I’ve spent my entire career investing in extremely small companies that don’t have a competitive advantage. These are the bombed out industries that no one wants to touch or talk about. I’m talking about newspapers, coal mines, cement plants, offshore oil and gas, prisons, radio, meat processors, textile manufacturers, desert land, mobile home manufacturers, etc.… you get the point.
My time spent on these industries is mostly balance sheet and asset based focused. I try to figure out what the assets and worth and how much potential liabilities there are. My investing style is heavily skewed toward Ben Graham and old school Warren Buffett. I’m a big Security Analysis fan, having spent countless hours digesting the bible of value investing by Graham and Dodd.
This deep out of favor style of investing works and I have returns to prove it. When you are investing in assets that no institutional investor is touching you have uncorrelated returns compared to money mangers who hug indexes. A small meat factory in the Midwest trading substantially under book value with a 25% free cash flow yield will have uncorrelated returns compared to PayPal with their measly 2% free cash flow yield.
My rolodex of companies I have researched in the past looks like a minefield of broken and busted industries. A lot of slowly melting ice cubes. Debt ridden companies that have gone through multiple restructurings. Revolving door management teams where the 10th CEO in 5 years still can’t figure out how to turn the enterprise around. Capital intensive crap businesses.
My entire career has been spent analyzing and investing in these out of favor companies and industries. If you ask me what company I would want to hold for the next ten years I would have no idea how to answer that question. Deep value investing is about getting that one last puff from an asset and flipping it into the next out of favor idea. The strategy isn’t about finding compounders and holding indefinitely. It’s a inefficient from a capital gains tax standpoint, but has some of the highest gross returns proven by back-tested methodologies.
During times when overall markets are down 25-30% are the times I regret becoming a deep value investor. High quality companies are selling off and I have no action plan to make any intelligent purchase decision. I am literally lost in the dark when it comes to high quality companies and have no high level understanding which companies I should be buying right now.
When we are in a recession investors should focus their time on acquiring the absolute highest quality companies as fear is driving valuations, not forecasted free cash flows for the next quarter. In times like this everything sells off. No one is spared. Why buy a newspaper business for under cash on the balance sheet when you can acquire some of the best tech companies in the world for 10-15x earnings?
But I regress. I know the newspaper company like the back of my hand. I understand their assets. I have a decent understanding where the future value lies. I have talked to the management team and met them on several occasions. My model is detailed and likely one of the best on Wall Street. Facebook on the other hand; I have an inactive Facebook account I use to talk to old high school friends and I have never looked at their 10-K. I’ll never be able to have a face to face meeting with Zuckerberg. And I will never have the best Facebook model on Wall Street.
Buying Facebook and other tech companies at 10-15x earnings is probably a deal of a lifetime. But I could never get up to speed on these companies and know them like the back of my hand. They are too complex and I don’t have a team of genius analysts working for me. I’ll be stuck forever in the land of out of favor stocks as that is where I have focused my entire professional life.
To overcome this problem with high quality companies I have considered buying index funds. As a stock picker and analyst, buying index funds is a Cardinal Sin. Buying index funds is submitting to the herd. Buying and owning what everyone else has. Going with the grain and traveling with the sheep.
I’m still toying with the idea of buying index funds and haven’t pulled the trigger yet. Eventually we will be at the bottom for the tech blowup and I would like to ride the next wave of innovation and compound a select portion of my portfolio to limit all capital gains tax.
I know I will never be up to speed on any one individual tech company. So why not own them all? Nasdaq is down 25% this year and counting. Eventually it will bottom and the next wave up will be incredible. My thought is to allocate 10% of my net worth to an index fund like the Nasdaq with a clear goal of never selling. Sure, we could be in a bad recessionary environment for the next decade. But humans are great at solving problems and creating new innovation. This would be a bet on hardworking American Capitalism. And I want a piece of that apple pie.
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