oil could go to $150 for a long time and their assets could be worth $2 billion. Same kind of situation with Pedevco, in terms of a big range. And is Seritage worth $25 a share, $40 a share, or $15 a share? Who knows?
What I like about these net asset value play situations is that, to me, they’re easy. They’re easy because of the margin of safety.
If a big guy walks in a room, I don’t know if he’s 230 pounds or 270 pounds, I just know he’s a big guy. But in this metaphor, Mr. Market is saying, “that’s not a big guy, that guy is average weight.” And I’m like, nope, no he’s not. It’s obvious he’s a heavy guy, and I don’t need to know the exact pounds. All I need to know is that he’s heavy, and as a result of that knowledge I get to take advantage of Mr. Market rewarding me with the opportunity to buy a mispriced asset.
There’s a lot more that goes into net asset value plays. They have to be in your circle of competence, you have to judge the risk if there are losses and debt, but in general, it just comes down to the assets net of the debt and what price Mr. Market is offering you. And if there’s a big disconnect, meaning a big margin of safety, and you think the risk is understandable and limited, then you buy. That’s my strategy with net asset value plays and they work well for a simple guy like me.
Growing Pies At Good Prices
I like exercise and I like to stay fit and active, but you know what, I also like to sit on my butt, a lot. I like to sit on my butt and watch television, read books, listen to podcasts, and sometimes just enjoy the breeze on a cloudy, cool day. As Tony Soprano said Popeye says, I am what I am.
And luckily for me, there’s an amazing style of investing that rewards sitting on your butt and doing nothing, and it’s called buying into growing pies.
There is an amazing book called Richer, Wiser, Happier by William Green. The best thing I learned in that book, that really changed me as an investor, was the way some investment manager at Fidelity talked about his style of investing. He said something to the effect of, I don’t know what the PE of companies should be. I don’t know if a stock should be at a PE of 5, 15, or 30. That’s Mr. Markets’s job, not mine. My job is to find businesses that will grow their earnings over time, and then buy those businesses.
The logic behind his statement is that if the E denominator goes up, then even if the P nominator stays the same, the price of the stock will go up. And of course the whole goal here is to see the price of our stocks go up. If earnings go up, and the mulitple value that the market puts on those earnings stays the same, then the price of the stock will rise.
For example, say General Motors has a PE of 6, earnings of $5 a share, and a stock price of $30. If the earnings go to $7 a share, and the PE stays at 6 because the market continues to value those earnings at a price of six times earnings, then the new stock price will be $42.
This kind of logic spoke to me because I struggle with the very popular discounted cash flow analysis style of investing for a few reasons that I’ll list below.
- I hate the false certainty and false sense of confidence that comes with DCF formulas.
- I hate trying to predict an unpredictable future with certainty. Do you really think this company will grow earnings at a 10% rate for 7 years? How do you know what will be happening in 7 years?
- What the discount rate should be?
- Mohnish’s 10 commandments of investment management say never use Excel.
- Li Lu told the Columbia class to never use a calculator.
- And I think I remember Mohnish giving a talk where he recalled Munger saying something to him like, “yea, Buffett never did that stuff, like he didn’t sit down and write out a formula.”
- And I recall Buffett saying something to the effect of “yes this is what investing and prices are based on, and we think about it, but it’s not like we sit down and scribble out some little formula.”
In a sentence, DCF formulas are not my style.
That said, I understand the logic behind them, and I agree that the price of a stock, the value of a business, is the value of the earnings that you can take out of a business over time as the owner, discounted back to the present date.
Either my skepticism about DCF formulas is correct, or it’s just that I’m not smart enough to do them, but either way, they’re not for me.
So if I don’t do DCF analysis, then how do I figure out how to buy stocks that are based on earnings and are not as simple as the NAV plays? My solution is to do what this Fidelity guy did.
I try and find businesses that I think are going to be successful over time and are going to continue to grow their earnings over time, and if the price looks good to me, then I buy them. And then I sit on my butt, collect dividends, enjoy buybacks, and get richer and richer over time.
My Apple investment comes to mind as an example.
I bought Apple in 2016. The PE was 10 to 12, there was no net debt, and the business prospects were strong (and I thought they were stronger than Mr. Market did). Apple is up a lot since then, way more than the overall market, and I still own most of what I bought then. In 2016 the earnings per share were $2 and the price of the stock was $25. Last year the earnings per share were well over $5 and the price of the stock was $140. The earnings went up, and the price of the stock went up. Exactly as planned. But it also did way better than just having the earnings go up becuase the price multiple of those earnings that Mr. Market decided was fair went up as well. That rerating of the PE acted like an amplifier and that’s why it’s been around a six bagger when the earnings were only up about three times.
I didn’t have to do a DCF formula, I just bought a growing pie for a fair price, sat on my butt, and got richer. It’s such a cool thing. All I had to do was make four easy decisions and get them right. 1) Decide that Apple’s prospects were good, 2) decide that the price was fair and worth buying at, 3) decide to buy more of their stock a few times over the years when I thought that the price was fair again, and 4) decide to have the discipline to hold and not sell. Four easy decisions and everything worked out magically.
I call this the growing pie at a fair price strategy. It’s easy, it’s profitable, and it fits my personality. But there are two major risks associated with buying growing pies.
- If you misjudge the business prospects, the management, or the industry, earnings could stay flat or go down, and you’ll end up with a breakeven situation that has an opportunity cost, or even worse, a loss. I worry about this with Greenbrick Partners. I love the business, I love the management, and I like the price, but I worry that I don’t understand the home building industry enough and that I could end up on the wrong side of a business cycle. But in this case, currently my position size is something that I’m comfortable with, and I also have an insider cloning aspect that I’m relying on.
- If you pay too much for a growing business, you’ll end up with a breakeven outcome as the company grows into that high price over a long time, which will cause you to incur an opportunity cost, or if the company doesn’t grow into that price, you’ll incur a loss. Paying a great price, good price, or even a fair price is fine for growing pies. The risk is that you’ll pay a bad price, pay too much, and have a lousy outcome. How do I know what the right price to pay is? I’m still working on this and trying to get better. Right now I rely heavily on looking at the earnings yield (inverse of the PE), I decide if it seems like a good price, I look at the growth prospects versus the price of that growth, and then I make a judgement call. And sometimes I look at what other companies in the industry are priced at.
The best part about owning growing pies that you bought at a good price is that you don’t have to do anything! You can just sit back, enjoy your ownership in a growing business, and follow the wonderful business holding checklist. This has many advantages that we won’t get into here, but it really can’t be beat in the investing world. That said, in my experience, most of the time these situations are rare. Mr. Market is emotional and unstable every now and then, but he’s not dumb most of the time. Most of the time these growing pies sell at prices that are too expensive. Sometimes they sell for fair prices, and they’re worth a look when they do and sometimes you buy. But every now and then, these wonderful businesses go on sale and you can buy them at a great price, and for me, that’s when I go to work. That’s when I bet big and take huge positions.
Patience to wait for great prices, courage to bet big when you find them, and discipline to hold on for decades are the three skills that are needed for success when investing in growing pies.
Cloning plays a major role in everything I do as an investor. I like buying companies my Superinvestors buy, and I like paying similar prices. It just makes sense to me for obvious reasons.
Sometimes I do venture out on my own like when I bought Ring Energy and Greenbrick Partners. But even when I buy something that’s not a clone of a Superinvestor, I still like having a cloning aspect to it, and that comes in the form of insider buying.
If I am going to buy something that my Superinvestors haven’t, then I feel much more comfortable if I see insiders at the company, like executives and board members, buying the stock at similar prices that I’m going to buy it for. Alternatively, when I see insiders only selling, it’s usually enough for me to decide to pass.
Cloning is a simple concept, but a powerful one, and it plays a role is most of my investing decisions.
The final aspect of my investing style is what I call speculative tuition. This is when I stray outside of my circle of competence and decide to buy a business that I don’t feel like I understand that well. I keep the allocation size small when I do this. I feel comfortable right now with no more than 10% of my portfolio in the speculative tuition category. Some examples currently in my portfolio are Navios Maritime Partners and Coupang.
I call this style of investing speculative tuition because I’m both speculating and also trying to learn. I say speculating because in these situations I’m outside of my circle of competence and mostly going on gut feel. And I say tuition because when I make these speculative moves I’m trying to learn more about a business and an industry, and I think I’m more effective at that when I’m an actual owner and have some money on the line, even if it’s a small position. For example, with Navios Maritime Partners, I’m seeing a PE of 2 for two years in a row, a price that’s lower than book (though I understand book value changes quickly in this industry), a large backlog, and a uniquely independent-minded manager who owns 5% of the company. It’s an interesting situation, it appears to be cheap, and I want to use it as an opportunity to learn more about the shipping industry.
And with Coupang, it’s a David Abrams clone, so that brings me comfort, and I have a gut feel that I might be getting a wonderful business very early on and that I might have a catalyst soon when it starts breaking out division profitability later this year. I want to learn more about Coupang, try to see if I can figure it out, and maybe get lucky and grow my level of understanding and get the confidence to make it a larger position and possibly get a huge win if I buy a big position very early on in what turns out to be a long-term grower.
So that’s it. That’s how I do value investing. I do net asset value plays, I buy growing pies at good prices, I clone, and I do a little bit of speculation with the motivation of trying to learn more and possibly getting some huge wins that I wouldn’t set myself up for otherwise if I wasn’t willing to speculate a little bit and possibly pay some tuition. This is my current investing style, it’s all simple, and it all works well with my personality. I’m a happy, curious, and content investor these days.