Introduction to Level-Headed Investing
My investment philosophy, inspired by legendary investors
Hello, world
Welcome to my corner of the web! My name is Bernardo. I’ve been working in tech for two decades, and over the past few years, I’ve developed a growing passion for investing. As an individual investor, I invest my own money, guided by the principles of value investing.
In this space, I intend to share my research on individual businesses, my investment choices, the mistakes I make along the way, and the lessons I learn.
I’ll be posting about the valuable insights shared by legendary investors like Warren Buffett and Peter Lynch, and how I attempt to apply their enduring principles in my own investing journey. My hope is that you’ll find these reflections useful in your own investing journey.
If you’re new to finance or investing, you might be asking yourself, “What is investing?” There are numerous definitions, but the one I refer to was laid out in the 1940s by the father of value investing, Benjamin Graham, in The Intelligent Investor, a cornerstone of value investing and one of my favorite books:
“An investment operation is one which, upon thorough analysis promises safety of principal [the amount of money initially invested] and an adequate return. Operations not meeting these requirements are speculative.”
I’m fascinated by the intersection of psychology and investing, particularly the cognitive biases that can influence our decisions. I plan on writing about these topics as well. I strive to maintain a level-headed approach to investing, rooted in facts and analysis, especially during times of market folly. Benjamin Graham has much to say about being rational while investing:
“[…] while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street [referring to the stock market] it almost invariably leads to disaster.”
“The intelligent investor realizes that stocks become more risky, not less, as their prices rise - and less risky, not more, as their prices fall. The intelligent investor dreads a bull market, since it makes stocks more costly to buy. And conversely (so long as you keep enough cash on hand to meet your spending needs), you should welcome a bear market, since it puts stocks back on sale.”
The lessons I’ve learned from investment thinkers such as Benjamin Graham and Charlie Munger have had a profound impact on me, both personally and as an investor. I am immensely grateful to them for sharing their decades of experience and wisdom!
Investment philosophy
I invest in businesses listed on public stock markets, following a concentrated approach that adheres as closely as possible to the sound principles of value investing. My process involves bottom-up analysis to identify great companies, run by talented managers, with ample growth prospects ahead of them, while paying what I believe to be attractive prices.
When I buy a stock, I see it as partial ownership of a productive business. As Jason Zweig, personal finance columnist and editor of the revised edition of The Intelligent Investor, aptly puts it:
“A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.”
I intend to buy and hold great business over the long term. Mr. Zweig also wrote in the commentary to The Intelligent Investor:
“[…] the term long-term investor is redundant. A long-term investor is the only kind of investor there is. Someone who can’t hold on to stocks for more than a few months at a time is doomed to end up not as a victor but as a victim.”
There’s a common belief in the investment world that concentrating into a few businesses is risky. I firmly believe that with fewer holdings, I can be more focused in my analysis, given the time at my disposal. The late Charlie Munger, vice chairman of Berkshire Hathaway and a lifelong business partner of Warren Buffett, once said:
“We’re partial to putting out large amounts of money where we won’t have to make another decision.”
Management
The great companies I buy are run by talented managers who operate with integrity and have a track record of making good capital allocation decisions, leading to sustained growth over the years.
Terry Smith, a charismatic investor, CEO and portfolio manager of Fundsmith, a UK-based mutual fund inspired me to use Return on Capital Employed (ROCE) to measure the return on capital allocation by management. I often use Return on Invested Capital (ROIC) for companies operating in certain industries. I will explore these metrics further in future writings.
The top executives of the businesses I invest in typically have skin in the game, with their own money invested in the enterprises they run. They walk the talk by delivering on what they promise in annual reports and during earnings calls.
I have a slight preference for investing in companies that are founder-led, where the founder is involved in day-to-day operations or provides oversight through a seat on the Board of Directors, typically as the Chairperson. When the CEO is not a founder, I prefer companies where the top executive has been with the company for many years, rising through the ranks.
In summary, I seek CEOs who have an in-depth knowledge of the companies they run, are skilled at allocating capital with high returns over the long term, and whose personal interests are aligned with those of the company’s shareholders.
Growth prospect
I try to identify companies that have a widening moat (competitive advantage) in the industry where they operate. The main characteristics I look for are:
Companies that have ample room to reinvest their earnings internally with high returns.
Companies with sustained earnings growth over the years and high conversation of Net Income (earnings) to Free Cash Flow.
Companies with operating leverage demonstrated by expanding operating and profit margins over time while growing top-line revenue.
Companies that operate in sectors with secular trends.
I will return to these topics in future writings when I discuss my investment thesis on the businesses I own.
Attractive price
I buy companies that I believe are undervalued, when their market price is below my estimate of their intrinsic value. As Mr. Graham said:
“[…] a common stock may be undervalued because of lack of interest or unjustified popular prejudice.”
Sometimes, stocks of small companies are not well-known to the general public and are not covered by financial analysts and market commentators. They may trade at low multiples to earnings, providing an opportunity for level-headed investors to buy great businesses at a discount before their potential is widely recognized. On price, Mr. Graham also noted:
“For 99 issues [stocks] out of 100 we could say that at some price they are cheap enough to buy and at some other price they would be so dear that they should be sold. The habit of relating what is paid to what is being offered is an invaluable trait in investment.”
Like many accomplished investors with long track records, I believe the value of a business is the sum of all future cash flows that the business will generate, discounted back to the present at a reasonable rate.
Market volatility
There are times, especially in the short run, when fear and uncertainty take over and investors rush to sell sound businesses, driving their prices down and creating opportunities for rational investors. The opposite is also true: during periods of euphoria and greed, investors may rush to buy stocks without regard for price, pushing prices to unattractive levels and widening the gap between a business’s intrinsic value and its stock price, making sound businesses uninvestable. This market dynamic is concisely illustrated by Mr. Graham:
“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.”
Benjamin Graham reminds us that over the long term, the gap between a stock’s price and the value of the underlying business will narrow. He puts it candidly:
“Stocks do well or poorly in the future because the businesses behind them do well or poorly - nothing more, and nothing less.”
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
Margin of Safety
I buy businesses with a margin of safety, selling at a Free Cash Flow yield above the risk-free yield paid by the US Government on 10-year Treasury Bonds, sometimes referred to as the FCF Premium. In other words, I demand compensation for the risk I’m taking by owning a stake in a business versus the risk-free interest (bond coupon) I would otherwise collect by owning a T-Bond.
There are times when I accept the trade-off of paying above the risk-free interest for what I believe to be wonderful companies with enduring moats, run by exceptional operators, and with remarkably consistent high margins. This approach aligns with the wisdom of two legendary investors who greatly influence me, Charlie Munger and Warren Buffett. As Mr. Buffett famously said:
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Buy and hold
What happens when I identify great businesses and buy them at attractive valuations?
Firstly, I shut down emotional impulses, not letting them get the best of me when stock prices fluctuate. I then review the companies’ progress over time to assess if my initial thesis has changed, regardless of the stock price. If there are no fundamental changes in the business and it stays the course, I hold onto the stock and let compounding work its magic. Investopedia’s definition of compounding is spot on:
“Compounding is the process in which an asset’s earnings, from capital gains are reinvested to generate additional earnings over time. This growth, calculated using exponential functions, occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods.”
In his wisdom, Charlie Munger once said something that has stuck with me:
“The big money is not in the buying or the selling, but in the waiting.”
My goal
My objective is to reach financial independence by 2038, while continuously learning and improving as an investor and in other areas of my life. Above all, I aim to enjoy the process. My target is a minimum 10% Compound Annual Growth Rate (CAGR) in my portfolio.
This platform serves to document the investment decisions I have made in recent times and the steps I will take in the future. There is a long way to go and much to learn. I hope you will join me on this journey.
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Disclaimer: I am not a professional investor and do not offer financial services. Nothing on this blog constitutes investment advice. The content here reflects my personal opinions only. The information provided is not intended as advice to buy or sell any securities or investment products. Results are not guaranteed. You are solely responsible for the decisions you make regarding your investments. Ensure that your portfolio and investments align with your specific income, risk tolerance, and timeline.