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How does a stock end up in our portfolio?

February 11, 2020 | Bogumil Baranowski
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I love this question. A prospective client asked me recently, a very simple, yet profound question. How does a stock end up in our portfolios? Whenever I get asked about what we do, my face lights up, and if you only have the time, I can share with you the adventurous journey each of our stock picks took before it ended up among our portfolio holdings. The beauty of our process is how repeatable, and simple it is, yet far from easy to execute.

I like to say that our securities (stocks) are selected based on quality, purchased based on value, and held with the business owner’s mindset.

We have a wish list, and a buy list. Our wish list has at least a 100 publicly traded companies that we would like to own. The buy list are stocks from the wish list that are currently available at compelling prices.

How does a stock end up on a wish list? The list is a product of decades of cumulative research effort of all our team members. To our best abilities, we look at almost every stock that goes public and becomes available to investors. We may never own the majority of thousands of stocks out there, but we know very well, which ones we would like to own, and we do our best to know them well enough to buy them when the opportunity arises.

As you may know from my earlier articles, we have a very clear idea of what kind of businesses we would like to own. They have to have three qualities: they are good businesses with good managements, and with good prospects. A good business is one we believe can earn growing and lasting profits over decades to come. It may already be earning a good amount in profits or in our opinion, itmay have very serious prospects of achieving profitability in the foreseeable future. Profits are the dollars left after all costs are covered.

Without overwhelming our readers too much, we would add that we are also curious how much a business needs to reinvest in growth and maintenance to be able to continue to deliver those growing profits – a transportation company, for example, will need to refresh its aircraft fleet now and then, a manufacturing company may need to upgrade it machines, and a service company may need to update its servers. As long as we think the capital is well used, we are happy.

In other words, a good business is a business that makes money by earning a regular, lasting, and hopefully growing profit.. The business figured out a winning formula where it’s able to offer a good or service to an ever-growing audience, and ideally at ever higher price, and it does so making a profit. The bigger it gets, the better the business becomes. Not every company out there will fit that criteria, but luckily for us enough to do.

Usually, when the business is good, the management and the prospects are equally good. It’s a chicken and egg argument whether a good management makes a business good or the other way round. What we do notice is that a good management can take a good business to a new level. A wise use of capital, long-term thinking, shareholder-friendly leadership can make a good business even better. It may happen that a business looks good in the rearview mirror, while the industry reality is not that promising looking ahead. Maybe they reached what we believe is the market potential, maybe the industry is shifting or the consumer is moving away to competition. For that reason, it pays to see if the prospects are good. Ideally, we like to see an open-ended market opportunity that could let the business grow many times over. There are great opportunities among slow and fast growth companies, the biggest determinant here is the price we pay, which leads us to the second list we keep: the buy list.

How does a stock end up on a buy list? We like to buy stocks that are down, cheap, out-of-favor. Just because we like the business, the management and its prospects, it does not it make an automatic buy. That’s where our fundamental research meets our value discipline. We know what we want to own, and why, now it’s a matter of a price we are willing to pay. It can be very tempting to blindly pay any price for a good business or a great business, but in the investment world, if you overpay for an overly optimistic future, you may lose more than you can afford.

It all comes down to profits, and how much we pay for each dollar of those profits. If profits are growing, we’ll pay more, if they aren’t, we choose to pay less.

We assume that at any given time any stock- or the market for that matter- is fully valued or overvalued. We believe that all well-informed investors with a variety of investment horizons cast their votes with a buy or sell order, and the price gets established. It’s a very efficient stock pricing mechanism. At that point in time, if you want to own a share of, for example, Coca-Cola, that’s the price you will need to pay.

Now, being disciplined value investors, we don’t have to accept the price that the market quotes. We also see no reason to buy a stock just because the price moved up in the last day, week or a year, as a momentum investor would. The price shows how investors are feeling about the business and its prospects, but it may not necessarily show how the business is really doing. In stock investing, fear and greed make the prices oscillate between pessimism and optimism.

We believe that the value of the business should be seen as today’s value of all the profits that a business can deliver from now until its demise. As you can imagine, the majority of those profits will come in the future, and the future as always is uncertain. That only makes the price more volatile over the time.

As value investors we have learned that there are times when the market is wrong about the price of stock, it happens both at the peak of optimism, and at the bottom of pessimism. It’s the latter that creates a buying opportunity for us.

Among the stocks in our wish list, we keep our eyes open for stocks that are down, cheap, out-of-favor. Every good business out there eventually suffers from a wave of pessimism. In many cases, the market might be right again. A good business turns bad, and the market rightly discount it. There are enough times when the market is wrong, and overreacts though. That’s when a good business ends up on our buy list. That’s a stock we not only would like to own, but it becomes a stock we are ready buy at the price offered.

That’s how a stock ends up in our portfolio. First, we do our fundamental research on a business we consider good, then it patiently waits its turn on our wish list, until the time comes when it joins our buy list. We feel confident that we have good odds of making money in such investments not only because we bought the right business, but also because we believe we paid the right price. Good odds are not certainty though, hence, investing never has a dull moment, and keeps us on our toes at all times.

We may never be faster or smarter than any other investor, as a matter of fact, I am continuously impressed with the number of talented investors out there dedicating many hours getting to know all kinds of businesses out there. Our advantage lies in the cumulative research that helped us develop a 100-stock wish list, and most of all, in our patience to buy those businesses at the right prices.

The journey of our stock only begins here, now it will take even more patience to hold on to it through thick and thin, and not sell it at the first gain we see. That’s where we feel we really start to stand out as not only value buyers, but also growth holders.

 

Happy Investing!

Bogumil Baranowski

Published: 2/13/2020

Disclosure:

The information provided in this article represents the opinions of Sicart Associates, LLC (“Sicart”) and is expressed as of the date hereof and is subject to change. Sicart assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by Sicart at any time without notice.

This article is not intended to be a clientspecific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.