Today I will focus on how I view my portfolio and how I allocate my capital.
This blog is inspired by Motley Fool’s CEO Tom Gardner’s following tweet:
I have been a member of Motley Fool Stock Advisor since 2017. The most important thing that I learned from Tom Gardner is that growth companies’ returns closely track their revenue growth rate in the long run. This insight was a revelation for me; before that, I dismissed companies with hyper-growth and early growth simply because they did not have a long earning track record, which is where I thought all the values lay. Another article from Bill Gurley that helped me evaluate growth companies without earnings but those that were scaling is the following:
The article by Bill Gurley states that growth company is scaling if its revenue is growing faster than its expenses. Simple. One can compare this QoQ or YoY growth rates. This will also tells us path to profitability.
There are many ways to manage portfolios and allocate capital. Each has its advantages and disadvantages. Many investors focus on maintaining a concentrated portfolio, while others advocate owning many companies or diversified portfolios across different sectors (e.g., health care, food, grocery, construction). I do not have a favorite management strategy because every strategy will have its risks and benefits, and we must learn to identify the risk-return tradeoff that we are comfortable with.
That said, a crucial but often underappreciated mantra for a successful investment strategy is to know that you should be as invested in managing your emotions as you are invested in managing your portfolio. As an example of managing my emotions and my portfolio, consider the following. In my early years of investing, I used to own stocks of less than 15 companies and the first two years returns were poor. I was amateure and was not as knowledgeable as I am now in investing. Now, I own stocks of more than 50 companies which helps diversify the risk. Think of it as distributing my proverbial eggs in multiple baskets, which gives me peace of mind—emotional management—and much better performance—portfolio management.
One of the main characteristics that define us all as retail investors is that we are busy professionals with a full-time job far away from finance. Most of us have children, and we have to take them to their soccer practices, their music lessons, and help them with their schoolwork. These family and work commitments make it hard, if not impossible, for us to track every news that may affect stock returns. Unlike us, however, many successful investors who run concentrated portfolios are full-time investors with plenty of resources to follow and track news. So, in the beginning, it was not clear to me how an “everyday investor” like me can construct a portfolio to stay in the game long term while maximizing return without losing a good night’s sleep.
The following steps have worked for me.
I view my portfolio as one holding company, Anil Inc, similar to Warren Buffet’s Berkshire Hathaway. Berkshire owns many companies under its umbrella. I am confident that Mr. Buffett does not pay too much attention to quarterly earnings calls, and I am sure that he does not trade stocks based on the interpretations and projections based on earnings calls. I try to do the same and aim to identify companies that generate value over a long period of time. Will this strategy work for me long term? Only time will tell.
Below you will see a snippet of my portfolio’s gross margin, revenue growth, and return profile.
I use Morningstar’s free portfolio management platform. I concede that it is tedious to enter all the transactions in the system, but trust me, it is worth the time and effort. We are dealing with numbers, and there is no substitute to compare performance across stocks and over time in one glance.
Next, I want to bring your attention to the last row of this portfolio. As you can see, the gross margin average is 64.8%, revenue growth is about 102%, 3 years revenue growth is about 53% (overall revenue is accelerating), and the price to cash flow is around 77. The total year-to-date return is around 30%, and in 2020 the total return was 186%, and in 2019 the total return was 76%. Furthermore, total 3 years and 5 years CAGRs are 62.8% and 47.66%, respectively. As you can note, three-year annualized revenue growth has increased from 52.9% to 1-year revenue growth of 102%. Another interesting observation is that 3yr. revenue growth CAGR of 53% tracks closely with 3 yr and 5 yr portfolio return CAGR of 63% and 47.66% respectively. These are not my actual returns, so yes, if I had held these companies for the last five years, the returns could have been similar.
Now let us see if my real brokerage returns stacks up to what I just showed you. I am going to show my fidelity brokerage return:
Please note that my 3 yr CAGR actual return is 41.75% which similar to revenue growth rate of 52% CAGR!
And now, here is the performance of my portfolio on March 2020 (at the start of the COVID-19 pandemic) drawdown relative to S&P 500.
As you can see, my portfolio drawdown was lesser than that of the S&P 500. I can tell you that it is comforting to know that you are doing better than the market, even during a severe downturn. No one likes when their portfolio goes through a drawdown, but if you pick the right stocks, the performance will be better than the average market even during a severe downturn.
I hardly ever monitor the performance of individual stocks. I, however, add a company to my portfolio only after proper due diligence, where I rigorously evaluate the said company’s potential for the next 3-5 years.
I have had my share of failures. Instead of being fixated on those failures, I try to learn from my mistakes and move on. Sometimes it takes two mistakes for me to learn and course-correct. To err is human, but not to learn from one’s mistakes is foolish. Nevertheless, we can be forward-looking and recognize that we will make mistakes in the future. Thus, I do not like to be overweight in one stock at the beginning of the investment journey. I want them to grow in a significant position over a long horizon.
As I mentioned earlier, I do not usually focus on individual stocks’ performance quarter to quarter. At the same time, I am not saying I am careless. Just that once I pick a stock, I stay put unless there is a significant breach in my thesis, or management is involved in some egregious acts, or if there is severe deterioration in business fundamentals. For example, in 2020, when the news came out that the management of Luckin Coffee lied, I sold the stocks immediately. I do not try to rationalize or justify such acts by the company and hope they will not repeat them. Recently, I sold all my Chinese holdings because I cannot support recent misbehavior by the Chinese government. Sometimes, I sell stocks if the fundamentals of a company change. In my view, a company’s fundamentals depend on their business model—how they generate value—and on their management team. So, when the CFO of Fastly left abruptly, I sold my Fastly shares. The point is that, because of position sizing and having a smaller position size, it does not matter to my portfolio whether I was right or wrong about one particular stock.
When the overall stock market trends downwards, I view my portfolio as if it were a company that I am considering for my portfolio. In the process, I consider the portfolio's past performance and broad operational metrics and find solace and happiness. Remember, it is as much about temperament management as it is about portfolio management. While I trust my process, it is constantly evolving and growing as I grow and gather more experience.
When starting a position, it is always good to go slow and small. If I am early and correct, the market will agree with me, and then I can continue to add. If, however, I am wrong, I can wait until the business fundamentals improve and the market agrees with me. If I find out that the company is not as promising as I had initially thought, I can exit with minimal loss.
One may wonder how I can follow so many stocks. First, as a long-term investor, I do not want to and do not have to follow each stock closely. For that reason, I eliminate positions that need constant oversight. Such stocks tend to be time-consuming and risky. I manage my portfolio like a portfolio manager who owns many stocks would. The difference between a portfolio manager and me is that I do not have analysts working for me. Instead, I subscribe to services like Motley Fool stock advisor, Morningstar, and I read letters to shareholders from reputed fund managers like Baron’s fund. I, however, rarely rely only on my analysis. To complement my analysis, I read other reliable resources on the market, and I constantly check my thesis and update them and only use the updated knowledge to make investment decisions.
In summary, there are several ways to skin the cat. Long-term successful investment entails stock selection skills as well as individual behavioral skills to stay in the game. Your portfolio should match your risk profile, education, experience, availability, and temperament that lets you stay in the game.
Thanks for sharing your thoughts and insights into how to select and manage a portfolio.
Very insightful Anil. Few questions -
1. Do you keep a certain amount in cash to add to positions when a correction happens or do you DCA with additional cash on a periodic basis?
2. Do you rebalance when a position becomes too big due to performance?
3. With 50 stocks, looks like you are trying to get to an allocation that's 2% of the total amount for each position? How much is your starter position?
4. What about Margin of Safety on the intrinsic value to start a new position?