Take What the Market Gives You

At Ahara Advisors, our approach to investing is simple.  We buy and hold good companies for the long term.  

As I’ve written before, just a small minority of companies (~5%) are responsible for all of the profits in the US stock market over the last ~90 years.  One will usually find this basic pattern of a small number of companies being responsible for a disproportionate percentage of shareholder profits across any time period.  So we try to pick “good companies” that we believe will be on this list over the next few decades.  We use the below filters to try identifying these great companies: 

• Net benefit to society

• Great businesses - high ROI’s for customers / sensible unit economics / reinvestment

• Great Management - recognizes salient features that make the business great and continues to reinvest in it 

My own portfolio is heavily weighted to companies that I think bear these characteristics, and has large weightings to well known companies like: Apple, Berkshire Hathaway, Google and Disney.  If you want to buy a basket of these names, it’s easy to do so - one can buy the S&P 500 or any other market capitalization weighted index of US companies and one will have a reasonable weighting to some excellent companies that should drive decent returns over the long run.  In fact, most people and institutions would be better off consistently buying the S&P 500 over a long period of time.

I emphasize the long period of time because it’s an important element to having good results.  There are periods of time when the market is cheap, and other times when it is rich, and if one is consistently buying one will average out at reasonable levels.  However, if one only invested at the richest points in time (say 2007, or 1999) one would have dramatically worse results than the investor who invested consistently and continuously.

Many clients do not have the luxury of waiting though - they have a windfall they want to invest NOW.  Cash is earning 0%.  But equity multiples are high.  But they keep increasing.  Every stock I buy continues to go up.  Elon Musk just tweeted “GameStonks!”  Ahh!  

So what do we do?  We invest in good companies that we think will make us money over the long term, and we try to quantify it a bit. I analyze companies that I own (that I believe fit the good company mold) and try to estimate what their returns are likely to be over the next 5 years.  

For this analysis I wanted to do a few things:

• Take into account that we are at a rich point in time for stocks.  Discount rates are very low (10 year bond around 1.5%), cash yields zero.  PE’s are very high.  Stocks have rallied over 90% since the lows in March.  

• Take into account a reasonable estimate of growth for the companies.  For this, I use consensus estimates from Wall Street analysts.  

• Think about what a normal valuation regime would look like in 5 years time, and price returns based upon that.  To do that, I used 3 different metrics to project forward returns: 

  • an EV = 20x cash flows

  • an EV based on multiples that are at a 10 year low for the company 

  • an EV based on multiples that are at a 10 year average for the company.

My next step is to look at my available capital, and start to buy these positions with the following heuristics:

• I want no company to be over 5% of my net worth at cost.  

• I want to earn at least 10% annualized.

• If two companies screen relatively close together, I will buy more of the one that I am more underweight.

• I will buy over time, not committing more than 1% of my capital to a position per month unless the expected return is getting very high (above 20%).  

• I will not be beholden to this chart - as there are circumstances where I may have a stronger belief in the earnings power of a company than the analysts have.

• For companies I have lower conviction in as being “good companies” - I will not buy as much and will look to not put more than 1% of my net worth into those at cost.