When I did my Q&A thread a while back I promised at least one person that I would share my general research process. So here you go...
Every analyst has his/her own way of conducting due diligence. There certainly is no one correct way to come to an investment decision, however, I’d argue that there are certainly several wrong ways, but that is neither here nor there for the purposes of this post. What I am going to describe in this write-up is my personal routine for conducting due diligence. As a disclaimer I would like to state that this is in no way a comprehensive list and my process can vary significantly based on the business and other factors. So, if you use this template to get up to speed on a business and end up missing something crucial don’t say I didn’t warn you.
Also, I think it is necessary to point out that my “process” has evolved significantly since I started managing a bit of money in 2008 and has progressed even more since beginning as an analyst. Howard Marks said, “[An] Investment approach must be intuitive and adaptive rather than fixed and mechanistic.” I do not think the importance of this belief can be overstated.
Throughout the write-up I will link to tools that have influenced me or that I think are great resources. In fact, at least one of them is listed twice because I think it is just that great of a resource.
The Investment Process
I’m going to begin by listing some resources that I believe were instrumental in helping me to learn to think like an investor and/or gave me a solid understanding of economics/markets, etc.
Economics in One Lesson
Economic Principles by Ray Dalio
Valuation by McKinsey
Berkshire Hathaway Letters to Shareholders
The Most Important Thing Illuminated
You Can Be a Stock Market Genius
The Little Book That Still Beats the Market
Margin of Safety
Fooling Some of the People All of the Time
Security Analysis
Mike Price at Columbia ‘06
Fundamentals of Value Investing by Bruce Greenwald
Hedge Fund: The Investment Life Cycle
Anatomy of the 10-K
I’ll consider this post a success if you monkeys understand the two simple main points I’ve tried to relay…
1) You need to think independently of everyone else and come to your own conclusions. Howard Marks said it best, “Unconventionality shouldn’t be a goal in itself, but rather a way of thinking.” In short, you have to be different and better.
2) You should know your target company better than your dominant hand knows your Johnson.
To illustrate these points, I have a short but sweet second list of general resources that may seem odd for a fundamental equity guy to recommend. However, I believe you’ll understand why I consider them so important if you really think about it and maybe even agree with me.
Resources:
The Handbook of Fixed Income Securities
Interest Rate Markets
Distressed Debt Analysis
Before I get in to the meat of the write-up I’d like to point out that I make use of nearly all SEC filings, Investor Days, Conference Call transcripts, Industry Reports, Industry and customer contacts, etc. There is a wealth of information out there about your target, go find it… [Part of what makes a good analyst is being able to find places to look for information. Use your imagination.]
What drives revenue?
The first thing I want to know about a business is how it makes money and, to dig a little deeper, how it defines it’s revenue - producing segments. If you can’t get a handle on how the business drives its revenue then it’s probably not a good idea to invest. Even further, how a management team divides up a business provides a great deal of insight in to what management thinks is important and how they are situating the company competitively for the present and future.
If you don’t understand how a business drives revenue then what do you know about the business? Essentially nothing.
What are you doing when you make an investment in a business? You are taking an ownership stake in a company based on the understanding that the operators of the business will execute a plan to provide you returns on your investment greater than your required return. Therefore, understanding what the operators of the business think is important and how they plan to compete in the marketplace is very important and should be one of the first things you understand about a business.
A quick, easy and not completely relevant example is Google. It isn’t completely relevant because Google doesn’t segment its business this way, but I think it will get my point across.
Google’s main revenue driver is its search/advertising business. You can call this its “bread and butter” or “cash cow”. A cash cow is usually characterized by high margins, solid returns on capital and strong free cash flow, and high barriers to entry – Warren would call this a durable competitive advantage. You generally want a cash cow because the large amounts of free cash flow it produces has the ability to organically fund other “growth” segments/areas of the business. Sometimes you get lucky and the cash cow for a business is strong enough and has enough run- way that it is a compelling investment in and of itself. This certainly seems to be the case for Google at the moment as its stranglehold on mobile is only going to get stronger while there are certainly a lot of improvements for Larry & co. to make in the area that can provide strong returns. However, more often than not there just isn’t a whole lot of room for growth/improvement in the cash cow that can realistically provide solid returns on its own going forward. This is when you need the growth segments financed by the cash cow to keep pushing the company forward. For the purpose of this exercise in mental masturbation we are going to assume that the company’s “Google Glass” division and “Driverless Car” division are the growth segments for Google. Each division is being financed internally by the free cash flow from the search/advertising business and each is – theoretically – well positioned to lead its respective market and, as such, may be considered a catalyst for multiple expansion, etc.
[Once again, this example was purely an exercise in mental masturbation and should be treated as such. I am fully aware that there are factual inaccuracies in the example as it relates to real-life Google. Therefore, there is no need to point them out.]
By now you should really have an understanding of how the business drives its revenue and a general idea of the way management sees the company competitively based on the way it segments the business. Which happens to allow me to transition nicely in to…
Competitive Positioning
At this point I’m going to take what I know about the company’s revenue drivers and management’s competitive mindset and judge the viability of each in the marketplace. Every company discloses a list of competitors, but sometimes the list isn’t that good and even if it is I don’t like to take anything at face value so having an understanding of revenue drivers and management’s mindset allows me to hand pick a universe of competitors.
After I determine my target’s competitors I can begin to get a handle on how a business should operate in the space in respect to competitors and customers.
Essentially I am asking three questions:
1) How does the market see my target?
2) How do competitors see my target?
3) How do customers see my target?
Resources:
Competitive Strategy
Competition Demystified
By now I should have an understanding of how my target is seen from most of the interested parties, namely the market, competitors and customers. While I’m answering these questions I’m developing an understanding for how the industry works as whole and am starting to think about how it is changing and what it may look like in the future.
If you take a step back and look at what I’ve got floating around in my head at this point… I know how the business drives revenue as well as where it is competitively situated. I also have an idea as to where the industry is headed as well as a general understanding of how management thinks of the business going forward. And, almost by accident – but, not really – my research has given me the same general understanding of my target’s competitors. I know how each competitor drives revenue as well as how each management team is situating its business going forward.
My thesis is probably starting to form at this point, but I’m going to have to keep calm and contain my excitement because there is still too much work ahead of me to get distracted. This leads me to one of the most important parts of – as well as possibly my favorite – my research process…
Management
Why is management so important to me?
As I previously stated, when you invest in a business you are taking an ownership stake in the company with the understanding that the operators of the business will execute a plan to provide you returns on your initial investment that are greater than your cost of capital.
Therefore, in my opinion, in order to make an investment you not only need to be confident in management’s plan going forward, but also in the management’s ability to execute that plan in a volatile and perpetually changing environment.
I divide my analysis of management in to two areas:
1) Structure and Incentives
2) Decision-making
By structure of management I mean that I look at who makes up the BoD and what each person brings to the table amongst other things as well as the operators of the business and what they bring to the table… amongst other things. Larry Robbins’ great letter about HMA is a perfect resource to learn about this stuff. A copy was floating around WSO not too long ago so you should be able to find it on the site.
Management’s incentive is pretty straight - forward. I want to make sure that management’s compensation structure aligns closely with what I want as a shareholder as well as my time frame for the possible investment.
Analyzing management’s decision-making is where it gets fun and interesting! Basically, I’m judging management’s capital allocation decisions based on realized returns and future positioning. If I’m feeling really bold I may throw together a bare- bones operating model and run the company over the past few years to see if I would’ve done anything differently.
Resources:
The Outsiders by Will Thorndike
Value by McKinsey
By this point I’m going to have an idea of how confident I am in a management team’s ability to execute on its strategy. Industry environments are constantly changing as is the overall economy and an exceptional management team can do a lot to position a company for continued success as well as limit downside risk.
My thesis is continuing to come together and now I’m going to sit down and talk with my boss and/or the most senior analyst on the team about what I have so far. This update is not mandatory or necessary, but I like to hear other people’s opinions and be as intellectually honest as possible. I may even talk to a few guys in the industry whose opinions I trust. As we should all know, “You gotta know what you don’t know.”
Financials
Right now I’m far enough along in my thesis that I’m committing to really get down and dirty in this thing. What I’m going to do now is dissect the financials in pretty great detail.
Basically, I’m going to tear the company to pieces line- item by line- item as deep as I can, going back usually 5 to 7 years. Anything that catches my eye, either good or bad, will go on a list of questions for management that I have been compiling since the beginning of my research.
This isn’t a post about financial statement analysis and it’s already unbearably long so I will refrain from going in to detail, but as always, will post some resources I’ve gotten a lot of insight from.
Resources:
Financial Statement Analysis
Quality of Earnings
Financial Shenanigans
Creative Cash Flow Reporting
By this point you should really have a good grasp on the company’s accounting procedures and know that there isn’t any funny business going on in regards to the way they report things, etc. This process should also reinforce everything you have learned about their competitive positioning, capital structure, and the way they drive revenue. I wait longer to actually model out the historical financials than most but that does not mean that I am not intimately familiar with them before this point.
Speak with Management
At this point I’m going to sit down with management and ask them any questions I have up to this point.
Model and Valuation
After management has answered my questions I generally feel like I’ve got a good handle on the business and what is going to happen going forward. So my next step is to sit down and try to knock out my forward model. I think it is important for me to say that I always model each company from scratch. No two companies are the same and you really do get a much deeper understanding if you start from scratch rather than just dropping stuff in a template.
I will not be able to finish the model in one sitting because more questions will come up that need to be answered and I will find an answer to those on the fly as they arise.
When it comes to valuation you just really need to find a way that works for you personally. My valuation method in skeleton form:
1) Derive projections from thesis.
2) Stress –test projections
3) Derive range of values for the business
I’m kind of vague on the valuation portion of this write – up not only for the reason I pointed to above, but because finding the exact valuation for my target is not my main priority. Basically, all I am looking for from my valuation is a reasonable range of value for a given set of operating scenarios.
My take on value isn’t very complicated. Essentially, in my eyes, value is a product of:
1) Growth
2) Returns
3) Cost of Capital (Also called Discount Rate or Required Return)
What’s more important – in my opinion – than a scientific and precise valuation is that you understand what is going to cause the market to realize the intrinsic value of the asset and that you get the timing of the catalyst correct. If you’re too early you can get forced out the trade before anything materializes for any number of reasons and if you’re too late you’ve lost some upside at the very least.
Much like my feelings about the search for a precise valuation, I find the search for the “correct” cost of capital to be – in the gentlest terms – a fool’s errand. The best investments are not made because you nailed the discount rate in percentage terms and if making an investment decision comes down to whether you go with a 10% or 12% discount rate I can say with almost absolute certainty that it won’t be a good investment.
I often find it helpful to know what discount rate the market is implying when I am looking to make an investment, but rarely – if ever – is the absolute number of great concern to me. Approximating a required rate of return is mostly a way to keep investment risk at the forefront of my mind. Risk is anything from macro on down to the guy/girl on the other side of your trade. Often, you may start with the market - implied discount rate and then adjust it based on everything from macro factors to industry/company factors and finally to the generally psychology of the other market participants.
Finally, I think it’s pretty important to understand that at any point in time a single driver of value can dominate the others. If we look back to not too long ago, in the tech bubble growth was the main driver of valuations and returns fueled the housing bubble. Today, one can certainly make the argument that risk is the driver of the current bull market. With liquidity being pumped in to the market and treasuries at rock-bottom yields it seems as though investors have re-priced risk in the search for return.
Resources:
Valuation by McKinsey
Accounting for Value
Financial Modeling
Investment Banking
By this point my thesis is pretty much complete and I have a general range of value for the business. Now I’m going to begin to prepare for my pitch.
The Pitch
Before I bring it to my boss for the real deal I want to feel like I’m prepared to answer any question he can throw at me confidently. I try to know more about the business than anyone, even the COO in a lot of cases, so this is a great test for me.
Every firm and PM is going to have a different structure for how they like an idea to be pitched. Some places may have a more formal process that involves multiple investment memos, etc. while my fund is pretty informal. My boss has never so much as asked me to write something down let alone write-up an investment memo. Everything is done via face-to-face conversation or maybe a phone call if one or both of us is out of the office when a discussion is necessary. I personally love this informal structure and believe it is great for my development as an analyst.
Basically, my pitch boils down to five basic steps:
1) Company/ Why market it wrong
2) Catalyst(s)
3) Upside %
4) Downside %
5) Brace myself for a game of 20(0) questions
I think it is important to mention that even though the way I pitch an idea seems simple, in reality it is far from it. I generally have multiple conversations with my boss about an idea before I actually sit down with him for the actual pitch and like I said earlier I come prepared to answer any possible question about my idea.
Conclusion
Much of what I described here is not very difficult. Most anyone can break down some financial statements or slap a value on a business. To do well you need to be able to time inflection points, properly handicap the risk/reward scenarios and determine the appropriate cost of capital (required return) for the risk profile of the investment. Each of these is extremely difficult in practice and is – in my opinion – what separates a great analyst from a good analyst.
The things I listed in the paragraph above that – I believe – separate a good analyst from a great analyst (and eventually allow a great analyst to become a PM) only come with experience. Risk includes everything from macro to the other guys in the market and it’s likely you’re not going to be able to pick these things up overnight or even in a few market cycles. Hell, there’s no guarantee that you’ll ever truly get it. [I’m including myself in the collective ‘You’ here.]
Inexperience isn’t damning for a young guy/girl in the business, even if it is difficult to overcome. If you work hard, stay humble, and make a point to be intellectually honest you’ll likely be more than OK.
A final, but very important part of my process that I forgot to mention is that I spend a great deal of time observing the way my target’s stock price moves/reacts to market/macro/micro news. Basically, this helps me to understand the psychology of those I am trading with in the market. I learn what they think is important about the business/stock relative to what I think is important about the stock.
Resources:
Extraordinary Popular Delusions and the Madness of Crowds
The Alchemy of Finance
The Hour Between Dog and Wolf
Thinking, Fast and Slow
The Practicing Mind
Manias, Panics and Crashes: A History of Financial Crises
The Social Animal
Market Wizards
The New Market Wizards
Hedge Fund Market Wizards
The Psychology of Judgment and Decision Making
Decision Traps
Reminisces of a Stock Operator
I’ll try to answer any questions as quickly as possible in the comments. Enjoy!
A few videos I think may be helpful to you all:
Interview with Jeff Ubben the Founder of ValueAct Capital. These guys have been absolutely killing it for the past few years. They’re just about as good as it gets on the Street.
Michael Price at the London Value Investors Conference. This guy doesn’t talk very often so you should probably listen.
Howard Marks at the Milken Institute Conference.
I’m including a few macro guys here because I think they have pretty interesting perspectives on the investment process, especially risk, and macro has always interested me in a lot of ways.
I was going to write an entire post about choosing the correct boss/place to work, but remembered this interview by Seth Klarman and realized he could do a much better job than me. Rarely does he speak in public so I take every opportunity I can to listen and learn from one of the better investors of all time.
I have to preface these two videos by saying that I am not a huge fan of Bill Ackman’s investing style, but as you can probably tell from my original post and answers to questions in the comments I don’t dismiss any investing style and feel that you can learn something from listening to almost anyone even if it is what not to do. With that said, Ackman has been a very successful investor over the course of his career and I would consider myself lucky to have even a fraction of the success he’s enjoyed.
The Psychology of Human Misjudgment – A fairly famous speech by Charlie Munger.
David Einhorn on the Federal Reserve. Here is a copy of his “Jelly Donut” Paper that is discussed in the video.
http://www.huffingtonpost.com/david-einhorn/fed-interest-rates_b_147250…
Jim Chanos on the Psychology of short selling.
Leon Cooperman on investing/leadership.
Bookmarked! thanks for keeping to your word. What aum is your fund?
Not a problem. AUM is currently
this is really fucking good. specially like the book recommendations. thank you! sb'ed.
Second that comment. Definitely appreciate the time you put into this one @"Simple As..."
Thank you good Sir.
How do you determine an appropriate cost of capital? I am looking for a conceptual answer sine you already established that it is extremely hard.
Well, theoretically, you determine the appropriate required return using the weighted average cost of capital. You would find the cost of equity, specifically, using the capital asset pricing model (CAPM) or the fama-french 3-factor model (FF3). At least, that's how you'd be taught in school or what you'd be forced to learn for the CFA exam series. I personally do not use any of those, but will refrain from bashing them because I'm sure there are investors out there who are much more accomplished than me who use them.
That being said, the market is always implying a required rate of return for an asset. For instance, let's assume there is an asset trading at 4x. The market would be implying a required return (cost of capital) of 25%. Now, where you earn your keep is in risk-adjusting that implied required return. As an example, should you have the opportunity to buy this asset at a price of 4x from a mutual fund that needs to sell because of a lot of cash outflows or a pension fund that needs to sell to re-balance there's a good chance you're get a good deal because they are likely forced sellers. This is where your industry/company/macro knowledge and experience will come in to play. Just as a clarification, I'm not saying that I use this method all the time or even at all.
Hopefully this gives you an idea of what the discount rate is and what you're looking to do with it.
hey simple as..., do you mind if i pm you a couple questions i had regarding HF recruiting/my specific situation?
Holy hell, that's quite the write up. SB for you sir
Well done. SB'ed
I noticed that I kind of ran out of steam towards the end of the write-up so I added some thoughts to model and valuation, the pitch, and conclusion.
I would love a torrent with all the books you mentioned
Deleted.
On average, how long does this process take start to finish?
I'd say generally 3 to 4 weeks. Maybe a little longer if I'm pretty new to the respective industry.
You forgot the most important step: "Call up my buddy Flake to get his totally unbiased sell side thoughts on the company."
I figured it was implied and everyone would just know that.
As an aside -- If I didn't stay away from financials like the plague I really would go to Flake. SS guys usually come off as mouth-pieces for management so it's often hard to really believe a lot of what they say. No bull-shit, brutally honest guys like Flake are a welcome addition to the SS in my opinion.
Awesome post!
nothing to add here except for the fact that "competition demystified" is my favorite book
It really is a great book. You should check out the link at the top called "Fundamentals of Value Investing". It's a video recording of one of Greenwald's classes at Columbia. It's about 3 hours long, but worth the time investment in my opinion.
http://www7.gsb.columbia.edu/video/node/1297
One of the best posts ever on WSO.
Great stuff, much appreciated. Will be compiling these books into a list and checking them off one by one
Wow what a great write up! Thank you
Probably the best post I've ever read on WSO. Thanks for taking the time to write it!
One question. I'm curious why you wait so long to build the valuation model? I'd hate to invest a ton of time researching a great business only to discover that it's over-valued.
No problem and thanks for the kind words.
I leave the valuation/forward model until the end for a few reasons:
1) I want to know as much about the business and my thesis as possible before I make any projections. Projections are at best an educated guess and the earlier I make them in the research process (meaning I have less knowledge/information) the less reliable they are. 2) I put maybe a 10% weighting on my model in making an investment decision. It's more of a sanity - check than anything, really. If the investment doesn't make sense from a high-level than I don't care how good the numbers look it isn't going to happen.
3) You should be able to get a decent idea of whether a business is over-valued or not before you model it out.
4) You can never know enough good businesses. Say I get through the whole research process on a good business and find out that it is overvalued at it's current price of $150/share, but should it ever fall below $120/share it would be a good buy. Well, let's say six months go by after my original research and by some crazy happenstance there is a government shutdown that temporarily depresses the economy (this would never happen, though, right?!) and as a result the business misses its top line (sales) consensus estimate number causing it's stock price to tumble below $120. But, since I know this business really well and can tell that the top line miss was a result of extraordinary circumstances rather than a material change in the business I can buy on another seller's irrationality at a moment's notice and let the price move back toward it's intrinsic value as the dust settles and operations go back to normal.
This hits harder reading it during a pandemic
Good post, much better than your last one. I would add channel checks / interviewing industry experts, which can be helpful to get an edge.
I added a little about that. The truth is, though, that it is hard to explain because gaining the edge in the research process is different every time. For one company you may find something no one else sees in a customer contact while for another it may be networking with the CEO of your target's largest private competitor. This is where being able to take the proverbial step back to look at the big picture helps to guide you in the right direction as it is different for every possible investment.
Do you ever have work related dreams, either about the boss man/woman or your thesis? On another note: how many different ideas are in you funnel? So from a PE perspective what's a rough breakdown of ideas to ideas invested/passed on in a month? Thanks.
No, luckily I haven't had any work related dreams so far. But, I guess I should note that not only do I bring my work home literally (as in I actually do work at home after I leave the office), but I also bring it home figuratively. There is a great deal of stress that comes with putting not only 8 or 9 figures behind an idea, but also your reputation and possibly even your job. While it's not likely for a person to get fired for one losing position, being ok with losing money is not a mindset you want to get used to. Things get pretty tense at the office when you're constantly picking losers and it's not pretty -- I experienced this at our office not too long ago (luckily I wasn't the one picking losers). So, in that respect I'm constantly thinking about work, but up to this point it hasn't really changed the way I live or go about things. I'm still able to relax and have a good time and I don't have a problem sleeping at night. Although, I guess that might change should I ever have a cold streak!
At any given time I am:
Loosely following 80-85 companies Closely following 30-35 of the 80-85 Managing 3-5 active positions Doing in-depth research on 1 or 2 ideas
Our ideal holding period is 6 months to 18-24 months. We've kind of started going toward a more deep value investing style where the holding period could be significantly longer than a "normal" position. So, we're pretty particular about what goes in the portfolio. With that said, I guess I'd say ideas : ideas invested :: 15 : 1. That's over a several month period as it really takes me about a month to get comfortable enough to even pitch a stock.
I added some more stuff that I thought of to the post so if you have the time / want to check it out.
This is really great. SB'd. I am curios as to whether this is the minimum work necessary to accurately evaluate an investment in your opinion, or whether this process is as in-depth as it is because you absolutely want to cover all your bases.
I ask because I enjoy investing/picking stocks and can devote some time to it while still in UG, but will be heading into IB soon and imagine I won't have much time for something like this. Researching on weekends only, it would take months to do the kind of research you talk about. I guess I'm asking about the marginal benefit of your level of research- in your experience, can you be confident about an investment with much less research? Assuming the answer is no, do you have any advice for investing while working in IB? Mutual funds/ETF's?
Another question- how does someone like me (going into IB with aspirations of working in investment management down the track) hone investing skills while working 80+ hours a week? Do you have any suggestions aside from learning on weekends?
I guess my answer would be both. Like I said in my comment above yours, I I'm often putting large sums of money behind an idea and do not take that responsibility lightly. Aside from the absolute dollar amount of the investment I'm also putting my professional reputation and livelihood on the line -- the care of which I do not take lightly either. Also, it wouldn't reflect very well on me if an LP happened to call and ask me a question about a company we own and my only answer is, "uhh, well, let me find out and call you back." The LPs are paying 2/20 for my services and I treat their investments accordingly. So, I guess I'd say I not only want to cover all my bases, but need to cover all my bases for the reasons I listed above and more.
I'm not 100% sure, but I think that there are limits to what you can trade and how often you can trade when you're in IB. So that may have an effect on your investing style/choices over the next few years. I'm going to plead ignorance on mutual fund and ETF investing. I've never owned a mutual fund and don't plan on it (outside of my 401k/IRA, obviously), but I do suggest you look at SEQUX (they're not really a MF, though) both as an investment and their letters to learn about investing. I've only used ETFs to hedge so I don't really have any insight there for you either.
I manage my PA by investing in businesses with high barriers to entry and solid/defensible business models that I don't have to worry about the position imploding over the short - term or long - term and my ideal holding period for my PA is life. Literally. One of the questions I always ask myself is, "Is there a reason I wouldn't want to own this in 30 years?" I currently own five stocks in my PA and three of them make up well over 60% the portfolio.
I'm not sure how much you know about the markets/investing so for the sake of simplicity I'm going to assume you are starting from scratch. It's not indictment on you, but just makes answering your question easier for me.
First, you're going to want to build your base. That means learning how to think like an investor. I'd begin with Valuation by McKinsey, The Most Important Thing by Howard Marks, and either Margin of Safety or Buffett's letters to Shareholders. While you're building this base I suggest picking two or three companies that you like and will likely want to follow for a long time. Start paying attention to all their press releases/news, investor days, earnings releases, conference calls, etc. You can get access to all this stuff for free on the company website. Watch how the stock price reacts to macro news as well as company/industry news, etc.
As you get more comfortable with the ideas you're learning about investing and get more familiar with the companies you're following you're going to want to increase your base of knowledge even more. You do this by reading more "advanced" books and expanding the number of companies you follow. Over time you'll discard things you learned in certain books and keep things you learned in others. You're slowly, but surely building your own personal investing style.
Honing your investing skills comes down to constantly learning and re-evaluating everything you think you know. Hopefully, you'll still be honing your skills 30 years in to your IM career. But, the importance of a good base can not be overstated. That base is to learn how to think like an investor.
I also recommend reading as many investor letters from the "great" investors as you can. They're usually floating around the internet after the guys send them out. The guys at Sequoia and Howard Marks at Oaktree actually put them on the company website.
This is great, thanks for the reply. I know a bit about investing but nowhere near as much as I'd like to. I have been running a virtual PA for a while that's doing relatively well, and once I'm more comfortable with investing/have my own income I'll start actually investing. I have read "The Most Important Thing" and have both "Margin of Safety" and Buffett's letters with me, waiting to be read. Will get on them ASAP.
Holding period to life? I see you kept what you learned from Buffett ha. I am similar in that I am definitely a long-term investor rather than a trader. I hadn't specifically thought about the benefits of personally investing in companies with high barriers to entry and defensible businesses (durable competitive advantage, anyone?) but that's a great idea and one I will take going forward. Thanks!
I am very interested in emerging markets and have heard/read (and believe) that investing in insurance companies is a great way to enter/reap benefits from an emerging market. Do you know of any good resources that I could turn to to learn about investing in emerging markets/insurance companies?
Love this book. It's the sort of reading that is so clear, concise and to the point (and very good points at that) that you just can't help but look around and think "what the fuck are these other people thinking!?"
I am in the same boat as you except I am already working in IB. I literally spend any and all free time I have at work (and on the weekend when I am not with the GF) researching my ideas, reading the docs, sell side reports, etc... pretty much doing everything SimpleAs mentioned above.
The last Co I research i ended up doing a SUPER deep drive and it took me ~2.5 months to finish everything and get comfortable enough to where I feel like i know the business better than the SS analyst do. The only thing I wish I could have done that I didn't was to start calling people about the business. Thankfully we work a lot with a consultant who knows the space really well and I have pinged several times for clarity and opinions.
Long story short, yes working full time and creating fully baked ideas is difficult but its def doable. In my opinion it is one of those things that you are not going to do it/want to do it unless you really really enjoy the work. I love breaking open 10-k's to learn about a business I don't know very well so it has never been an issue for me.
Nice stuff. I'm just curious what you're batting now thus far? Let's handicap it with winners are those that beat the market (whatever index you think it should be put up against).
Yeah, sorry, but I'm not going to talk about returns on individual positions. I will say, though, that my long book is doing pretty well against our benchmark (S&P 500), but my short book could definitely be doing better. I'm hoping that my lack of success with shorting thus far is more a result of the general market environment rather than my deficiencies as an investor. However, then the same could be true for my recent success with picking longs.
In general, I won't really know how good (or bad) I am until I've made it through a few market cycles.
I was wondering if you could give your opinion on portfolio size.
In my opinion, I believe that if I'm already planning on a long-term holding period my portfolio would be optimized with around 20 positions that've gone through a rigorous DD and research process with the mentality of investing as a business owner, because I'm not sure how someone can have more than 30, 40 or even 50 positions and confidently say "this is my 34th best idea, or my 45th best idea", know what I'm saying?
I've always been told that the benefits of diversification go to about zero once you have about thirty stocks in your portfolio. That being said, I currently have five in my PA.
My problem with the belief that a portfolio is optimized at an arbitrary number is that inevitably you'll end up lowering your "buy" standards in the name of optimizing your portfolio / diversifying away risk. Saying this is my 8th best idea or 13th best idea is just about as hard as saying this is my 35th or 42nd best idea in my opinion. This is why I am a firm believer in trusting your process. Construct your portfolio around what your research process gives you not the other way around. Obviously you don’t want a portfolio of stocks that are all particularly sensitive to say interest rate changes for example, so you’re going to want to diversify some in that sense, but don’t compromise quality in the name of diversification.
I start all my positions at 5% of net assets and add from there if/when I feel it is prudent. I have no problem holding cash, even a significant percentage of net assets, in my PA. It offers me the flexibility to add a position/change direction at a moment’s notice and the only way I know I’m not going to lose money is by not putting it in play.
I usually have a few positions that become “core” positions either through capital gains or me adding to the position. They can make up anything from 40 – 70% of my PA at any given time. I then have a few “ancillary” positions that I have either just started or are more speculative type bets that kind of surround my core positions to fill out the portfolio.
Let me know if you want me to clarify anything.
Maybe I missed this but, how in depth do your models get?
Do you build out very detailed 3-statement models with stuff like revenue breakdowns by individual product line, D&A tables, debt schedules etc or is it a more general IS and FCF build?
I know this probably isn't the answer you're looking for, but it just really depends. The best answer I can give is that I get as detailed as I need to be -- no more, no less. It should really be pretty clear to you based on the business situation how in- depth you need to go.
ANy comments on the healthcare sector?
Is there anything specific you want to know?
I'll answer the rest of the questions this evening. I also have some stuff to add to the write-up. Sorry it's taken me a few days, earnings season has been pretty hectic.
Edit:
I haven't forgotten about the PMs I've gotten also. Gonna try to get to the them tonight. Thanks for your patience, guys/girls.
You allude to this throughout but how much of the process comes from you, how much from your PM and how much from your fund? In other words, if someone gave you money to manage by yourself tomorrow, what would you change/add/cut-out?
Essentially nothing would change in the event I started managing money on my own.
I'm not sure if I mentioned it in this post (I hope I did because it's pretty relevant), but I managed money for a few small businesses from my sophomore year of undergrad until I began this job. Because of this I had a pretty well developed research process when I began at this firm and no one actively tried to make any changes to my process. Obviously every PM asks different questions so I had to tweak a few things as I went along to best fit my PM, but the changes were negligible and I honestly don't even know if I could point them out to you anymore.
In general, though, I just had to pick up my game in really every way when I made the transition. I know that's not the most in-depth answer, but hopefully it makes sense. I've tried to impress upon everyone throughout this post that this stuff is no joke. Shit gets real pretty quickly when you're putting pretty large sums of money and your ability to pay the bills on the line.
Let me know if I didn't answer your question well enough.
Edit: Obviously, I didn't have management access, SS access, or analyst/investor day access prior to starting at this fund.
Super helpful, thanks. Agreed conviction can be a scary thing.
I've still got a few things to add here, but I got stuck doing some extra unexpected work tonight. My plan is to get it up here tomorrow morning. Sorry for the delay.
Amazing post. Ostensibly, you're a value guy. In terms of idea generation, how do you go about that? Are you looking at Greenblatt's magic formula, low p/e, EV/EBIT, p/b, etc. What are some red flags that would help the novice investo4 avoid value traps?
Once again, thanks for the insightful post.
Probably one of the best post I've ever read on here about ER. I think after spending some time on the buyside this summer, I realized how crucial it is to have a highly structured research process. When your universe of equities is boundless and you can cover any sector, and your manager wants at least one presentable idea a month, it seems you better have a very refined, quality research process to weed potential investments out early in the process or you risk wasting valuable hours in a non-presentable idea. The amount of information you need to sort through these days can almost be a handcuff if you can't figure out whats important and whats not important. Your process seems to get down to whats important and I wish I had read this post a few months back, haha.
An Interview from the Founder of ValueAct Jeff Ubben from 2010. They've been absolutely killing it these last few years. These guys are just about as good as it gets on the Street. Listen and learn:
//www.youtube.com/embed/cbFBQAm75ew
Part Two of the Jeff Ubben Interview:
//www.youtube.com/embed/h8CvlaR9LOA
Mike Price at the London Value Investors Conference:
//www.youtube.com/embed/Nph-sDz1EtA