Why I’m Confident About My Hedgehog Portfolio When The Worst is Yet To Come

IMPORTANT: Please read the disclaimer before continuing.

Back in February 2022, I updated all of you about the progress of the hedgehog portfolio. It was down by 30% and I was not fazed. I was informing you guys that I have been buying stocks selectively. I’m buying stocks that are inflation resilient, with strong balance sheets and huge addressable markets at sensible prices.

Before I share what’s the latest P/L, I hope to provide some insights into my decisions. 

The hedgehog portfolio started as a small experiment to demonstrate the compounding process of wealth using Super Stocks. Nothing more. Along the way, I found it very gratifying for myself because I got to reflect on my thinking process. 

As an investment coach, it’s important that I put myself on the public record and there is accountability. If I’m bad, I show it. If I’m good, I show it. I’ll let the public judge if there is something valuable I can offer to them. Unlike other trainers, I do not post the results of individual trades. I post the results of my entire portfolio instead. It gives a clearer picture.

As you may know, we have experienced several events that created volatility in the market. Supply chain issues, covid resurgence, the surge in oil prices, higher inflation rates, the possibility of higher interest rates, and geopolitics in Europe. There are even talks of recession or stagflation in the next few months. In short, we are facing money tightening. When the money supply drops lower, it will affect the valuations of companies. The road ahead will definitely be bumpy

While being cognizant of these risks, we must not be discouraged or distracted. 

Drivers of Stock Prices

First, we need to understand what drives the stock prices (aka valuations) of companies.

As a recap, there are two factors: Earnings and price multiples.

Earnings refer to how much a company is earning. 

Price multiples refer to how much an investor decides to pay for every dollar of earnings produced by a company. This is often affected by sentiments, interest rates and a wide range of macroeconomic variables. One common price multiple used by investors is the Price-to-Earnings ratio.

To demonstrate how the two factors relate to each other, use the table below: 

Under scenario 1 (normal market), a company earning $10 million of profits with a 20x price multiple will be worth $200 million. 

Under scenario 2 (bear market), the same company is worth $150 million simply because the price multiple compressed from 20x to 15x. It’s still earning the same amount of money. 

Despite earning the same amount of profits, the company is worth lesser to investors. A company can control the earnings factor but it cannot control the price multiple factor.

Is it true that a company cannot grow its valuations during a bear market? The answer is false.

Under scenario 3 (bear market), the same company is now worth $300 million. While still having a low price multiple of 15x, it grew its earnings from $10 million to $20 million.  

In the long run, the growth of profits is able to offset the negative effects of a compressed price multiple. 

This shows that, despite adverse market conditions, it is still possible to make money by buying stocks that are able to grow their profits well. These are called growth companies, or as I termed them, Super Stocks. 

Once again, we cannot predict the market or the price multiples. But we can spend time choosing and analysing businesses that will grow for multiple years ahead. 

This thinking is supported by BCG and Morgan Stanley’s research. It shows:

1. In the short term, price multiple matters a lot.
2. In the long term, revenue growth and margin matter the most.
   

In my previous article, I pulled out top-performing companies from the past 5 years and this is what their performance looks like. I’m using S&P 500 as a benchmark.

Year-to-Date

5-Year Basis

Clearly, these companies either look like thrash or gems depending on our time perspective. Right now, they are going through price multiple compressions as described to you in scenario 2 (bear market). As long as they continue to grow their revenue/profits, it is possible for them to make a strong comeback. 

This shows how misunderstood Super Stocks are because most investors misinterpret their falling share prices as weak company performance. They did not differentiate whether the movements of the share prices are affected by price multiples or earnings. 

This is our advantage because when assets are misunderstood, the prices become cheap for us to buy more shares. If anything, I see the current market conditions as a gift to us. If we practice sensible dollar-cost averaging on great companies, there is a very high possibility that we will be sitting on profits 1 – 2 years from now. 

The Hedgehog Portfolio Updates

One of my positions, Sea Limited, suffered from fundamental deterioration and price multiple compression. The stock corrected significantly. To my best estimates, the valuation of Sea Limited today is undemanding and the risks are probably priced in. 

For the rest of my portfolio, I prefer not to disclose them because I might be accumulating more of their shares. Unlike Sea Limited which has a big market capitalisation, the remaining of my stocks tend to be smaller and the prices may move quickly.

Also, in the event any of you are copying my portfolio fully without performing any due diligence and then end up losing money, you might start blaming me. These days, taking ownership of one’s own decisions in the stock market is rarely seen. 

To evaluate one’s portfolio effectively, a time frame of one year is too short to make any conclusions. A rolling 3-year time frame is better. 

As such, here are my hedgehog portfolio results and screenshots from Interactive Brokers: 

You may have noticed the portfolio recovered somewhat from February 2022. There has been no significant change in my portfolio allocation. The bulk of returns came from the stock market recovery. I will continue to implement my Super Stocks strategy and add on more companies opportunistically. 

My View on Volatility

Once again, I’m in the business of buying good companies. I’m not in the business of timing the market. I acknowledge that my portfolio will face volatility and I’m comfortable with that. I also accept that there will be stocks that I buy today and lose money tomorrow. I’m not concerned about it because I’m playing a long game here. I might not make money tomorrow, next week or next month. 

However, I will likely make money 2 – 3 years from now. I’m removing the element of predicting the direction of the market so that I can focus on company research. 

Wanting to invest without suffering drawdowns is like wanting to drive without encountering red traffic lights. You stop for a while at traffic lights and then just move on. Your compounding stops temporarily, and then it resumes. 

Even Warren Buffett can’t avoid red traffic lights. You’ll eventually reach your destination. 

But if you choose to get out of the car and stop driving, you will not reach your destination. 

Closing Thoughts

Persistent inflation will be around for quite some time, forcing the Federal Reserve to raise interest rates to tame it down. There might be further price multiple compressions in the next few months that will cause share prices to fall further. Some well-known investors are calling for a possible recession. I don’t think the current recovery in the stock market marks the end of the issues we’re facing today. 

While I do not know when a recession is coming, I can prepare my portfolio for a recession. Whether it happens or not is another question altogether.

On a separate note, some of you may have watched Chicken Genius’s recent video where he shared that he’s leaving YouTube because it’s affecting his mental life. I can understand what he is saying.

In the past few months, I’ve received countless Instagram messages from different people judging me based on my recent portfolio performance. Some messages are downright negative.

When the market is down, I do receive negative comments from random people. When I teach people and charge a fee because of the time and resources that go into creating the educational materials, they call me a scam.  

It’s normal. I can empathise with their feelings. They are channeling their fear and frustration onto me. Maybe they had negative experiences with other investing coaches previously. 

When I look at the demographics of those who are making negative comments, most of them are young people who only started investing 1 – 2 years ago. After 2020 when we experienced huge returns on our portfolio, the returns in 2021 and 2022 were not fantastic at all. 

Investors who started in 2021 have no context of the broader long term trends. They allow the short term narratives to drive their actions and emotions. My worst fear is that they give up on investing even before our current situation improves. It would be a great pity. 

I’m here because I want to make a difference. I want to share my reflections, wins, and losses together with you. All of us are working hard together, so let’s support each other through it.

Be less judgemental, and more caring and helpful to one another. We will get through this together.