Here’s Three Tips For You To Become Better At Picking Great Stocks
IMPORTANT: Please read the disclaimer before continuing.
As an investor, I like to surround myself with good reading materials. They expand the horizons of my mind, serve as good reminders, and teach me how to become a better investor.
One of my favourite materials to consume is the student-led investment newsletter of Columbia Business School, called Graham & Doddsville.
The Spring 2022 edition features Christopher Lin, an investment manager running Fidelity OTC Fund. It has a 10-year track record of 17.8% – despite the drawdown this year! His fund is one of Fidelity’s best mutual funds for 2022.
Photo source: https://www.investors.com/
Christopher Lin (pictured above) comes from the lineage of Peter Lynch and his mentors include Joel Tillinghast, Larry Rakers, Victor Thay, and Sonu Kalra.
I’m featuring him in this week’s article.
If I had to list out three things Christopher Lin excels in, they are:
- Playing the Devil’s Advocate
- Buying Durable Businesses At Fair Prices
- Understanding Macroeconomics, But Focusing on Companies
I’ll elaborate.
Playing the Devil’s Advocate
In a normal situation, nobody likes to be questioned on their investment thesis. With this in mind, investors avoid quizzing each other and, instead, form a herd mentality by agreeing with each other to be socially accepted in a group setting.
We’re psychologically engineered to agree with one another.
When it comes to stocks and money, Christopher Lin thinks differently.
When there is a lot of agreement by a group, he will push hard in the opposite direction to test the soundness of the group’s thesis. He will be a devil’s advocate. He will attempt to poke holes and destroy a thesis.
Charlie Munger once said, “Any year that you don’t destroy one of your best-loved ideas is probably a wasted year.”
An individual investor tends to focus on the best-case scenarios. This could turn out to be wishful thinking that doesn’t account for any margin of safety. Blind spots are also not covered.
In my team, we have a rule where if everyone agrees, the last person must disagree and talk about the potential risks/downsides. Even with this arrangement, we are still vulnerable to mistakes. But this lowers our chances of making an error.
Case in point – in late 2018, we spotted a company called Stamps.com. It was listed on NASDAQ as STMP.
The company displayed strong revenue, profit growth, and return on equity. While it seemed good, what underpinned the business was its exclusive deal to sell postage for the U.S. Postal Service. Should either party terminate this deal, Stamps.com would lose the bulk of its profits. While the risk is low, the impact is fatal. One of our team members pushed against this idea.
True enough, the exclusive partnership was called off and the stock sank by 60%.
Thanks to this team member, we dodged the bullet.
I would encourage all of us to have someone who can act as our sounding board. Someone who is comfortable sharing with us what we do not like to hear, but MUST listen to. This will make us a better investor in the long run.
Buying Durable Businesses At Fair Prices
A durable business is one that sets itself apart from other competitors. It’s a business selling valuable products/services that customers are willing to pay for. In most cases, there are few or close to zero competitors.
But a durable business is made up of many interlocking parts. It cannot be distilled down into simple formulas or checklists. A durable business could have strong brands, low costs, and loyal customers.
Christopher Lin defines durable businesses differently.
In his words, a durable business provides foundational infrastructure. For example, in the United States, Warren Buffett bought BNSF Railway. It’s a company that built over 32,000 miles of railroads. Many customers rely on BNSF to move goods around. It would be nearly impossible for a new competitor to build such a massive network of railroads.
BNSF is an infrastructure player.
The same goes for a water utility, electricity utility, or telecommunications company. Once they have invested and laid out the grids, it is hard for them to be displaced.
In India, Reliance Jio is the largest mobile network operator. They have the majority of the broadband spectrums as well. As broadband spectrums are not regularly made available by the government, Reliance Jio is nearly impossible to replace.
Businesses like BNSF and Reliance Jio will enjoy growth through the rise in population and their ability to raise prices.
In short, it’s hard to remove infrastructure businesses.
Aside from physical infrastructure businesses, what about internet infrastructure businesses?
Hyperscalers like Amazon Web Services (Amazon), Azure (Microsoft), and Google Cloud (Alphabet) are like the digital landlords where software applications are being hosted, designed around, and relied upon. With sensitive data held by these providers, companies would not risk switching to other competitors – even with price discounts.
This is because as a company, you don’t want to be risking data integrity.
Some of us may have heard about this company called Nvidia. It is a technology company that produces some of the world’s most advanced semiconductors.
Christopher Lin mentioned Nvidia because “AI and machine learning are going to be meaningful in terms of computational technology and computer science.”
Think about it. Semiconductors are foundational to modern society. There is no Internet/software/Netflix/cryptocurrencies without semiconductors.
I would argue that Nvidia is also another infrastructure type of company. Without its chip, the future of self-driving cars and metaverse would be pushed back probably a decade later. Nvidia’s graphic processing units (GPUs) are essential to Amazon’s, Microsoft’s, and Alphabet’s data centres.
When I think about these durable businesses, they provide steady growth that lasts longer. It’s better than heady growth that proves to be short-lived. I will be taking his approach very seriously because we live in a world filled with disruptions while infrastructure businesses provide certainty.
Boring businesses are good because this means we can predict consistent and steady cash flow.
The final step is buying them at fair prices. When overpaid, a good investment does not give good returns.
Understanding Macroeconomics, But Focusing on Companies
No investor can be a good investor by ignoring macroeconomics. For example, we saw how tightening monetary policies caused growth stocks to fall. We saw how concerns around the economy and inflation caused major indices to sell off too.
Throughout his career, Christopher does not time the market. Instead, he allows time to grow his assets over time. He is aware of macroeconomics but it does not determine how he makes decisions. It’s not his main input. He has opinions on macroeconomics but at the same time, macroeconomics cannot be the thesis.
I’m interpreting it as such – if we buy a durable business, it should be able to withstand shocks in the economy. It should be able to take advantage of weaker competitors and capture more market share. As Andy Grove once said, “Bad companies are destroyed by crisis, Good companies survive them, Great companies are improved by them.”
In the long run, it is the performance of companies that delivers the results, not reading macroeconomic news.
Perhaps macroeconomics can tell you whether you should hold more cash, buy more stocks or whatever. But it cannot be the thesis of why you own certain companies. The thesis has to be a secular tailwind, a great industry, competent management, an attractive business model or whatnot.
Summary
Investing is all about assessing businesses accurately. We cannot do this alone. We can do this when we learn from others, ask for help, and be open to feedback. This is how I have found my own success in investing and I believe others can do it as well.
Before I end, here are some quick thoughts about the state of the stock market:
In this year alone, many investors are shell-shocked by the length and depth of this correction. This is unlike March 2020’s drawdown where the drop and recovery happened within months of each other.
We are almost 6 months into this correction with no end in sight.
In my previous article, I shared that history has shown us bull markets are more frequent than bear markets. In times like this, we should be accumulating stocks, not selling them.
I’m most afraid that newer investors who do not have the correct mindset may sell their stocks at low prices due to emotional reasons. If you are feeling confused and anxious about your portfolio, you can always reach out to me.
On my end, I’m not in the business of speculating when the recovery will come. I don’t wait for S&P 500 or NASDAQ to drop to certain levels before buying my stocks. I buy my stocks when they are undervalued and make sure that I account for a sufficient margin of safety. My goal is not to bottom tick a stock. It requires more luck than actual investment skills to do that.
My portfolio has formed higher highs and higher lows despite going through painful drawdowns. I believe that it is at its higher lows right now and it’s time to accumulate more stocks so that when the recovery comes, my returns are magnified.
I believe in better days for everyone.
Stay safe and happy investing.