The Alpha of "Best" Ideas, Investing with Only an Hour a Day, and Stocks That Returned 1,000% in 10 Years

Market Talk, Edition 66, January 8th 2023

Jan 8

Once every second Sunday I will curate the most interesting things I have consumed during the previous two weeks. These will be bucketed into 5x must-reads (works I wish to highlight and comment on) and honourable mentions.

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Aaaaand we’re back. It’s been three weeks instead of the typical two since the last edition of Market Talk, but regular programming will now resume. I shared a few thank-yous and comments in a pre-new year update last week, and have a few pieces coming your way this month. My latest memo “Investment Maxims Are Not One-Size-Fits-All” seemed to resonate with a lot of people, as I got more feedback and inbounds than usual. I thank those who reached out.

In other news, I decided to knock off two goals that I had in mind for 2023 early. The first, to quit smoking, is now complete. The second, to start a YouTube channel is now underway. I previously explained that this was not a project related to investing and pertains to my second passion in life; cooking. I find it a fun creative outlet for me, and I value the importance of diversifying those kinds of pursuits. I cook daily but am interested in developing skills related to video-related content, editing and learning about a new platform. It’s a new muscle to flex. I am setting a stretch goal of 1,000 subscribers (currently 138) and 4,000 watch hours (currently 31) by the end of the year. It’s audacious, but falling on a cloud when you aim for space isn’t a terrible outcome. Here’s my worst-performing videos so far, let me know what you think.

Recent Publications: Memos I have shared since the last Market Talk.

• Investment Maxims Are Not One-Size-Fits-All

5x Must Reads

In every edition of Market Talk, I share a number of readings that I have consumed over the past two weeks. Here are 5 that I found particularly enjoyable or insightful. Note, that these articles are not listed in order of perceived value.

To access the suggested article, click the purple link after the source subheading.

1) How to Invest When You Only Have an Hour a Day

Length: Light

Source: (Focused Compounding)

This fairly short essay starts out with an intriguing thought exercise, prompted by an individual asking the duo at Focused Compounding “If one was a widely read value investor but only had 5 to 10hrs per week to spend on investing - what strategy would you recommend under these time constraints?". Geoff Gannon then makes his demands; one hour of uninterrupted time spent on investing each day and formulates his response based on the individual’s willingness to follow those orders. “You don’t have to spend a lot of time on investing. But you do need to be focused when you are doing it. Most people who invest are never fully focused for even an hour on a narrowly defined task.”

He prescribes a focused, concentrated, approach to investing. Spending a lot of time on what matters most; stock selection. You may not completely agree with the prescribed process, but it’s still hearty food for thought. This was the first thing I read after the hiatus of holiday leisure and found it to be a light thought-provoking piece that revived my flow of reading.

“Let’s go back to the ideal. You spend an hour a day – including weekend. You only hold 5 stocks. And you hold each of them for 5 years on average. That’s 365 hours of thinking for just one great idea. This is what I want every value investor to reach for. Come as close to spending one focused hour a day on investing as you can. Come as close to keeping stocks for 5 years as you can. And come as close to owning just 5 stocks as you can. Most investors will fall short of each of these 3 goals. But these should be the goals you’re reaching for.”

2) The Alpha of Best Ideas

Length: Dense

Source: (Harvard Business School)

The gist of this 2020 study surmises that most active fund managers underperform because of diworsification; largely via external or internal influences and institutional pressures. The authors suggest that stocks which have been picked with the most conviction (ie, their best ideas) outperform the market by 2.8% to 4.5%. The vast majority of the others picked, do not. They feel that the organisation of the money management industry makes it “optimal for managers to introduce stocks into their portfolio that are not outperformers” and believe investors would benefit if managers held more concentrated portfolios. Whether you agree with the methodology of the study or not is up to you. I simply thought it was an intriguing read, littered with some qualitative analysis of concentration, that might interest many of you. This one came recommended by my friend

Invesquotes

, so thanks for sharing it.

“We argue that these results present powerful evidence that the typical mutual fund manager can indeed pick stocks. The poor overall performance of mutual fund managers in the past is not due to a lack of stock-picking ability, but rather to institutional factors that encourage them to overdiversify, i.e. pick stocks beyond their best alpha-generating ideas. We point out that these factors may include not only the desire to have a very large fund and therefore collect more fees but also the desire by both managers and investors to minimize a fund’s idiosyncratic volatility: Though of course managers are risk averse, it seems investors may judge funds irrationally by measures such as Sharpe ratio or Morningstar rating. Both of these measures penalize idiosyncratic volatility, a penalty whose benefits in a portfolio context are extremely questionable.”

3) Four Pillars of an Exceptional Investment

Length: Light

Source: (Deep Sail Capital)

Everyone has their own idea about what makes for a great investment. Deep Sail Capital believes it falls down to four pillars; a high-quality business model, outstanding management, substantial long-term growth prospects, and a reasonable valuation. Sounds simple? That’s because it is. The hard part is more often staying true to the course and avoiding the distractions that appear promising despite deviating from one of these four pillars. Like the devil on your shoulder. So what if it’s just slightly under your bar of quality?

“Management seems shady but everything else seems great”

“I am not sure how they are going to reinvest or grow in the future, but I’m sure they’ll figure it out”

“It trades extortionately, but it’s a quality business, so..”

These are all deviations that have the potential to derail an investment; like a metal rod through the spoke of a wooden wheel. Strict adherence to standards may feel constraining, but they limit the pool of potential investments by design. It’s unlikely you are not going to have 100 great ideas in your lifetime, and there is no rush to jump into an investment when you are looking for home runs. The essay itself is fairly concise but walks through each of these themes.

“Assessing management strengths is often a difficult task, as many management teams may "talk the talk" and sound very convincing but lack execution and decisiveness. We like to access management's track record of executing on what they have promised. We do this by reviewing earnings and investor calls for the past few years to determine if the current management has executed on their recent plans. An exceptional management team should reinforce to investors that they are executing at every earnings call. The more you hear the management team speak, the more comfortable you should become with them. If the opposite is true, you should likely reconsider your investment in the company.”

4) 3 Ways to Measure Management Integrity

Length: Light

Source: (Ensemble Capital)

“I look for strong management, who are honest and have integrity”, or some anagram of that sentence is used so often today that it has become banal; like some boilerplate phrase that must be inserted into every investor checklist. How often do people actually think about what that means? The team at Ensemble tackle the task of breaking down how to measure managerial integrity.

It’s one of those qualitative variables that doesn’t appear in SEC filings, isn’t quantifiable in a discounted cash flow model, and possesses a wide margin for error based on the individual’s biases, perspectives, scepticism, and management’s ability (or willingness) to talk without walking. It’s possible to dance on broken glass for some time, but not forever. Eventually, every poor management team is found out. Sadly, it can be too late for some investors by the time that comes to light. Transparency, authenticity, and stewardship are the three pillars that Ensemble believe can help the investor identify quality management teams with integrity.

“Company management has integrity when they consistently act as stewards of our capital and are authentic and transparent. When those factors are combined with an exceptional business, good things tend to happen. Even with an evaluation process for integrity, we will at times be challenged to reconsider our assumptions. Well-intentioned management teams make mistakes that can call their integrity or judgement into question. When those situations occur, we must determine whether we still consider management to be of high integrity that made a poor decision or if our view of their integrity has changed. We can be forgiving about the former, not about the latter.”

5) Marketplace Pulse Year in Review 2022

Length: Moderate

Source: (Marketplace Pulse)

The sentiment surrounding ecommerce has rendered both despair and euphoria over the past few years. While US ecommerce penetration progressed by a decade in 2020, it receded to the trend line come 2022. Onlookers, investors, and even CEOs of the world’s largest ecommerce businesses were assuming that this pull-forward represented a “new normal”.

Despite the shift in narrative, ecommerce spending the in States still surpassed $1 trillion (ttm) by the third quarter of 2022; a milestone that was previously thought to have been reserved for 2024. In fact, if the pandemic were not to occur, that same quarter was projected for $815 billion of ecommerce spend, assuming annualised growth rates of 14.5% (midpoint). This resetting of ecommerce is just one of the themes that Juozas Kaziukenas, author of Marketplace Pulse, covers in this annual review. He does an exemplary job of covering everything ecommerce related, often in bitesize articles. This piece looks back at the most intriguing trends and revelations that have occurred in the industry over the last year, paired with visuals and commentary.

Themes include Chinese e-commerce, Shopify, advertising, social commerce & social media, and a fair bit about Amazon. I think this is a must-read for anyone with ecommerce exposure.

“Social apps are ahead in the commerce race with Amazon. Practically all have launched some version of e-commerce functionality, even if ads still define all of their commerce. Amazon is catching up, but social features are a unique challenge, which, even given Amazon’s excellence in other fields, will be very hard. Social commerce is a competition for attention, and that’s where Amazon will face the biggest hurdle - stealing it from TikTok, YouTube, and Instagram.”

6) Global Outperformers: A Study of Stocks that Returned 1,000% in 10 Years (Bonus Must Read)

Length: Dense AF

Source: (Jenga Inverstment Partners)

I stumbled across this on Twitter during the week. The author, Dede Eyesan also posted a neat thread about it if you just want the TLDR. I haven’t read the entire PDF yet but figured it was interesting enough to share with you all. The goal of the report was to study the best-performing listed companies around the world and seek to understand what factors supported their outperformance. The report dives into factors such as profitability, management influence, technological advancements, geography, growth rates, and so forth.

The study is split into four parts (see below) and is packed with a plethora of case studies and observations.

Factor analysis: Insights into valuations, multiples, and profitability of the 446 outperformers.
Geographical view: A breakdown of the world into 13 economic regions from Australia to the South East Asian Tiger cubs.
Industry view: An analysis of how industries from energy to healthcare performed during the decade. We include over 25+ company case studies like Airports of Thailand in Industrials, Britannia Industries, a consumer staples Indian leader and Lasertec, a Japanese semiconductor 100-bagger.
Ten lessons on outperformers: A summary of everything we learned on global outperformers from the rise of Asia to lessons on turnarounds, cyclical growth and the dangers of thematic investing.

Note: The source will take you to a PDF request page, where you can have a copy emailed to you the same day.

“Global outperformers can not always last forever. Business models which seemed risky to market participants become investor darlings. Sectors in a downturn experience an upturn, and their improved fundamentals become reflected in the price. Geographic regions which seem risky, gloomy and filled with economic problems turn out to be not as bad as market participants thought. These and many more factors make outperformance more difficult after the first few years. The solution is to turn over new rocks, examine new ideas, search for new sectors and industries in downturns with depressed valuations, explore business models the markets are overly pessimistic on, and identify new founders and management sell-side research analysts may have neglected. As we have learned, investing is about the future, not the past.”

Honourable Mentions

• CFA Institute: Aswath Damodaran on Acquisitions: Just Say No

• Consilient Observor: Capital Allocation

• Richard Cook: How complex systems fail

• McKinsey: How incumbents can use M&A to grow new businesses

• Mostly Metrics: M&A Strategies

• Nick Sleep: Thinking about how to think: Short-term vs long-term

• MacroOps: 2022 Performance Review

• Neckar: Phil Stutz's Tools for Life

Net Interest: Insuring the Unknown

• Lewis Enterprise: The Problem with Prudence

• 01Core: 1 billion new people, but no more mouths to feed. Yet another ChatGPT post.

Company Related Write-Ups

• SLT Research (IDXX): Idexx Laboratories write up

• Platformer (TikTok): Why TikTok's future has never been so cloudy

• Alaric’s Picks (SCS:LON) Sofa Carpet Specialist: Not another value trap

• Kingswell: (DIS): Disney's Terrible, Horrible, No Good, Very Bad Year is Finally Over... But What Happens Now?

• Stock Opine: United Rentals Inc: A Leader in the Equipment Rental Space

• From100kto1M (LKQ): LKQ Corporation Deep Dive

• Vestrule (XPEL): Expel, Building an Ecosystem

• Nicoper (MKL): Markel Corporation – Valuation Through Float

• Best Anchor Stocks (STZ): Constellation's Spin-Out of the Lumine Group

• Overlooked Alpha: (MTCH, SIX, SPB, LOVE, SHOP): 5 Stocks Facing A Big 2023

Macro

• JP Morgan: Guide to the Markets Q1 2023

• Baillie Gifford: China’s changing automotive landscape

• Kyla Scanlon: The Fed is Hiking Up That Mountain

• Apricitas: The Most Important New Inflation Indicator

• Last Bear Standing: Spotlight on the Treasury

• Last Bear Standing: The Inside Game

Authors Mentioned

For some reason, Substack’s mention feature is broken and won’t allow the @’s to have other writing on the same line. So I am doing this until it’s fixed. Please be sure to visit the publications of the mentioned writers!

kyla’s Newsletter

Kingswell

Alaric’s Picks (With Some Risks)

Macro Ops Musings

Apricitas Economics

Nicoper’s Notes

Neckar's Minds and Markets

Lewis Enterprises

Vestrule

Net Interest

The Last Bear Standing

Platformer