How I think about investment strategy and other pompeous nonsense
Simplicity and common-sense for the long run.
Introduction
Dear readers,
In this article, I will discuss how I think about investment strategy. I started out on an article discussing everything from quality growth investing, how I think about risks, investment edges and how to learn from others. It became an unruly mastodont spanning far to many pages.
I will therefore follow this article up with at least four more articles. This will be sort of a philosophical series. Apologies for putting you in this boring position, as I am no great thinker of investing and probably just repeat what everybody already knows.
But I do enjoy writing about these core principles of investing, and as I mostly write for myself, I want to outline and clarify the why, what, and how of investing for myself. I can only hope that it can provide some value for my readers.
This is the first article in a series on how I think about investing. It will consist of five parts, namely:
How I think about investment strategy and other pompeous nonsense
The case for quality growth
Duality of risk
Accepting uncertainty and great management
Investing is a game
Why do I spend time on “strategy”?
I think one of the more important things we as investors can do is have a clear idea of what our long term goals are, and solid reasoning behind putting our hard earned savings into small pieces of companies. After all, what I am doing is effectively distributing my time into other companies value-creation processes and buying myself pieces of skilled people’s time and effort.
I.e., I am trading my time, effort, and creativity for other people’s time, effort, and creativity.
Time spent should not be taken lightly. When I dipped my toes into the stock-market at the beginning of 2021, I was (as many other people) drawn in by the allure of earning money whilst doing nothing. I had surplus brainspace to learn new things as work slowed down, time was spent at home, and less money and time were spent on socializing.
Over time I have learned a lot, mostly through expensive lessons in the market and helpful individuals smarter and more experienced than myself. Thankfully, I have not had a lot of money to lose, and the tuition I have had to pay to Mr. Market hasn’t really been that high in absolute amounts of cash. Thankfully, I think I am starting to see the fruits borne by this costly education.
What I want to do in this article is to articulate and expose my fundamental strategy for investing. By articulating this, I hope to gain a better clarity of why I am doing what I am doing and how I can achieve these ambitions.
By exposing it to others, I can hopefully gain valuable criticism and feedback, as well as being open and honest to my readers about what it is I am aiming at doing.
I wrote about my motivation for starting this substack in my first post, which originally was in Norwegian but is now translated. It might be worth revisiting.
Some clarifications
Before continuing this discussion, I want to clarify some terms that I believe are integral to the understanding of what a strategy is (and more importantly, is not).
I believe it is important to understand the distinction between a strategy, and a tactic. So let’s briefly outline the difference.
A strategy is the overarching principle that defines and frames decision-making. It should be designed to create clarity of the why and what of things.
A tactic is the concrete action that somebody uses to achieve the goals, and is centered on the how of things.
I always hope to steer away from cliches, but I will allow myself one now, and that is to quote Sun Tzu:
Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.
To translate this to investing as a retail investor: We all have tactics. This can be the common tactic of buying a monthly sum of a global index fund at low fees.
But I am not so sure if we are all either aware of our strategies, or have one at all. Why are we buying this monthly sum of index funds? Is it to enjoy retirement in peace? To act prudent and care about our future?
In this article, I want to steer away from the tactics of my investing, and mostly focus on my strategy. I might not succeed, but now you at least know my motivation for writing this piece: To clarify the overarching intention of my investment process.
I have written two pieces about what I would call tactical decisions and considerations:
Why am I really doing this?
Core goal - To build value that will benefit myself, my close ones, and hopefully also help other people.
My goal for investing started out with an ambition to earn more money for myself. And if I’m being honest, it was also because it was a fun way to pass time as the world was closed and we all sat in our homes. I enjoyed chatting about these stocks on forums and Discords, hyping myself and others up. It was a social activity.
Over time, it has changed. First of all, I’ve grown as a person and have landed a steady job that pays well, and I have bought and moved into a home with a partner I want to build a life with. I have the means to plan for the future, and the motivation to create something for myself and my future family.
In addition to this, I hope that I sometime in the future will have a disposable amount of money that can do more good in the world than simply make life comfortable for myself and my family. Ethically, I am not sure if I am making any sense, as I am sure that Peter Singer would point out that the most good I could do was give as much as possible as soon as possible. However, I believe there are fundamental values in taking care of one’s own front yard, before helping others take care of theirs.
Secondary goal nr. 1 - Learn and develop through the investment process.
The name of this project is “Learning to Grow”. One of my core ideas has always been that I can benefit from my curiosity and motivation to earn more money and develop myself as a person. I want to continue to understand the world and what drives it, and investing is a way of putting myself up for success in this matter. If I am to be able to grow my hard-earned money, I need to put in the time to learn how to do so to the best of my abilities.
Secondary goal nr. 2 - Have fun and live a good and stimulating life.
I believe games to be a good allegory for investing. As I am writing this, I also have an article in my draft-pile titled “Investing is a game,” in which I will go into further detail on the topic. Put shortly: I want to approach investing as an infinite game. By this, I mean that my goal is not to win a set of investing matches and then be finished with investing. I want to play the game of investing in a way that allows me to continue playing it for as long as I am enjoying it.
The reason for including this in my strategy is that my motivation for investing is more than earning money, it is to stay engaged with the world and stay motivated to learn more. To be able to do so, I must find this fun, stimulating and engaging. A core part of my strategy must be to allow myself to have fun, to learn and to create positive value for myself outside of the monetary side.
How should I go about achieving this?
Now that you are familiar with my goals, how do I aim at achieving these rather lofty goals?
In this part of the article, I want to write about three things:
Core values
Core ideas
Edge
In my very first article, I discussed two key topics relating to my tactics as an investor.
Keep it simple, stupid. Simplicity and common sense are integral for how I want to maneuver in the investing world.
Fundamental investment pillars: A track record of excellent growth in EPS, great return on invested capital combined with the opportunity to reinvest over a long period of time, no or low debt, aligned and skilled management and competitive advantages.
You can read more about it here:
Core values
I believe values to be important for any strategy. It is the why of things. I want to start with the why, before we turn our attention to the how. Broadly, I have five core values that are going to guide my work as an investor and as a writer:
Simplicity
As individual investors, we all want to be smarter than the next person. If not, we would just invest in the index. This often leads investors into trying to find things that are smart and sound smart. I want to avoid overthinking and overcomplicating things. Simplicity, or as I have put it before: Keep it simple, stupid, is something that I place great value on. The goal is to remind myself not to think too highly of myself and my abilities, and to avoid mistakes of overconfidence. I hope this will spare me of a lot of future troubles.
This piece by
is wonderful for a discussion on the value of simplicity that I recommend to everyone.Common-sense
Charlie Munger was the great champion of common sense. I believe there is a treasure trove of investing wisdom in good old common sense. I will try to exhibit and develop a keen sense of worldly wisdom.
Humility
As with simplicity, I think that humility is a key value to growing as an individual, and an investor. It is a value that hopefully will shield me from not learning the lessons that I am handed, that I listen to and join the discussion on topics that I need to learn about, and that I avoid taking unnecessary risks because I think I can handle the risks due to my smarts.
Non-dogmatism
This is aligned with humility. Dogma is the killer of curiousity and learning. Staying non-dogmatic will allow me to change course and adapt when I learn new lessons. Staying wrong is worse than being wrong.
Curiousity
The road goes ever on and on, and we never know what is around the next turn. Wanting to learn what is around the bend of the turn, staying interested in new events and information, and trying to expand my understanding of the world is essential to staying interested and engaged in the world. This is key to being a good investor, in my opinion.
A common-sensical and ambitious goal
As recently mentioned, my goal is to compound my disposable income at a level that will allow me to contribute meaningfully to my close ones and hopefully also the world in large.
I also invest because I enjoy investing. My goal is to stay invested in great companies that show the ability to reinvest at great returns over long periods of time so that I can reap the benefits of compounding.
I believe a key goal to be able to compound both money and learnings, is to set common-sensical goals.
My goal for returns are to be able to compound my wealth at a 11-15% range over decades. My hurdle rate for investing in a company is that I believe it can realistically return 12% per annum.
Depending on who you are and how you like to invest, this might sound either very weak or very ambitious. The historical returns of index funds have been somewhere around 8-10% depending on the time and market context. If I beat that by 2% a year, I will do very well for myself.
Core ideas
How do I want to go about achieving my goal of compounding knowledge and wealth at above-average returns? Let me continue into the fundamental ideas of what I aim to focus on to achieve my goals.
I have the simplest of tastes: I only like the best.
- Oscar Wilde
This remark from Oscar Wilde is something that Francois Rochon often quotes in his investment letters. I share this sentiment. I have a strong belief that there is simply no reason one should invest in anything but the very best companies.
I have a two-pronged strategy aimed at delivering returns over different parts of the market cycles, and running down separate tracks to achieve my return goal.
My investment baskets
I have two baskets of investments:
Large-cap companies, run by stellar management and that are exhibiting a world-class track record with (almost) undisruptable products.
Nordic small-cap companies carving out their growth in niches, run by stellar and aligned management with frugal goals and a great track record.
For all of my companies, I expect them to be quality growth companies. By that, I mean these are companies that exhibit quality traits such as being the best in their sector and who have great track records of growth with a predictable and replicable reinvestment runway.
Why these two baskets? Let me elaborate:
In regards to the first basket of quality growth, I believe there is plenty of edge to find for patient investors willing to align themselves with companies growing at a double-digit rate over extended periods of time.
I want this basket to be composed of companies that are less susceptible to the general market cycles and that are able to generate growth across the highs and lows of the macrotrends. I am a bit more short-spoken about this category, as I am currently working on an independent article on the topic of quality growth companies.
In regards to the second basket, I want to capture the small cap factor with a twist. Nordic small caps have been a fortunate place to be for investors, with shares in this space outperforming most indexes. Here’s a crude and quick comparison of the Swedish fund run by Spiltan Investment focusing on Swedish small cap companies vs the Nasdaq (in yellow):
As discussed in this Investopedia-article, small cap companies tend to have shown a higher return on investments made. But they also exhibit several core risks:
Less transparancy
More volatility
Tougher competition
I try to work around this with my second basket by investing in Nordic small caps. Nordic companies are often easier to trust with a high level of transparency; this should allow us to alleviate the risks of transparency and uncertainty. Volatility is bound to happen. This should create opportunity, and combined with my first basket of safe and sound tortoise companies, I believe I will be able to weather the mental storms of volatility.
Competition is hard to predict. Thats why I prefer my small cap basket to consist of niche players. Big fishes in small ponds have less competition to worry about. I also want to see that my companies have won battles before, and I believe all my small cap companies have shown their provess in battle throughout history. I think by looking to the north for small-cap investments, I can hitch a ride with great companies and enjoy the returns from these companies carving out their spot in profitable and predictable niches.
For both baskets, I focus on the fundamental pillars of high return on invested capital (with a focus on future returns on invested capital), great history of earnings growth, aligned management (in the small-cap basket, I am especially focused on invested management), low or no debt, and niche positioning.
A quick pit-stop for some previous tactical discussion
Within these baskets, I also have three main themes that I discussed in detail in an earlier article published. This article also touches on how I view portfolio construction.
In addition to the above article discussing my portfolio, I wrote about my thinking on risk and concentration in this article:
What I want to avoid
High fliers: Companies with the spotlight shining brightly on them are often mired in high expectations, investors expecting revolutionary results and multiples that have already paid for many years of growth.
Fast growth: I am not a good growth investor. I do not like it. I feel the fear of heights looking at stock prices. Also, I believe in gravity: No company can maintain decades of high growth, why should I believe in my ability to time the slowdown?
Pre-revenue: I do not want to be invested in companies that do not earn money today. If my ownings don’t generate earnings or high returns on invested capital, my investments will not yield any returns on invested capital. I am not doing this to fund hopes and dreams
Management who is unaligned or dishonest: If I want to be scammed, I’d play the lottery. If I wanted to own companies with people working for them not for the company but for stock based compensation, then I would be better off donating to charitable causes that are bound to do something good for the world.
Debt: Companies who do not control their own destinies are bound to make bad decisions at bad times. Debt is a weight and pressure on companies, and reduces the room for errors that management has. I want my companies to have the elbow-space to navigate tough times.
Exposure to macro and cyclical earnings: I do not invest in companies that don’t have any power over their demand and cycles and that are mostly dependent on the mood swings of the economy. I want low volatility in my companies’ earnings.
Some reflections on macro
The Economy. A dreaded or loved partner in the investing world. We all have to deal with how macro trends ebb and flow, and there is no avoiding that how the macro conditions develop will affect our companies. Interest rates, quantitative tightening or easing, and geopolitical unrest or straight-out war will have real effects on any company in the world. I want to invest in companies that can shrug these effects off as best as possible.
I spend absolutely zero time assessing macro conditions. It’s not for me. I am sure many people are able to earn money investing in uranium, macro-cyclical stocks that will get positive effects from something happening, or other trades where analysis starts from the top and moves down.
My thinking is that stable winners who have shown throughout their history that they have the ability to adapt and absorb in the face of crises are bound to come out stronger from macro-challenges.
As the former CEO of Intel, Andy Grove, put it:
Bad companies are destroyed by crisis. Good companies survive them. Great companies are improved by them.
How I can act differently than everyone else
As Howard Marks has remarked in several essays, books and talks: To get a different result than the average (i.e. the index), you must differ from everyone else. This is what we call an edge. I want to be able to spot potential edges in my investment cases. I want to outline three edges I believe individual investors can have and that we should look for:
Edge no. 1: Differing view on a company’s predicament. By this, I mean that I disagree with the market’s reaction to short-term problems in quality companies.
Edge no. 2: Differing time horizon. By this I mean that I believe I have a better understanding or patience in regards to the companies long term ability to invest in growth at high returns.
Edge nr. 3: Avoiding comparisons. I define my own ambitions and results. My goal is to achieve an annualised return on my investments in the range of 12-15% over several years (5-10). I do not need to beat any index every year. I would not be sad if the Nasdaq grew at a CAGR of 20% for the next two years while my investment “only” returned 12%.
Sources of inspiration
I do not pretend to think that I am original in my approach to investing. I do not think I need to be either. My goal is to learn from the very best so that I can adapt and adopt the practices that made legends. Here is a list of core sources of inspiration that I have learned from and that have shaped my strategic investment thinking, ranked in no particular order:
Francois Rochon - For his rational and fundamental approach to high quality investing.
Pulak Prasad - For his discipline, humility and common-sensical approach to investing.
Charlie Munger and Warren Buffett - What has been said about the legendary duo? They have paved the way and laid the foundation for thinking about investing that have shaped almost all of the best investors out there
Howard Marks - Nobody puts it quite as well, or slices through noise with as much clarity as Howard Marks. I absolutely love his writings and talks on the most important lessons in the markets.
Many independent writers and investors, primarily The Compounding Tortoise, Arne Ulland and the many skilled folks from the StockUp community. I learn new things from people who share their learnings, time and passion everyday through dialogue and discussion. Thank you!
And many more!