I often get the question, “do you only invest in tech?” The answer is a big, fat no. I try to invest in the companies where the underlying earnings power is growing the fastest. If stock prices follow earnings, it makes sense to me that if you want to compound at a high rate, you need to find companies that are growing their cash flows as fast as possible. Tech just happens to be the place where a lot of companies are doing that (also the word "tech" is kinda superfluous. Railroads were high-tech at one point).
Now, in theory, investing this way may sound easy but there are a few caveats.
One, fast-growing companies attract competition. Therefore, I try to find clear leaders that are dominating so this risk is minimized as much as possible. If it’s obvious that a portfolio company is slowing down due to competition, I will likely move onto greener pastures. It’s nothing personal. Stocks don’t know we own them.
Two, fast-growing companies often go for very high valuations. This is extremely uncomfortable because:
a) it’s tough to cognitively get around the fact that you are overpaying in the short term and
b) the stock prices can be wildly volatile (I don’t need to prove that to you, the last few weeks is enough evidence).
Three, fast-growing companies can be riskier. My definition of risk isn’t volatility. Volatility should actually be defined as opportunity. Instead, risk is when you permanently lose money. That’s what we’re really talking about. When a company is doubling its revenue, things can break. It’s tough to rapidly scale and sometimes the company culture can get out-of-whack, the CEO can burnout, employees can get complacent with fat options packages, etc. That’s why I follow Glassdoor ratings and company culture so closely. I figure that if the culture is still top-notch, things probably aren’t breaking down permanently.
So to recap:
I want to compound money as fast as possible (AFAP – I don’t think this will catch on lol) so I find companies that are growing their underlying earnings power as fast as possible. However, these companies can have a lot of competition, their valuations can be too high and the culture can break while rapidly scaling. To limit the risk of these factors, I study competition in-depth, try to test the assumptions in the price and keep track of the company culture. It’s not a perfect science, but that’s my broad strategy. It has nothing to do with a top-down view of the world, though that often helps identify where to fish for fast-growing companies. It also has nothing to do with paying low or high multiples. It’s about conviction and upside. It also has nothing to do with SaaS or tech. It just so happens that there are some fantastic, fast-growing SaaS companies. And lastly, it has nothing to do with small or large cap. Typically, you won’t find a $500 billion company growing 50% (though it’s quite possible) so I tend to try to find smaller companies, even micro-caps if they fit the criteria. It’s not about boxing ourselves into a sector or company size, it’s about finding companies that will compound the fastest.
Besides laying out the portfolio strategy, the purpose of this post is to remind myself about not getting complacent and locked into one style. It’s important to keep testing the assumptions and finding better companies with more upside. It’s not easy but that’s why it can be rewarding. As Charlie Munger says, “anything who thinks investing is easy, is stupid.” I could not agree more.
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