Portfolio Review – Year End 2023

Another blockbuster year. And I reveal the secret to my investing success.

This Thing Works

This investing thing I do really works. To my delight and surprise, it continues to work year after year. It works passably well in bad times and it works amazingly well in good times.

I started out investing in tiny little micro-cap companies. It worked well for those. I gradually expanded my field of operations into slightly larger small caps. It kept working. I’m now applying the same value investing principles to multi-billion dollar companies. It’s still working.

I tried it out in the Hong Kong market for 10 years. It worked well over there, despite the rampant fraud and corruption. I tested it out in the UK market. Again, it worked well. Recently I’ve been focusing my attention almost entirely on the large and deeply liquid US market. It seems to work great there too.

It works for companies from different sectors of the economy, for companies in different stages of their life cycle and for companies with different growth profiles.

It just works.

Another Notch On The Belt

2023 was one of those years where it worked particularly well. In 2023, my stock portfolio gained a healthy 41.3%. That compares to an annual return of 16.9% for the Russell 2000 index of small cap stocks. I outperformed my benchmark by 24.4% last year.

Looking back over the last 5, 10, 15 and 20 years, the long-term comparisons are also very favourable…

Ebb And Flow

Over any time period longer than 3 years, I’ve beaten the market. But do I outperform always, everywhere and under any circumstance? Sadly, no.

From the beginning of 2018 to the beginning of 2021, I did not outperform the market (although I didn’t underperform either). That’s three years I could have just stuck my money in an index fund. Same goes for the three year stretch from the beginning of 2010 to the beginning of 2013.

In 2007/2008, the market dropped by 53%. My portfolio dropped by 51%. In a 5 week period from February of 2020 to March of 2020, the market dropped 41%. My portfolio dropped 50%.

So over shorter time frames, this thing I do doesn’t always work. When investors are panicking, they sell indiscriminately.

And it doesn’t work for every stock I buy. I buy plenty of stocks that turn out to be duds. My long-term hit rate is only around 60%. Which is to say I lose money on 4 out of every 10 stocks I buy.

As well, the degree to which what I do “works” ebbs and flows over time. Like a bellows or an accordion, my level of outperformance waxes and wanes in periods typically lasting 2 or 3 years at a stretch. I’ll enjoy a strong run for a few years followed by a few years of more moderate returns. Every so often I’ll even trail the index on an annual basis.

I’ve just enjoyed a strong 3 ½ year run from the depths of the covid-induced panic in early 2020. If history is any guide, that suggests that my performance over the next little while could be more pedestrian.

Fooled By Randomness

But the timing of these periods of ebb and flow is irregular. I have no advance knowledge of which years will be good years and which will be less good. I also have no way of knowing in advance which of the stocks I buy will be the winners and which will be the losers.

It’s all a very chaotic and murky process. There’s a temptation to attribute any investing success I’ve enjoyed to simple good luck. Except that my long-term results have been undeniably robust. I think my underlying stock selection process provides a very strong foundation. But it gets easily overwhelmed day to day, quarter to quarter, stock to stock, by the overwhelming randomness of the universe. It’s only when you step back and look at longer term averages that the true merit of this thing I do really shows itself.

“It’s It, What Is It?”

                                   – Faith No More

So what is it, this thing I do? This thing that I say is so great? This thing that has the potential to make a poor man rich, if he (or she) is willing to wait 20 or 30 years?

I buy stocks that are trading for low prices relative to what I think their earnings are likely to be about 5 years down the road. That’s it. Also, the companies can’t carry too much debt. Okay, now that’s really it.

Why doesn’t everyone do that? I don’t know.

“Poor simpleton”, you say. “Clearly, the naïve fool does not understand the complexities of the market. Best to leave this investing thing to the professionals.” I’d be inclined to agree, except that my long-term performance numbers suggest otherwise.

Conceptually, this thing I do is not very difficult. It scares me how easy it is. That’s why, every year that the portfolio notches up another blockbuster performance, I shake my head in disbelief. There are millions of investors out there, managing trillions of dollars of money. Plenty of them call themselves value investors but very, very few of them are able to consistently outperform the market to the degree that I’ve been able to.

Why not? What is it I do that is so unique? At the heart of it there are only two variables that enter into my stock selection equation: The current share price and my estimate of a company’s earnings 5 years down the road. The share price is not open to interpretation. It is what it is. Therefore, it’s only that one piece of information that is at all up for debate.

Could it be that I am much better at predicting the medium-term future than almost every other investor, professional or otherwise, on the planet? That seems really unlikely. Just look at my track record over the past year. During 2023, I sold Skyworks, Designer Brands and Sylvamo. In all three cases, I sold because their earnings did not live up to the expectations I had set for them when I first bought the stock. In other words, my earnings estimates were demonstrably wrong in all three of those cases.

That’s not terribly unusual. If I go back and look back at where actual earnings end up compared to where I expected them to end up, for both the stocks that I’ve bought and the stocks I’ve chosen not to buy, my prognostic acumen would not be winning me any soothsaying medals. I could give the weather man a run for his money.

The Secret Sauce

So what the heck is going on? Why does this thing work so well? I think the secret that sets me apart from the herd of professional analysts and most hobby investors out there is my selectivity. I am really, really picky. I don’t just buy a comfortable selection of moderately undervalued companies, I search and I search and I search until I find the absolute cheapest companies I can find. The very small handful of companies that are trading at such extremely low prices relative to my admittedly unreliable and flawed prediction of their future earnings that, over time, I can’t help but make money, even if my predictions turn out to be garbage.

If I can’t find anything that is cheap enough, and that happens a lot, then I don’t buy anything. I’m patient. I’m disciplined. I’m extremely selective.

That’s my secret.

Full disclosure: I do not own shares in Skyworks, Designer Brands or Sylvamo.