What you want. And what you get.

Like many investors, I follow other professional investors through their quarterly letters and public writing. I am sometimes bemused when I read about their investment process, extolling their deep due diligence, focus on cash flow, and companies with incremental investment opportunities. Or something like that. Then I look at their holdings and see a bunch of cash-burning growth stocks, busted SPACs, and what looks like a hodgepodge of random companies. My smug attitude doesn’t last long - as soon as I look at my portfolio, I see a bunch of cash-burning growth stocks, busted SPACs, and a hodgepodge of random companies. I realize that I know almost nothing about where other investors’ cost basis is on their holdings and what the variant perception might be that led them to make an investment that, on the surface, seems not to align with their stated criteria. In fact, a few of my own investments have come from trying to understand why someone may have made an investment that seems contrary to their strategy. Once I dig in and try to understand the reasoning, I learn something that may not be obvious at first glance.

In the simplest terms, what I am trying to do is find investments that fit a few broad criteria:

Good Business Economics: companies exhibiting high returns on capital. Particularly high returns on incremental capital that can be invested in the future.

Good Management: honest, ethical, and capable management to lead the company. Preferable with significant stock ownership to ensure alignment with me, the passive shareholder.

Good Price: a valuation that is sensible based on current or future business earning capacity.

That’s it, really. Everyone probably likes to put their own spin on the categories above. Some lean growthier, some more cash-flow based, but most long-term investors are looking for shades of the same thing. And it seems so simple. But my experience is that finding an investment that hits all three just right - and is in your wheelhouse - is exceedingly rare. One of my investing Yodas - Ian Cassel, tweeted the following:

The longer I invest the more I realize you get 1-2 really great opportunities every few years. The rest of the time is spent wondering if you will ever get another great opportunity again and convincing yourself to own mediocre opportunities while you wait.

-@iancassel

Finding the correct investments requires time, turning over a lot of rocks, and saying “no” quite often. And that’s OK. That’s the gig. But sometimes, in the course of looking for great investments, you find something… else. One of the most common opportunities that I stumble upon are special situations. I used to spend a lot of time specifically looking for special situations. And I think it’s a real skill to focus on that area, and you can add tremendous value. But it was not a full-time endeavor for me. I still find compelling ideas during my regular research process. Assuming that is a good use of cash that would otherwise be idle, I will include it in the portfolio.

Additionally, although the basic investment criteria are easy to understand, there may be times when you want to violate them. Maybe you are an expert in a particular industry, and you find a company with a compelling idea that is pre-revenue. So you buy a little and add as it proves out the product. Or a compelling company with new management, but they are unproven and don’t own much stock yet. I think the times you thoughtfully deviate from your core criteria are as important as blindly following them just for consistency.

What you get in your research may not always be what you are looking for. But it may be profitable. And before you know it, you too will have your own hodgepodge of random companies.

A lovely almost spring day in Stockholm