March portfolio update

The portfolio had a great month in March, returning 1.22% compared to the benchmark's -3.77%. While I don't expect this level of outperformance will be regularly repeated, I am confident the portfolio will turn in its best months relative to the benchmark when the broader market is down.

This month, I sold one of my holdings, Global Construction Services (ASX:GCS). I bought the stock in October for $0.785 and was able to sell it for $0.81. (I also received the 2 cent fully franked interim dividend, which was paid out at the end of the month.) Including franking credits, I received a return of 5.16% on my investment over that period, which equates to 13.96% annualised. If you are unfamiliar with GCS, I suggest you read Tony Hansen's blog post about the company.

As a general rule, I don't intend to make short-term gains from stocks, expect in special situations — and GCS is not one of those. My reason for selling was simple: an opportunity with a more attractive risk-adjusted return presented itself. I thought I would be able to make the investment in this new opportunity this month, but it turns out I will have to wait at least until May. Because of this, I bought a new stock during the month with the proceeds. This stock is a special situation: it is subject to corporate action due to complete about the time the other investment should become available. If things proceed as I think they will, I should end up substantially ahead compared to the alternative, which is holding the proceeds from the sale in cash.

My stocks held up better then the benchmark during the month and I received a substantial dividend from one of my other holdings, which accounted in large part for the gain.

	August 3, 2017	March 31, 2018	Since Inception	Annualised
G&W Portfolio	1.0000	1.0483	4.83%	7.34%
Benchmark (SPAX2F0)	61,250.80	63,658.89	3.93%	5.98%

As of the end of March, the portfolio consisted of eight securities. Since inception, the portfolio is 0.9% ahead of the benchmark.

A note about my performance calculations

I have decided to slightly change the way I account for my investment returns. In the past, I had been registering the "purchase date" of non-ASX stocks as the date the stocks were issued to me. (For ASX stocks, I recorded the date of the transaction.) From now, I will record the "purchase date" for non-ASX stocks as the date when the cash flow to purchase the stocks occurred. This change does not significantly affect my results — but it brings them closer to reality. If you are concerned — as you should be — that I am "moving the goal posts", please take a look at the table below, which records the original results for posterity. (I will edit the previous posts to reflect the change.) You will notice that, had I not made the change, I would have reported a 5.57% cumulative return as of the end of the month. The difference is due to an investment paid for in late February, for which I haven't received a holding statement. Under the old regime, it was not counted as part of the portfolio; under the new regime it is.

Interested readers should also note that I have not accounted for cash in the portfolio since inception. The reason is because my money flies around between my brokerage accounts, my savings account, general day-to-day expenses and other investments, such as managed funds, which would complicate accounting. What this means is that, even after my accounting change today, in reality, my returns are still likely somewhat overstated. While I am nearly always close to fully invested, during the early days of the G&W portfolio, for instance, I had a substantial sum of cash in a brokerage account, which was later used for something else.

	Revised	Initially stated
August 3, 2017	1.0000	1.0000
August 31, 2017	0.9976	0.9976
September 30, 2017	0.9970	0.9993
October 31, 2017	1.0146	1.0146
November 30, 2017	1.0340	1.0340
December 31, 2017	1.0676	1.0676
January 31, 2018	1.0597	1.0597
February 28, 2018	1.0356	1.0427
March 31, 2018	1.0483	1.0557

Until next time…

February portfolio update

February was a very interesting month. I mentioned in my last update that I had identified some potential opportunities to deploy capital. As a result of this work, I added one security during February. While I am reluctant to provide too many details, the position deserves some explanation as it now accounts for about 44% of the portfolio. 

Those who have read my earlier writings — in particular my very first post and my comments on Mohnish Pabrai's book — will be unsurprised that this particular business is stable, with an operating history of more than 10 years, and well-run. More importantly, the stock provides safety of capital and was bought well below any reasonable estimate of its intrinsic value. Stocks that display such attractive characteristics are hard to find. As an investor, if you are presented with such an opportunity, you should load up. To borrow words from Charlie Munger: "Opportunity meeting the prepared mind — that's the game." In my view, there is an extremely low probability that owners of this particular stock will earn less than a double-digit return over the next five years. (A return in the low-to-mid teens is far more likely.) The risk of permanent capital loss is extremely low to negligible. This is why it now speaks for nearly half of the portfolio's assets.

A number of my holdings reported interim results during the month. There were no big surprises — either good or bad. Despite this, the portfolio fell 2.27% over the month. Some of this drop can be accounted for by the significant purchase. While that stock has not fallen in value, my purchasing increased the overall size of the portfolio by about 70 per cent compared to January, which had the effect of diluting the impact of my existing gains. The benchmark was up 0.36% over the month. Since inception, the portfolio is trailing the benchmark by 4.45%.

The portfolio now consists of seven stocks. During the coming month, I expect to purchase an eighth security and add to at least one existing holding.

	August 3, 2017	February 28, 2018	Since Inception	Annualised
G&W Portfolio	1.0000	1.0356	3.56%	7.45%
Benchmark (SPAX2F0)	61,250.80	66,153.94	8.01%	13.98%

Until next time.

January portfolio update

Happy New Year to any readers out there. It's that time of month again, so here's the portfolio update.

The G&W portfolio was down 0.74% this month and trailed the benchmark (-0.45%).

	August 3, 2017	January 31, 2018	Since Inception	Annualised
G&W Portfolio	1.0000	1.0597	5.97%	13.04%
Benchmark (SPAX2F0)	61,250.80	65,918.88	7.62%	16.66%

Spicers, my largest position, is thinly traded and prone to frequent price fluctuations. This month it finished at 0.034, down 2.85% for the month. (It should be noted that this was after a 5.56% drop today — the final day of the month — for no apparent reason.) These fluctuations are of no consequence and, while my performance may be rocky, I expect Spicers to do substantially better than the broader sharemarket over a reasonable period.

I did not do any buying or selling during the month. I have found a few attractive situations where I may be able to put capital to work in future — but more work needs to be done before any dollars are put down. 

December portfolio update

Yesterday was the last trading day of the year, so it's time for a portfolio update.

	August 3, 2017	December 31, 2017	Since Inception	Annualised
G&W Portfolio	1.0000	1.0675	6.75%	17.23%
Benchmark	61,250.80	66,215.65	8.11%	19.72%

The month was a good one for the portfolio and the benchmark, which were up 3.24% and 1.81% respectively. The markets have continued their steady rise upwards. Speculation is rife: more and more people are "investing" in cryptocurrencies, or the "growth story" stocks trading on sky-high multiples. If this trend continues, the portfolio is almost certain to fall further behind the benchmark over the short term. In periods like this, I simply hope to keep up; when the benchmark performs poorly, I hope to do better. Over the long term, I expect such gains will result in an above-average performance.

I added one new stock this month, bringing the total to six. Of these six stocks, five were net cash as of June 30. If these five stocks were bundled together and sold at current market prices, the buyer would find 38% of his purchase price in the company tills and bank accounts.

Mohnish Pabrai and The Dhando Investor

Thanks to the summer holidays, I've just finished another book, Mohnish Pabrai's The Dhando Investor. For those who are unfamiliar with Pabrai, he's a true-to-label value investor in the Graham-Buffett mould. Earlier in his career, he founded an IT business, which he sold for about $20 million. (It was after this he started focusing on stock market investments.)

The Dhando Investor is a quick, easy-to-read book that, in my opinion, most investors or business people will find interesting and useful. At the heart of the book is Pabrai's concept of Dhando — making low-risk, high return bets. (This is, of course, exactly what we do as value investors.) He provides a number examples of Dhando at work: the story of the Patels and the US motel industry, Richard Branson and Virgin Atlantic, and his own business career. The philosophy, as Pabrai describes in the fifth chapter, is based on a few key ideas:

• Invest in existing businesses;
• Invest in simple businesses;
• Invest in distressed businesses in distressed industries;
• Invest in businesses with durable moats;
• Few bets, big bets and infrequent bets;
• Fixate on arbitrage;
• Margin of safety — always;
• Invest in low-risk, high-uncertainty businesses;
• Invest in the copycats rather than the innovators.

In the sixth chapter, Pabrai discusses how to value a business listed on the stock market. As value investors know, the value of a business is the net-present value of its cash flows. Pabrai demonstrates a couple of simple NPV calculations for a private business — a gas station — and a listed company, Bed, Bath and Beyond. Despite the fact that they both businesses are relatively simple to understand, Pabrai ends up with a wide range of potential intrinsic values. This, of course, is one of the key problems with using discounted cash flow analysis: small changes in assumptions, such as the discount rate or terminal value, can lead to widely different outcomes. The key to investing successfully then, according to Pabrai, is to invest only in simple businesses — where conservative assumptions about cash flows are easy to figure out — and only when it is clear that, using these conservative assumptions, you stand to make a great deal of money and are unlikely to lose much. Sounds simple, right?

Pabrai, like many other good value investors, always writes down an investment thesis: "If it takes more than a short paragraph," he says, " there is a fundamental problem ... if it requires me to fire up Excel, it is a big red flag that strongly suggest that I ought to take a pass." This is excellent advice. If I had implemented it in my processes earlier in my investing career, I would have avoided some of my major mistakes. For his DCF calculations, Pabrai looks 10 years into the future and applies an appropriate multiple to expected cash flows in the final year to come up with an expected IRR. In chapter 15, Pabrai discusses the process of selling a stock. He suggests that investors should have a crystal-clear exit plan before ever thinking about buying a stock. He provides seven questions for investors to ask themselves before making an investment.

• Is it a business I understand very well — squarely within my circle of competence?
• Do I know the intrinsic value of the business today and, with a high degree of confidence, how it is likely to change over the next few years?
• Is the business priced at a large discount to its intrinsic value today and in two to three years? Over 50 per cent?
• Would I be willing to invest a large part of my net worth into this business?
• Is the downside minimal?
• Does the business have a moat?
• Is it run by able and honest managers?

According to Pabrai, one should only consider buying a stock if the answer to all seven of these questions is a resounding yes. "If a well-understood business is offered to you at half or less than its underlying intrinsic value two to three years from now, with minimal downside risk, take it," he writes. "If not, take a pass ... There will be better chances in the future." He also discusses his rule of not selling stocks at a loss for at least two years, which was mentioned in Guy Spier's book and my previous post. There is an important caveat: Pabrai will not sell in this period unless both of the following conditions are satisfied:

• He is able to estimate its present and future intrinsic value, two to three years out, with a very high degree of certainty;
• The price offered is higher than present or future estimated intrinsic value.

The purpose of this restriction is that it stops investors from selling out of a stock during times of peak pessimism. Cheap stocks don't usually grow at a steady 15 or 20% per year as one might like — they might, for instance, drop 50% in the first year and grow 200% in the second. The rule helps us avoid selling out for psychological reasons at the low point.

All in all, I think the Dhando Investor was very good. It has given me much food for thought. There were no new ideas in the book, but Pabrai illustrated the precepts with great examples. If you are interested in learning more about Pabrai, I suggest you check out his excellent channel on YouTube. Here's one of his most recent videos, a lecture given to students at Boston College in November.

Until next time.

Thinking about investing rules

I recently finished reading Guy Spier's book The Education of a Value Investor. The book was interesting but unremarkable: there won't be a whole lot new for well-read investors.

Spier himself seems rather unlikeable. He comes across in parts as vain and self-conscious and driven by ego and status: what Mr Buffett might describe as an "outer scorecard". He does, however, do a great deal of reflection about this in the book. Nevertheless, the book was interesting in parts and worth reading.

Some of the best parts were when Guy was discussing his good friend Mohnish Pabrai. (Spier and Pabrai famously paid $650,100 to have lunch with Buffett in 2008.) The real takeaways, in my opinion, were in the chapter about Spier's investing process. Here he describes eight rules, routines and habits he has developed over the years with help from Pabrai.

Many of these principles make a good deal of sense, and as someone still developing a sound investment process, I intend to incorporate them into my decision making. So here they are — Guy Spier's eight investing rules.

1.  Stop checking the stock price. I have a terrible habit of constantly checking stock prices. This habit is dumb and pointless — and I intend to break it as soon as possible. We know from the great psychologists Kahneman and Tversky that investors feel the pain of loss twice as acutely as the pleasure of gain. We also know from psychology that humans have limited willpower. While a stock market portfolio with average volatility is typically up in most years over a 20-year period, there is a much higher probability that it will be down on any given day — which exposes us to making bad decisions due to our psychology. My concentrated portfolio will have above-average volatility, which amplifies this situation and the risk of making bad decisions. So from now on, I'm going to limit myself to checking stocks once a week. Peter Phan has written an excellent blog post on this topic for those interested in reading further.
2. If someone tries to sell you something, don't buy it. Spier has developed a heuristic to avoid being conned: he won't buy anything from people trying to sell to him. Whether it's technology for his fund or an IPO, if there's someone on the blower with a sales pitch, Spier simply says "I'm sorry but I don't allow myself to buy anything that's being sold to me". This is eminently sensible: buying something from someone who has a self-interest in your buying can be a recipe for disaster. From time to time, this will mean you might miss a good deal or two, but you're certain to come out much better in the end. 
3. Don't talk to management. Spier did a lot of talking to management in the early days of running his fund. His experience taught him that close contact with management is more likely to be detrimental to his returns than the opposite. This might sound unintuitive, but managers tend to be charismatic and this can muddle our thinking. This is not to say managers aren't important to a business's prospects, but that first impressions can be misleading. Charlie Munger points out, when it comes to thinking about management, the paper record should count much more than any interview. I haven't done much talking to management yet and don't intend to change this in future. However, investing in small companies means that talking to management can be extremely useful from time to time. Buffett, of course, was always one to talk to the managers and it worked out pretty well for him.
4. Gather investment research in the right order. There are a couple of points here. Firstly, as Munger's misjudgement speech points out, we tend to give more weight to ideas that enter our brain first. In investing, we might for instance, hear a stock pitch from a fellow investor that muddy the waters of our thinking. Spier makes a few suggestions: he says if someone starts suggesting a stock to investigate, he stops them in their tracks until he's had some time to do his own reading and investigation. At that point, but not before, he's happy to have a conversation about it. The second point is that we should be careful about the order in which we read materials about a prospective investment. Spier's process is to start with unemotional public filings such as the annual and half-yearly reports, especially notes from the auditors. After that, he'll turn to less objectives sources: for instance press releases, news articles, presentations and the like. If the business is a well-known one, like Berkshire, there might be a good book to read. In some cases, they might be thorough enough to read even before the corporate material. Equity research should never be relied on and should be read only once you have formed your own impression of a company or industry. It can be useful to know what the consensus is in the market, but reading others' research early on will only muddy your thinking.
5. Discuss your investment ideas only with people who have no axe to grind. This is another good tip. If you have an investment idea, it doesn't make a great deal of sense to talk about it with someone who already owns it or someone who has come out publicly as a bear. Trust is another important thing: Spier suggests that discussions about investment ideas should be strictly confidential, that no party should tell the other what to do, and that the parties shouldn't have a business relationship that could skew the agenda. Investing is largely a solitary activity for me at present, but over time, I expect that I'll discuss ideas with other like-minded investors. I'll be keeping these ideas in mind when I do.
6. Never buy or sell stocks when the market is open. This is an idea Spier has appropriated from Mohnish Pabrai. By limiting trading until after trading hours, we can help detach ourselves from price action that can stir up our emotions. The market needs to be our servant not our master. (Spier admits that he breaks the rule occasionally when there are particularly compelling reasons to trade during market hours.) Once again, I think this ideas makes a great deal of sense and I intend to incorporate it into my own process.
7. If a stock tumbles after you buy it, don't sell it for two years. The hardest part of stock market investing is selling. Another hard part is seeing a stock you've recently bought tumble. This experience can be emotionally fraught and lead to bad decisions. To counter this, Mohnish developed the two-year rule to deal with the psychological forces at play. I intend to adopt this rule for the G&W portfolio, which will have wide-ranging consequences. The rule works in two ways: first, the two-year minimum makes you think especially hard before laying down money on a stock; secondly, it'll prevent situations where stocks are sold too early simply due to the psychological impacts of price action. Obviously, I will retain the right to sell out before two years if the investment was a mistake or it is impacted by a major development. I haven't had to sell any stocks in the G&W portfolio yet except for a couple of arbitrage opportunities. Selling is an important topic so I hope to write a blog post about it when I do finally make a sale.
8. Don't talk about your current investments. This has to do with our well-documented bias, as humans, to be consistent with our prior statements. Simply put, it is emotionally difficult to back away from what we've said, even if we come to regret that opinion. This is described in Robert Cialdini's great book, Influence. I'm a bit conflicted about this, because while I agree with Spier, writing posts about stock picks could be a useful exercise for me to develop my skills. I am yet to write a post explaining my reasons for holding any particular stock and after reading this, I'm not sure if I will. It may be that writing a post-mortem is a better option. 

Finally, I'll leave you with a deeply insightful interview with Charlie Munger, where he discusses business, Bitcoin and everything in between. You'll learn much more from this one-hour video than you ever will from me.

Until next time.

The first four months

In this post, I will examine the performance of my direct shares portfolio over the past four months. As I mentioned in my first post, I bought my first ever stock about three years ago. I have had satisfactory returns over that period, but I feel this has as much to do with luck as any particular skill. Over those three years, I did a great deal of reading and started taking my investing more seriously.

In August this year, I felt my knowledge and skills had improved to the point where I might be able to beat the broader share market over a period of, say, three to five years. So, on August 3, I set out towards the goal and bought the first shares in the Generals and Workouts (G&W) portfolio. My results over the four-month period are summarised in the table below.

	August 3, 2017	November 30, 2017	Since Inception	Annualised
G&W Portfolio	1.0000	1.0340	3.40%	10.43%
Benchmark (SPAX2F0)	61,250.80	65,037.65	6.18%	18.96%

I unitised the portfolio to assist in calculating performance. (There is a good post on the Monevator blog explaining the process.) There are two reasons for doing this: firstly, it makes tracking performance against a benchmark simple; second, it's free. Portfolio software like Sharesight can be neat, but I prefer not to spend hundreds of dollars in subscription fees.

A few other things to note:

• The returns are pre-tax, include franking credits and assume dividends are reinvested. 
• The benchmark I have chosen is the SPAX2F0 — the S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt).

The SPAX2F0 is simply the ASX200 index adjusted for franking credits. By using it, we are able to fairly compare our returns including franking credits to the experience of investing in the ASX200. Franking credits are an important, and often under-appreciated, component of the returns of Australian investors.

As of November 30, the G&W portfolio is trailing the benchmark by 2.78%. This is neither surprising nor concerning. I suspect, as is often the case with investment programs focused on capital preservation, that outperformance will come in periods where the broader market declines. I hope to keep updating the portfolio's performance monthly.

Until next time …