The DIY Investing Podcast

Trey Henninger: Private Investor and Portfolio Manager

Do you want to learn how to manage your own investments? Are you ready to stop paying investment management fees and start building wealth? The DIY Investing Podcast is dedicated to providing you with the knowledge, skills, and resources you need to be a better investor. Learn how to make investments through the use of fundamental analysis, mental models, and business management insights. Please visit our website and subscribe to our mailing list at DIYInvesting.org for guides, videos, and resources to help make you a better investor. read less
NegociosNegocios
EducaciónEducación
InversiónInversión
Superación personalSuperación personal

Episodios

136 - Selling Stocks for Value Investors (Part 1: Strategy Matters)
10-07-2022
136 - Selling Stocks for Value Investors (Part 1: Strategy Matters)
Want Investing Research Directly to your Inbox? Sign-up for my Free Substack: https://diyinvestingstocks.substack.com/subscribe? Mental Models discussed in this podcast: Second-Order EffectsMean ReversionFactor Investing Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Show Outline Selling Series A lot of time is spent on buying stocks. Yet, almost just as important, if not more is knowing when to sell stocks. I find this area relatively underexplored, so I want to begin a long-term series on selling stocks from the framework of a value investor. Previously talked about selling in a single episode on Ep. 106 Today’s focus: Strategy matters There is no one-size fits all approachHow you buy stocks will influence how you sell themYour portfolio allocation strategy will matterTHe number of stocks you review in a year will matterWhether you plan to own a cash position or not will matter. Excluded from this series: Won’t be discussing momentum investingWon’t be discussing trading or technical analysis investing (except as a marginal part of value investing when relevant)Entire focus assumes that you are a value investor of some sort (whether deep value, compounder, graham value, quality, etc…) Deep Value: Buy at 2/3rds of value and sell at “full price” Compounders: You want to hold for a long-time. Sell when compounding ends, plateaus or you were wrong Net-Nets Hold a year then reassess Waterfall Stocks:  Hold so long as dividend yield is sufficient to provide target return Dividend Growth Investing: Buy companies that pay dividends and grow them and sell them when they cut or eliminate their dividends Buy and Hold “Never sell”Works for a subset of stocksTends to overlap well with compounders and Dividend Growth investing
135 - Investing in the Face of Uncertainty
03-07-2022
135 - Investing in the Face of Uncertainty
Want Investing Research Directly to your Inbox? Sign-up for my Free Substack: https://diyinvestingstocks.substack.com/subscribe? Mental Models discussed in this podcast: Second-Order EffectsMean ReversionFactor Investing Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Show Outline Today’s podcast will focus on a single precept: You can’t predict the futureFirst and Second Order Effects Margin of SafetyPreference for cash now vs cash later (Plays into want for profitable companies) Time value of money. Growth is important because it can correct for mistakes, but you know you can’t predict it Some of what you “know” about investing may not be trueImportance of Zero-Based Thinking (what is the best decision today based on what you know today) Wrong because past price performance can’t predict the future (it may, but it may not) Wrong because it assumes that winners will keep on winning and losers will keep on losing “Don’t catch a falling knife”“Hold onto winners, trim your losers” The central problem with rebalancingIt is definitely true that successful rebalancing CAN add valueIt is also true that it is IMPOSSIBLE to know if your rebalancing will be successfulHow then do you behave? How do you invest in the face of uncertainty? First order:Second order: Investing in the face of uncertaintyYou cannot assume business momentum. You plan for it and buy stocks you think will have it, but your strategy cannot assume it will continue.You cannot assume reversion to the mean. You plan for it and buy cheap stocks because it offers the opportunity of reversion to the mean, but your strategy cannot assume stocks WILL mean revert in the time frame you want.You cannot assume that growth will continue.You cannot assume a specific growth target will be hit.You cannot assume that your predictions about business quality will be better on company A than on company B.  The only thing you can know to be true is that the future is uncertain.  I personally use some absolute rules (like no margin debt, no options, and no shorting). Not because they’re optimal, but because they limit my risk and allow me to take risks in other areas.  Some of your decisions will be a mistake. That doesn’t mean you don’t make a decision. Indecision is a decision. Selling some winners may be correct and selling others may be a mistake. Your strategy needs to incorporate that understanding. “Absolute rules” can be helpful to limit mistakes, but they will inherently be suboptimal.  What is my point: It would be a mistake NOT to trim when I am given the opportunity to do so. Failing to take advantage of opportunities that ignore zero based thinking will result in me having lower returns across an investment lifetime. You want to build a strategy that follows this precept: “If I lived my life 10,000 times, what strategy would result in a favorable outcome across the most possible lifetimes?” Don’t optimize for the “perfect” scenario.Don’t optimize for the “worst case” scenario. Optimize for uncertainty. Prepare for the worse, plan for the best, and adjust daily.  There are aspects of my strategy that go against established norms. However, there are clear reasons for that. I know that I cannot predict the future. Therefore, I am willing to sell or trim my winners when I believe it improves my potential returns and reduces my risk.  Summary:  You cannot predict the future.Be more humble.
133 - How to Solve the Dead Money Problem?
27-03-2022
133 - How to Solve the Dead Money Problem?
Mental Models discussed in this podcast: Dead MoneyOpportunity CostTime is MoneyIntrinsic ValueCompounding Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Show Outline The Dead Money Problem and Solution “If you remember only one thing today: Time is Money” What is Dead Money?  Any asset you own that is not growing intrinsic value over a period of time. The focus here is on the fundamentals of the business. NOT the stock price. We can’t predict stock prices. We’re not going to try. Why is this a problem?  The longer you hold a dead money position the worse off you are. Principle: Time x Position Sizing x Expected Return of Alternatives = Lost value  By using this formula you can anticipate how much exposure you have to dead money losses. The Solution:  The impact is large (Big “lost value” bucket) [>> 1%]The likelihood of success is high (Big difference in expected return between opportunities) At least 10% Passivity is better than action. Action leads to errors. Always remember that you had good reasons for your original buy decisions. Summary: Time is Money! Investors lose value on any asset they own that is not growing intrinsic value over time. This episode provides value investors with my solution on how to optimize their portfolio in the face of dead money assets and potential opportunities
132 - Is it better to pay management fees or performance fees?
20-03-2022
132 - Is it better to pay management fees or performance fees?
Mental Models discussed in this podcast: IncentivesSkin-in-the-GameAccredited vs non-Accredited Investors Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Show Outline Key Concepts for thinking about compensating a Portfolio Manager Management Fees  Management Fees are priced a percentage of the assets under management. A 1% management fee means that you will pay 1% of your assets being managed to the investment manager regardless of the returns you receive on your investment. If you have $100k invested at the beginning of the year, you’ll pay $1k in fees, if your investment doubles, and $1k in fees if your investment gets cut in half. (ignoring the weighted average effect)Management fees can be charged to both accredited and non-accredited investors Performance Fees  Performance fees are priced as a percentage of the profit earned on investments over the course of a year. For instance: A 10% performance fee would provide the manager with 10% of the total profits earned during the year. If you invested $100k, and the $100k grew to $200k, then the investment manager would earn $10k. (10% of the 100k gain). However, if the investment fell to $50k, the investment manager would earn nothing. Performance fees can be charged only to accredited investors. Hurdle Rates  Hurdle rates are often paired with performance fees to ensure that investment managers only earn performance fees above a certain level of return. For instance: A hurdle rate of 5% would mean that the profit sharing only kicks in after 5% returns have been earned for the year. In our prior example, if you invested $100k that doubled to $200k, then the “profit pool” is instead $95k, because the first $5k is exempt. The investment manager then only earns $9.5k. High Water Marks  High water marking is where hurdle rates are compounded across multiple years. In this case, let’s assume you invest $100k, and the hurdle rate is 5% per year. In year 1: your investment declines to $80k. You pay no performance fees. In year 2: Your investment grows to $110k. You still pay no performance fees because despite earning 37.5% rate of return in year 2, the hurdle rate of 5% compounded in each year, so the investment manager only starts to earn fees after 10% (5% + 5%) on the original $100k. So they would only earn returns above $110k in year 2. In year 3: They only earn performance fee returns above $115k (ignoring compound growth here). The Buffett Model  0 % management fee, 6% hurdle rate (w/high water marks), 25% performance fee I think this is an attractive setup and I’d prefer to structure any future fund of mine with a similar arrangement. This is the best alignment of incentives in my view. You don’t get paid for AUM growth (directly), and only get paid for performance that beats a certain hurdle rate. However, to do so excludes non-accredited investors. Therefore, if I want to serve non-accredited investors I’d have to charge a management fee at least for them. What is the right answer then? Non-accredited: You only have management fees. You obviously want a manager willing to charge them, or you don’t get that manager at all. Accredited: Performance Fees may be your instinctual first option. They tend to align your interests with management. However, there are also downsides for you. May encourage managers to take more risk. Unless they beat a hurdle, they don’t earn anything. They’ll never be 100% aligned with you. Without a management fee, you are limiting yourself to investment managers who are already financially independent and can afford to have years without income. Personally: I would be willing to pay or charge both sets of fees. My ideal setup is the Buffet arrangement: 0, 6, 25%. However, this isn't ideal for all investors. I could see the benefit of a 0, 10, 50% setup. I can see the benefit of only charging management fees (especially for retired investors who are seeking wealth preservation, not growth) As always: The answer is it depends. But, I hope that I have given you the information you need to understand how it applies for you. Summary: As an investor, you want to properly align your interests with your portfolio manager. A key consideration is how to compensate and incentivize that manager with either management fees, performance fees, or both.
131 - How to choose an Investment Manager?
13-03-2022
131 - How to choose an Investment Manager?
Mental Models discussed in this podcast: Opportunity CostAlphaSuperpower of IncentivesCompetitive AdvantagesProcess vs Results Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Show Outline Key Concepts for selecting a Portfolio Manager Choosing an investment manager is a lot like choosing a stock Don’t invest in anything you don’t understand - this includes managersWhat is their process?How do they earn alpha? Do you need alpha? What are your financial needs? Wealth preservation?Wealth Growth?Do you need alpha? Not every manager can provide alpha. Not every manager seeks alphaNot every investors NEEDS alpha Value Cost - How are they paid? What is the expense structure? How does it compare to alternatives?Management Fees Performance Fees Next podcast will be a whole podcast on fee structure, so I’ll limit my discussion on it here. Growth Investment managers inherently benefit from growing AUM. This is unavoidable. Regardless of pay structure. However, you want to understand what drives them. Is investing a passion or a money seeking endeavor? Are they trying to grow AUM?Do they plan to shut down growth at some point? Quality Competitive advantages? How are they different from other investors? Communication? How do they communicate with clients? Do you understand their process? Are you comfortable with them? Style Size of stocksLiquidityValue vs Growth vs Quality? Overlooked companies?Index hugging?Concentration vs Diversification  Custom Portfolios vs Investment Fund  Some managers will setup a customized portfolio just for youOr do you simply want to own a portion of a mutual fund or hedge fund. Past Performance - Luck vs Skill It is difficult to analyze a portfolio manager based on past performanceInstead, focus on their process.  If you understand their process you can potentially understand the odds of future outperformance (if you even need outperformance) Summary: Choosing an external investment manager for your wealth is a difficult decision. In this episode, I outline the key concepts you should consider when evaluating someone to be your personal portfolio manager.
130 - How to invest during a crisis?
08-03-2022
130 - How to invest during a crisis?
Mental Models discussed in this podcast: Stress TestingTime HorizonStoicism Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode130 Key Concepts for Investing during a Crisis Stress Testing - Bankruptcy Risk? Goal: SurviveStress test businesses not stocks Focus on Fundamentals Long-term is where all of the value is atThe next 1 or 2 years is only 10-20% of the value most of the time. War somewhere is not inherently a crisis for your portfolio Are your specific businesses being affected?Land war in your country?Destruction of infrastructure owned by your companies?Sanctions against your companies?There has been almost constant war for the entirety of the last 100 years somewhere in the world Doomsday Scenarios It is usually worth betting on optimistic outcomesIf you're wrong, you likely won't be around to deal with it. (Nuclear war) Summary: The Russian Invasion of Ukraine has created a situation where three crisis grip the world: War, Inflation, and COVID-19. How should investors think and act during such a crisis?  Stress test your portfolio. Focus on the Fundamentals. Does the war affect you directly? Avoid doomsday thinking.
127 - Scuttlebutt on Overlooked Companies
06-02-2022
127 - Scuttlebutt on Overlooked Companies
Mental Models discussed in this podcast: ScuttlebuttQuality InvestingCapital StackDark Stocks Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode127 Scuttlebutt on Overlooked Companies - Areas of Focus Capital Stack: Clean is better. Ideally only common stock.No lending to insiders or other self dealing.Has management issued themselves options in the past? Were the prices reasonable? How much of the company does this represent?"Overdue or delayed payment to insiders." Red flag. This basically menas the company is in default putting your equity at risk. Can't even really mount a proxy fight because the management could force the company into bankruptcy. Filings: Current or pink limited on filings with the SECI want to see financials. (They don't have to be audited)Some sort of management commentary is nice. (Shows shareholder friendliness) Business Model: Change New productsNew managementGrowth of some kind Asset Base: Ideally assts to cover the market cap (providing a margin of safety) Earnings Power: Profitable (every year for 10 years, no more than one loss in 10 years)   Summary: Overlooked companies are often cheap. Therefore, scuttlebutt on overlooked companies needs to focus on filtering for the quality of the business. High-quality and cheap makes for a great stock. Look for abnormal signs of positive potential.
126 - Series I Bonds: My Inflation Protected Emergency Fund
30-01-2022
126 - Series I Bonds: My Inflation Protected Emergency Fund
Mental Models discussed in this podcast: InflationEmergency Fund Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode126 Series I Bonds Current Yield: 7.12% (through April 2022)Re-rates every 6 months according to an inflation index (not sure which one)Combination of a fixed rate (currently 0%) and a variable interest rate. Maximum of $10k/year per person.  On a calendary year basis. Available for purchase on TreasuryDirect.gov Emergency Fund Need LiquidityPrincipal protectionNormally lacks inflation protection (nice to have, not a need)My plan: 50% savings account50% Series I Bonds Take a few years to move into the I Bonds slowly to limit liquidity risksNormal recommendation is 3-6 months of expenses. I like 12 months as a long-term goal.    Summary: Series I Bonds are an inflation protected security issued by the United States Government to individual US Citizens. These non-marketable securities offer interest rates comparable to inflation and are an ideal asset to include in an emergency fund.
125 - Phase Change Investing
23-01-2022
125 - Phase Change Investing
Mental Models discussed in this podcast: Phase Change (Chemistry)Earnings PowerConsolidation Period Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode125 Phase Change Mental Model In Chemistry, you have the mental model of a phase change.Think: Solid, Liquid, GasIn order to exercise a phase change youhave to increase the energy in a fluid. Increasing energy causes the temperature to rise, but when a phase change is close to occurring, the temperature will stop increasing for a period of time.  During this time, you have to keep increasing the energy, but the temperature will stay the same.Why?The excess energy is being applied to changing the phase of the fluid. This pause is incredibly important and the amount of energy needed to change phase is the "latent heat." In the same way, you should try and profit from businesses undergoing a phase change. Applying the Phase Change Mental Model to Stock Investing Two ways to look at this: Underlying earnings powerShareholder base changes Underlying Earnings Power Often, stocks may be stuck in a trading range for a period of time, months, maybe years. On the surface (via the stock price) no change appears to be occurring. However, under the surface, the company is improving, cutting costs, building new products, and pleasing customers.Then all of a sudden, th e company breaks out to new highs as eanrings go up 50%, 100%, or 200% when a new product launch occurs and operating leverage plays itself out. Shareholder Base Changes There are a diverse set of possible shareholders you need to be aware of. Types:  Deep valueValueGrowthMomentumSpeculators Sizes: RetailInstitutional Investors Active FundsPassive Funds It can take a long time for a shareholder base to change over and that's one of the things that can occur during this consolidation period. Deep value sells to value, value sells to growth. Retail sells to Active funds, and active funds sell to passive.If you want above-average returns, it can help to ride the wave from one set of investors to another.If you can buy stock as a retail investor when NO isntitutional investors are involved and then wait long enough to sell to institutional investors, you can be bneefit from massive multiple expansion as the liquidity that they bring forces the stock price up faster than earnings.  Phase Change Investing Applied to My Portfolio I want to buy stocks when they are nano-caps, trading for sub $50m and sell them after they have 10-20x becoming Small-Cap companies. The goal is to hold them through their nano-cap and micro-cap phases when there are no institutional investors and sell them once they are in the $500m-$1bn+ range.At that time, ETFs, mutual funds, and hedge funds will be involved and I may be able to benefit from buying at sub 10x P/E multiples and sell at 25+ P/E multiples to these passive investors.This process may take many years, but it can lead to supercharged returns.  Summary: A phase change occurs when excess energy is added to a fluid. For aperiod of time, energy rises without temperature changing. Investors can learn from this mental model how to seize investing opportunities during consolidation periods.
124 - How I Value Trade Stocks
16-01-2022
124 - How I Value Trade Stocks
Mental Models discussed in this podcast: Value TradingHorizontal Risk ShiftingRebalancingLook-Through Earnings Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode124 Value Trading Definition Partial selling of a core holding to buy more of another core holding.If the core position size is 20%, you may buy up to 25% or 30% of a surplus position when relatively undervalued and then sell it back when it is relatively overvalued. Key: Using valuation specifically to change the weightings in your portfolio Necessary assumption: Assuming you have a sufficiently good comparable idea Goal Only value trade when the exchange is clearly beneficialHigh bar50-100% increase in look-through earnings I use a spreadsheet that constantly calculates look-through earnings for each position. Horizontal Risk Shifting Diversification of my risk by reducing my exposure to a single stock without having the value trade component. May not increase look-through earnings but minimizes risk.  Say splitting a 30% position in Coca-Cola into a 10% position in KO, Pepsi, and Dr. Pepper. Want to target similar P/E ratios or better, but this has a lower bar. Really used mainly for overly high current allocations or used when a stock is highly valued.  Summary: Value Trading is the process of rebalancing a portfolio using valuation specifically to adjust the weightings of your individual stocks. I value trade to optimize the performance of my portfolio, increase returns, and reduce risk.
122 - Are you the next Warren Buffett?
19-09-2021
122 - Are you the next Warren Buffett?
Mental Models discussed in this podcast: Second-Order EffectsPassive vs Active InvestingStanding on the Shoulders of Giants Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode122 Key Observations I have seen many writers, presentations, and discussions around this idea that YOU are NOT the next Warren Buffett, therefore...X "Don't concentrate""Don't buy individual stocks""Buy Index Funds""You won't outperform...etc..." What is the impact of this?Is it true?How many future Warren Buffett level investors will never arise because we've convinced them it is impossible? Imagine if we treated scientists like this."You aren't the next Einstein (or Bezos or Zuckerberg)" The lesson: Don't even bother trying How many future inventions would we lose out on? Summary: Are you the next Warren Buffett? This question discourages potential investors from attempting to outperform. I discuss the second-order effects this has on the investing landscape and your personal financial situation.
120 - Philosophy of Concentrated Investing
05-09-2021
120 - Philosophy of Concentrated Investing
Mental Models discussed in this podcast: Concentration vs DiversificationHurdle RateCircle of CompetenceConvictionOpportunity CostSatisficing Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode120 How many stocks should you own? As many as you can that meet your hurdle rate?Only the best opportunities available?Optimal vs Satisficing Constraints on Holdings: TimeCircle of CompetenceConviction Additional Thoughts Collector of BusinessesHypothetical: What is the highest level of concentration an individual investor should be willing to place into a single stock (when buying?) Specifically, asking about non-special situations, more long-term holdings. Presumably, at some point, cat-risk is too high even when you have an edge.Imagine you own a 5-10 stock portfolio. Over the weekend, it is announced that all 10 companies are merging and will be subsidiaries under a single capital allocator that you like. Do you make any portfolio changes? You still own the same companies, but now 1 stock, not 10. What are you buying when buying a stock?Concentration: " The number of stocks you own is dependent on how you view yourself as an investor."  Is it possible to produce alpha? If yes, concentrateIf no, diversify Are you a good investor? If yes, concentrateIf no, diversify Conviction If yes, concentrateIf no, diversify Summary: How many stocks should you own? This is a critical question without a single answer. Your portfolio concentration is constrained by time, circle of competence, and conviction.
118 - NACCO Stock Post-Mortem $NC
29-06-2021
118 - NACCO Stock Post-Mortem $NC
Mental Models discussed in this podcast: DurabilityPost-MortemResultingCapital Allocation Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you’d like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode118 Timeline NACCO spun off Hamilton Beach Brands in September 2017I first bought shares in March 2018 at a price of $40 per shareI averaged down in May and June 2018 with shares at a price of $34 per share.Averaged down in September 2018 at $32 per share and October 2018 at $29 per shareWithin a year, the stock doubled to over $65 per share in October 2019. This is the recent peak. Instead of selling, I held because I valued the company at $75 per share at the time. It wasn't yet at fair value.May and June 2020, I averaged down again at $26 per share and then $22-24 per share.In March 2021, I recognized that holding $NC was a large opportunity cost on my portfolio and I shifted some money to other stocks while the stock was around $24-25 per share.In May 2021, I exited my stake in $NC completely at a loss around $25-26 per share.Some lots were sold at a gain and some at a loss. Overall, the position was a net loss and a much bigger loss on an opportunity cost basis. Thoughts and Key Questions I should have sold or trimmed after the stock doubled in less than a year. $65 per share was within my error margin for my $75 fair value estimate. Even simply reducing my stake by half would have been a good decision. The main reason I didn't do this was that it would have had to sit in cash. I didn't have many other good ideas at the time.My biggest mistakes are often made when I'm in cash or when I would be creating a cash position. (Always do research for new ideas!!!) Was buying $NC in the first place a mistake? No, I don't think so. My theory was sound. I expected positive news from NACCO and it was cheap at $40 per share. It was the best idea I had at the time, I was also running a diversified 10-15 stock portfolio when I bought NACCO. My thesis was correct, but I had thesis creep as news flow came out. My original valuation placed the stock as worth between $50-65 dollars. I only upped my estimate after high natural gas income. I should have recognized that was temporary and sold. I thought NACCO was a 3-5 year hold business, but it probably should have been sized as a last puff cigar butt. When that puff came within a year, I should have sold.  Did I accurately assess NACCO's business model quality? Yes. NACCO's service model of earning money from unconsolidated subsidiaries allows it to earn high returns on capital as the customer puts up all of the capital. Did I accurately assess the durability of NACCO's business? No. I misestimated the likelihood of a coal mine closure.I did assess that coal mine closures were likely and I accurately predicted the degree to which they would harm the business. However, I underestimated the degree to which NACCO's stock would decline. I thought the decline was overdone.  Did I accurately assess management/capital allocation? Partial yes, Partial No.I accurately predicted that management would NOT dedicate new capital to new coal mines.I accurately predicted that free cash flow would be dedicated to growing the North American Mining business.However, I underestimated the maintenance CapEx needed for the MLMC consolidated coal mine. This sucked up a large amount of cash flow for the 3 years I owned the stock. Future maintenance CapEx is going to be lower, but the timing was bad on my part. I also underestimated the ROIC from the money put into the North American Mining business. I expected higher returns for the cash outlay. Thoughts and Lessons Learned Don't buy companies that lack durability and really dive into this question of durability.  A mistake on durability could mean that a very low P/E is justified.  Personal preference: I highly prefer buying steady growth companies. I did not enjoy the constant negative and bad news reports from the company while I owned it. The primary problem with owning NACCO for the last 3 years was the opportunity cost of how that money could have grown with other better companies.My actual losses weren't that high. Some of my purchases made a profit.However, the process of turning one profit center (COAL) into a new profit center (NAM) is slow and costly. That's basically a turnaround situation. I don't want to own turnaround situations until after they've been turned around. It's basically dead moneyCreates large opportunity cost situations Management is critical I want a management team that I believe is fully aligned with me on skin-in-the-game.NACCO has a good management team, but they don't run the company how I would run the company. They receive regular ongoing stock options and issuance which dilutes me as a shareholder. There isn't a lot of insider buying and there weren't a lot of share buybacks which I would have preferred.If I were assessing NACCO today, while I still believe it is cheap, I don't think it would pass my current management/capital allocation filter. Perhaps that will change in the next 5-10 years.  Be wary of thesis creep. NACCO would have been one of my best success stories if I simply sold it after it hit $60 per share. A quick double and it would have been a lot of money for my portfolio as a 20% position. Instead, I allowed my thesis to creep which resulted in $NC being a drag on my performance for years 2 and 3 of my holding period.  Summary: I want to buy and hold high-quality, durable businesses that are growing AND are selling at a cheap price. NACCO had a cheap price and was high-quality, but it was of low durability and had no growth. Going forward, I am going to be more diligent at filtering out ideas that don't meet ALL of my highly stringent criteria.