My Investing Philosophy

I've had a few folks ask recently if I subscribe to any particular philosophy of investing -- if I'm an aggressive growth investor, or a Graham and Buffett-following value investor, or a buy-and-holder or frequent trader.

Well, it's hard to say what kind of investor I am -- and I definitely invest differently with the "play money" that I talk about here than I do in my employer sponsored retirement accounts.

It's easiest to say what I am not -- I am not a committed low-PE value investor or a dividend hawk, though I'm happy to receive dividends and buy on the cheap sometimes, and I am not a momentum investor or day trader and generally don't make short-term moves.

I think I can generally sum up my stock investing philosophy in a few rules.

• Buy with the intention of owning a company for a long time.
• Diversify significantly. I'm not confident enough in my wisdom to invest in only a very small number of companies, and I find it interesting to follow many companies at once. At this point I'm overdiversified and I'd like to winnow down the list, but I think I will likely always hold a minimum of 25 companies or so (right now it's nearer 40).
• Only sell for very good reasons. My past mistakes in selling early have dramatically overshadowed my mistakes of holding too long. All else being equal, once I've committed to a stock I'd like to stick with it and I need to have a more compelling reason to sell than I need to buy. I'd rather hold a company and ignore it then sell out of impatience.
  

That "philosophy", if you can even call it that, translates into some specific behavior that I try to follow when investing. Basically, my relationship with a company follows this pattern most of the time:

1. I hear about a company from reading in the media, seeing them as a newsletter pick, culling them from a stock screen, or encountering their products in the real world. I put compelling companies on my watchlists and begin getting an understanding of their business model and prospects.
   
2. I buy an initial small position after researching and becoming convinced that a company has excellent growth prospects, is reasonably fairly priced, and has solid management. I'm not terribly price sensitive with this first purchase.
   
3. I continue to monitor the company, follow their filings and research their business more deeply, and look for a better reason to fill out the position -- that might be a new line of business or unexpectedly quick success, or it might be a drop in price that presents a buying opportunity, or a reassessment of the company's fundamental prospects after doing further research. By the time I buy a second position in a company I should be quite committed to it and know it very well. I pay more attention to valuation when I fill out a position, and I'm likely to do a much more specific analysis of growth prospects and relative value for the company.
   
4. Finally, I try to have a very, very good reason before selling. A drop in price is not enough of a reason for me to sell, on it's own, and I try to be much more aggressive when buying than when selling. When significant changes occur at a company, I reassess and see if there are convincing reasons to refute my initial investment thesis -- if management is not as capable or trustworthy as I had previously thought, or their business appears significantly impaired by events I didn't foresee, or the company is otherwise showing itself to not be the company I thought it was, selling might be a reasonable reaction. I'm more likely to sell a small position than a large one, just because those are the companies I generally don't know as well and am likely to overestimate early in my relationship with them. I do also occasionally sell small portions of my holdings to take profits if I think a stock has gotten well ahead of itself or is overvalued, as I did in early 2006 with Vertex and Middleby -- but since I'm often wrong on this, I sell only a small portion, perhaps as much as enough to recoup my initial investment if it has more than doubled ... oftentimes, these stocks I sell will continue to climb, which makes me gnash my teeth.
   

I am perfectly willing to invest in "growth" or "value" companies as long as the growth rate and the valuation seem acceptable given my assumptions about the marketplace, or to invest overseas or in the US -- though I don't trade on foreign exchanges so I have so far restricted myself to ADRs and funds for my foreign holdings. I try to avoid OTC and Bulletin Board stocks, but I have broken that rule twice and I may do so again someday if the company is compelling enough (and especially if that company is likely to move up to the big exchanges eventually).

I generally do not invest in companies where my investment thesis is predicated on a short term event or a near-term catalyst -- for example, I generally wouldn't buy a biotech in the months before an FDA decision with a plan to ride it through the decision and then sell. I only add companies to my portfolio that I see as having a bright long-term future, and I don't plan to sell in the near future.

I do trade in options on occasion, though I almost never write about those because most people couldn't care less and, frankly, I'm no expert and probably shouldn't even do it. Generally, if I'm tempted to make a short term play on a company I'll consider doing so with a very small option position just to satisfy my gambling instinct. I am wrong as often as I'm right in the short term, probably more often.

That's not to say that I hold every company forever -- I have sold plenty of holdings, and some have been very briefly held over the years. Recently, I sold Great Wolf after just a few months because it became clear to me that the company was not as well managed as I had hoped, and was not as well positioned against their competitors. I also sold Cendant after holding it for less than a year, not only because performance was disappointing to some degree but because I thought their plan to break up was foolish and I didn't want to be a part of it.

I invest in individual stocks because I like to research and understand individual companies that are doing extraordinary things. I want to own companies that can grow significantly over many years, and I generally focus most of my energy on small cap or undercovered companies because I think small investors generally have an advantage in those areas and those companies are usually easier to fully understand.

I reserve the right to be irrational, and to make dumb mistakes. And if this ever stops being entertaining I might do almost as well by buying a few good mutual funds -- it would certainly take less time.

Keep up with One Guy's Investments, Free Subscription
Enter your email address:

Delivered by FeedBurner