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Overall Investment Strategy

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galumay:
from a friends post about his investment strategy,

The Gent's Pre-Investment Checklist

Economic Moats: are there signs that the company already has, or could develop an Economic Moat (a structural advantage that can insulate the company in the future against competition)

Network Effects: Does each new customer make the network more valuable for existing users? The least likely moat source, but IMO the most valuable and lucrative from a future Return On Invested Capital (�ROIC�) and margin perspective

Intangibles: Increased pricing power emanating from proprietary technology, patents, brands or regulation (i.e. licences)

Switching Costs: Does the cost of switching to a competitor�s product/service outweigh the benefits of doing so (due to risk, integration with the customer�s systems (mission criticality), hassle and distraction). Higher customer retention/lower churn = increased pricing power and potential future ROIC

Cost Advantages: The ability to price below competitors due to cost benefits arising from cheaper processes or manufacturing economies of scale, better buying power, proximity or access to infrastructure or a low-cost resource, or low-cost financing

Efficient Scale: Does the company operate in (dominate) a smaller/limited market which is unlikely to be attractive to larger rivals?

Management: How high quality does management appear and what is its track record for building lasting larger companies?
Does the management team have significant skin in the game (I like to see management owning at least 10% of a company, and I love it when 30% and higher)

Industry dynamics:
Favourable tailwinds driving structural growth (such as a new technology or migration of customers from one platform to another)?
Porter�s 5-Forces: power of customers and suppliers, threat of future substitutes making the company�s product/service redundant, existing competition and threat of new entrants? How do these forces impact on industry and company profitability?

Presence of larger well-capitalised competitive gorillas which could squash the company? Could this company become a monopolist/oligopolist in the future?

Strategy:

Is there a long runway for growth? Is this a disruption play which has a solid chance of succeeding?
Is the company targeting a niche where it can be the dominant player (preferable to aiming to be an Also Ran in an industry with many behemoths)?
Does the company have a strong market share and continues to take share from rivals?

Financials:

Is the company self-funding? Can it continue to grow organically � but also via acquisitions � without continually coming back to shareholders for dilutionary capital raisings?
Are gearing levels low? Has growth been funded by operating cashflows (not debt)?

Are revenue, margins and profitability growing over time? What is the company�s ROIC, is it growing and how does it compare to other industry players?

For companies which are loss-making, how far away is the cashflow and profitability break-even inflection point? Does the company have sufficient cash on hand to fund operations through to this point, or will a capital raising be necessary?

Other factors:

What level of institutional ownership is there already? (I personally prefer low � means the company is relatively undiscovered, and if possible I want to be finding companies before institutions realise they need to own it)

How liquid is the stock (prefer illiquid versus highly liquid stocks � higher risk, but *if I�m right* on the investment thesis and people need to own the stock later, the stock price can soar).

galumay:
Re-reading most of the posts above, I feel like that is a detailed description of where I have developed as an investor. I feel some urge to summarise and simplify my strategy,

We seek to invest capital in the partial ownership of businesses, at a price that if we had sufficient capital, we would be happy to buy the whole business.

Our intention is to partially own them as long as they continue to be businesses we would be happy to own in entirety.

galumay:
Had a reality check today, went back and did a theoretical exercise of looking at the portfolio at the end of 2014-15 FY and projecting forward if I had simply held the same portfolio up to the present day without selling or buying anything.

Amazingly we would only be about 3.5% worse off over the 6 years if I had done absolutely nothing - instead of thousands of hours of reading, writing, research, analysis, deliberation and effort! Of course as someone on twitter pointed out, the sample size makes any conclusion impossible. Its interesting to note a few things though, 4 winners made up almost all the gains by multibagging, 4 losers went to nothing basically, the rest muddled along.

So something like only 30% of positions outperforming strongly was enough to offset 30% going to nothing, 40% doing bugger all and still give superior returns over the time period.

  2015.xlsx (12.47 kB - downloaded 57 times.)

galumay:
In terms of measuring the performance of the SMSF on an absolute basis, long term the stated goal is returns of at least 10% on invested capital. My  belief is that measuring the unrealised gain once per year is a necessary if undesirable activity for reporting purposes, measuring the CAGR of those unrealised gains over the life of the SMSF is preferable. The second part of the returns come from actual cash returns, we are inactive enough to ignore capital gains and losses realised and just measure dividends paid. There is a necessary blurring of these measurements because in general the dividends have been reinvested into the fund. We track these metrics each year for the SMSF.


We seek total returns of at least 10% CAGR over the life of the SMSF.

galumay:
Filling in the gaps,

how do I identify these businesses? Most of our investments are characterised by being small or micro cap businesses, often with founders who have significant holdings, profitable, high ROIIC, very low debt, positive FCF, financial stability (history of earnings, FCF & dividends). I have created a spreadsheet that helps to quickly check whether a business is worth deeper research to determine if it is investible for us. The final criteria is price, the business needs to be trading at a discount to value, or have a compelling catalyst for rerating. To summarise,

We look for good businesses we can buy at a fair price.

Finally, invert, always invert!

We look for a business good enough that we can get the valuation a little wrong and cheap enough where we can get the quality a little wrong.

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