My Investment Philosophy: The Publicly Traded Business
I was introduced to the world of investing in the summer of 1992, when I worked my first job as a grocery store bagger. My boss said that I could become part owner of the company.
I found this idea intriguing. So, I asked, “How do I do this?”
He said, “You buy stock.”
Sometime that fall I bought shares in my first employer, Winn-Dixie Stores, Inc. I was hooked on investing. I read everything I could get my hands on about the stock market, including financial magazines and investing books about and by investing greats such as Warren Buffett and Peter Lynch.
Over the years, I’ve always taken a fundamentals approach to investing. The nuances of my approach have evolved. I cut my teeth on Ben Graham’s value investing approach, and I followed Warren Buffett’s lead by incorporating Philip Fisher’s qualitative approach to investing.
Below I’ve outlined my current philosophy.
It’s a business first
Before an investor can research any stock in the publicly traded universe, he must understand that behind every stock and associated ticker there’s a dynamic business. I believe every shareholder in a company should think of himself as a “publicly traded business owner”. As publicly traded business owners, investors should search the stock market for companies that consistently expand revenue, net income and free cash flow.
Moreover, publicly traded businesses should exhibit financial prudence via plenty of cash and low amounts of long-term debt. Preferably, operations, acquisitions, expansion, capital returns and any other cash disbursements will come from internal funds as much as possible. A truly profitable business can’t lean excessively on external funds.
My ideal target company will have cash on its balance sheet equal to or greater than 20% of stockholder’s equity. I like seeing long-term debt that amounts to less than 50% of stockholder’s equity. My ultimate preference is NO DEBT. Long-term debt can create excessive interest costs. I like to see operating income exceed interest expense by five times or more. For companies that pay a dividend, I like to see them pay out less than 50% of their free cash flow in a year. Considered together, I prefer to see less than 75% of their free cash flow in dividends and share buybacks combined annually.
Long-term viewpoint
Having a long-term viewpoint really belongs on an equal footing with viewing a stock as a business. The two thought processes go hand in hand. A thriving business enterprise translates into higher chances of superior stock price appreciation over the long-term. Moreover, the detrimental effects from trading costs such as taxes and commissions are well documented. I would add that there is an emotional cost to keeping track of every little movement of a company’s stock price. Energies are better spent on researching investment ideas with superior wealth building potential. I believe that keeping a level head is crucial to any successful investing strategy. With a cool head, investors can purchase shares in excellent publicly traded business on the cheap and avoid offloading stocks on a temporary downturn.
Preferred publicly traded businesses
Pillar of Civilization – A Pillar of Civilization company is my preferred choice for investment. A Pillar of Civilization company maintains a ubiquitous and well-known presence throughout civilization. If the company disappeared, its products would certainly be missed…at least for a while. These companies exhibit high barriers to entry and their products are relatively unique or close to being unique. Preferably, their products serve a crucial role in civilization. The downside to this type of business is that even pillars start to crack eventually, and investors need to be mindful of this trait.
Niche Companies – As the name implies, Niche Companies are really good at one or two things. These companies aren’t necessarily Pillars of Civilization, but they can profitably exploit a core competency in a way that their competitors can’t. Preferably, their products will be unique or close to unique. One of the downsides to owning these types of companies often lies in the lack of diversity in their product portfolios.
Picks and Shovels Companies - A corollary to the Niche Companies category is a “Picks and Shovels” company. These companies sell products crucial in the operation of another business—a sort of Pillar of Another Company if you will. For example, companies that sell train and air plane parts fall into this category.
Market leaders - These are companies that may operate in a highly competitive industry but reside in a position of market leadership. Companies in this position garner extraordinary pricing power allowing them to profitably sell products at a lower price than competitors. This category, in its purest form, doesn’t represent my favorite, though I will invest in this type of company if it exhibits extremely conservative financials. Pillar of Civilization companies are usually market leaders.
Combination – Most good publicly traded companies exhibit some combination of these listed elements, including the undesirable one described below.
Publicly traded businesses I avoid
Perfect competition – I like to avoid investing in businesses that operate in a highly competitive industry or whose products are not differentiated from their competitors. Price largely determines product demand, not brand or need. Also, many of these companies possess high fixed costs. If the price of their products falls below the break-even point due to some unforeseen circumstances, then these enterprises can loss profitability over a sustained period of time.
A Word on Valuation
It’s a well-known fact in the investment world that price ultimately determines investment return over the long-term. With that said, I typically confine my investments to stocks that trade at a P/E ratio of 30 or less. I will tolerate a P/E ratio above that threshold if the target business is expanding its fundamentals at a brisk and consistent pace.
Risk to this Approach
Any investment approach has inherent risk. Ironically, what makes this approach so practical is also why it exudes risk—Dynamism. Businesses underlying stocks are dynamic and face ever changing challenges and opportunities. Investors who utilize this approach need to take this into account. Pillar of Civilization stocks eventually show cracks, consumers eventually lose interest in specialized niche products, picks and shovels businesses can see the demise of their client industries and market leaders can lose their positions. Thinking for yourself is crucial here. It’s up to you decide if a business has degraded to the point of not being able to significantly add to your wealth over the long-term.
I am not an advisor, always do your own research.
I found this idea intriguing. So, I asked, “How do I do this?”
He said, “You buy stock.”
Sometime that fall I bought shares in my first employer, Winn-Dixie Stores, Inc. I was hooked on investing. I read everything I could get my hands on about the stock market, including financial magazines and investing books about and by investing greats such as Warren Buffett and Peter Lynch.
Over the years, I’ve always taken a fundamentals approach to investing. The nuances of my approach have evolved. I cut my teeth on Ben Graham’s value investing approach, and I followed Warren Buffett’s lead by incorporating Philip Fisher’s qualitative approach to investing.
Below I’ve outlined my current philosophy.
It’s a business first
Before an investor can research any stock in the publicly traded universe, he must understand that behind every stock and associated ticker there’s a dynamic business. I believe every shareholder in a company should think of himself as a “publicly traded business owner”. As publicly traded business owners, investors should search the stock market for companies that consistently expand revenue, net income and free cash flow.
Moreover, publicly traded businesses should exhibit financial prudence via plenty of cash and low amounts of long-term debt. Preferably, operations, acquisitions, expansion, capital returns and any other cash disbursements will come from internal funds as much as possible. A truly profitable business can’t lean excessively on external funds.
My ideal target company will have cash on its balance sheet equal to or greater than 20% of stockholder’s equity. I like seeing long-term debt that amounts to less than 50% of stockholder’s equity. My ultimate preference is NO DEBT. Long-term debt can create excessive interest costs. I like to see operating income exceed interest expense by five times or more. For companies that pay a dividend, I like to see them pay out less than 50% of their free cash flow in a year. Considered together, I prefer to see less than 75% of their free cash flow in dividends and share buybacks combined annually.
Long-term viewpoint
Having a long-term viewpoint really belongs on an equal footing with viewing a stock as a business. The two thought processes go hand in hand. A thriving business enterprise translates into higher chances of superior stock price appreciation over the long-term. Moreover, the detrimental effects from trading costs such as taxes and commissions are well documented. I would add that there is an emotional cost to keeping track of every little movement of a company’s stock price. Energies are better spent on researching investment ideas with superior wealth building potential. I believe that keeping a level head is crucial to any successful investing strategy. With a cool head, investors can purchase shares in excellent publicly traded business on the cheap and avoid offloading stocks on a temporary downturn.
Preferred publicly traded businesses
Pillar of Civilization – A Pillar of Civilization company is my preferred choice for investment. A Pillar of Civilization company maintains a ubiquitous and well-known presence throughout civilization. If the company disappeared, its products would certainly be missed…at least for a while. These companies exhibit high barriers to entry and their products are relatively unique or close to being unique. Preferably, their products serve a crucial role in civilization. The downside to this type of business is that even pillars start to crack eventually, and investors need to be mindful of this trait.
Niche Companies – As the name implies, Niche Companies are really good at one or two things. These companies aren’t necessarily Pillars of Civilization, but they can profitably exploit a core competency in a way that their competitors can’t. Preferably, their products will be unique or close to unique. One of the downsides to owning these types of companies often lies in the lack of diversity in their product portfolios.
Picks and Shovels Companies - A corollary to the Niche Companies category is a “Picks and Shovels” company. These companies sell products crucial in the operation of another business—a sort of Pillar of Another Company if you will. For example, companies that sell train and air plane parts fall into this category.
Market leaders - These are companies that may operate in a highly competitive industry but reside in a position of market leadership. Companies in this position garner extraordinary pricing power allowing them to profitably sell products at a lower price than competitors. This category, in its purest form, doesn’t represent my favorite, though I will invest in this type of company if it exhibits extremely conservative financials. Pillar of Civilization companies are usually market leaders.
Combination – Most good publicly traded companies exhibit some combination of these listed elements, including the undesirable one described below.
Publicly traded businesses I avoid
Perfect competition – I like to avoid investing in businesses that operate in a highly competitive industry or whose products are not differentiated from their competitors. Price largely determines product demand, not brand or need. Also, many of these companies possess high fixed costs. If the price of their products falls below the break-even point due to some unforeseen circumstances, then these enterprises can loss profitability over a sustained period of time.
A Word on Valuation
It’s a well-known fact in the investment world that price ultimately determines investment return over the long-term. With that said, I typically confine my investments to stocks that trade at a P/E ratio of 30 or less. I will tolerate a P/E ratio above that threshold if the target business is expanding its fundamentals at a brisk and consistent pace.
Risk to this Approach
Any investment approach has inherent risk. Ironically, what makes this approach so practical is also why it exudes risk—Dynamism. Businesses underlying stocks are dynamic and face ever changing challenges and opportunities. Investors who utilize this approach need to take this into account. Pillar of Civilization stocks eventually show cracks, consumers eventually lose interest in specialized niche products, picks and shovels businesses can see the demise of their client industries and market leaders can lose their positions. Thinking for yourself is crucial here. It’s up to you decide if a business has degraded to the point of not being able to significantly add to your wealth over the long-term.
I am not an advisor, always do your own research.