Monday Musings - 16

This edition of Monday Musings will have a bit more to do with how we look at our holdings instead of how to find our holdings. 

When you look at your portfolio I hope that you don't simply see them as stocks or bonds that have a certain value, certain price to earnings ratios, dividend yields, or even margins of safety. Instead I would ask you to take a look at the positions you hold as what they are: real flesh and blood businesses. 

Remember that as we collect shares in our journey to financial freedom we are not simply looking for a quick profit, but instead we are collecting a percentage of an actual business. Do you really like the business that you hold or do you simply just like the price that you hold it at? If you answer no to the first and yes to the second then I urge you to sit down and take another look at your holdings.

While I am not a Tesla (TSLA) fan, in terms of the company's financials, I am in understanding in why it has such a massive cult following. Elon Musk is a genius at the top of the Tesla kingdom and that has many people believing that the company will be a success. There is also a tremendous belief in not only the product but also in the future changes to the world that will make this product a tremendous asset. This is why people continue to believe, and will continue to believe, unless there is something catastrophic that happens that will change their minds.

But it is really where the fanfare and financials meet that lead to what I would call the investing "sweet spot". Warren Buffet has stated that where early he would buy fair companies at wonderful prices he later, after meeting Charlie Munger, would buy great companies at fair prices. I tend to agree with both.

Here's the problem though, how many companies that you own agree with that latter train of thought? Do you even know enough about each of your holdings to make an argument whether they are a fair or great company? Let's jump in just at how to figure that out...

 

  1. What's the Moat?
    First off, for those who do not know what a Moat is let me explain in the way that Warren Buffett has many times. If a company is a castle, the moat around it is what protects it from others. In terms of a company this is the competitive advantage it holds over other businesses that attempt to do the same thing. In terms of a company like Amazon (AMZN) the moat is huge. The company holds a stranglehold on the online retail market due to its massive inventory and ease of use, along with quick delivery and huge Prime customer base. Does it do something that another company cannot? Absolutely not! But it does it better and now is the brand name that is synonymous with online shopping.
    To look at the flip side let's take a company like Proctor & Gamble (PG). While I like this business, with a massive legacy, their moat is actually shrinking. With generic products coming out that are pressuring their margins it appears that the brand names no longer hold the kind of weight they used to. This becomes troublesome and you begin to realize that the advantage of the brand they once had is now getting smaller and smaller.
     
  2. Who's in control?
    Seriously, this is an actual question that sometimes is tough to answer. Who makes the decisions? In Tesla's case this is an easy answer, but with some other companies there are boards with control over CEOs, new blood in that same CEO position, or sometimes it can even be an activist investing group. To go further you have to know who actually is pushing the decisions that are being made. Without this knowledge it is very confusing to continue your trek towards figuring out if a company is great or not.
     
  3. What's their past?
    How many years has there been a profit? Is it growing or receding? Are they taking steps in the right direction or are they simply treading water that soon will overtake them? These are all simple questions that you can learn about simply by reading through the old earnings reports and investor presentations. If the company seems like they aren't making strides towards improving over the last 5 or so years, then they probably aren't. If they seem to make moves that widen their moat and increase their profitability then maybe this is a quality company after all.
     
  4. What's their future?
    Now I'm not telling you to go find a crystal ball and begin predicting what the company will look like in 10 years but you should be able to at least observe catalysts on the horizon. Is the company in an industry that is going to benefit by a future tax break perhaps? Is there an innovation they are working on that could send them to the stratosphere? Maybe they just have a product that continues to grow in revenue stream. Either way you should definitely be able to look into the future and see a GOOD reason to add the company to your portfolio. If not, stay away until you do.
     
  5. Are they consistent in their reports?
    This isn't about whether the profits or revenue is consistent, but instead is more about what management is saying in the reports and calls. Listen closely to these and also go back and read the past 4-5 years. Does management make promises that never come to fruition or are they always honest and forthright about what their strategy is going to be. I never want to own a company that constantly says one thing and does the other. Sorry TSLA owners, but I am not owning until I actually SEE those cars rolling off the line in the amounts that are always promised. 

 

While these aren't the only things that you should be considering when doing evaluation on each of your holdings, these are some of my most important when I consider the whether the company is really great, or simply a mirage that is priced to steal a couple of bucks from Mr. Market.

Whether you get a fair priced "great" company, or a great priced "fair" company is up to you and honestly I think most portfolios of active investors include both. As I look at my portfolio I have a mix of positions that are okay companies that I believe I an make a decent percentage gain off of over 12 months or so, and some opportunistically priced great companies. One will get you great gains over a short term, while the other will keep you safe and sound, gaining over a long period of time. If you can do both, your gains will add up much quicker than if not. 

As always, feel free to leave any comments below.