2019 Performance Review

In 2019, my portfolio returned 11.59%* and the S&P 500 index returned 31.49%.

Underperformance relative to the index was driven by: a relatively concentrated portfolio (7 holdings, on average); poor short-term performance of a few key stocks, detailed below; and substantial cash holdings that ended the year at 57%.

Personal Performance vs. S&P 500 Index (with dividends reinvested)

Year Personal S&P 500
2018 30.36 (4.38)
2019 11.59 31.49
Compounded Annual Gain 2018 - 2019 20.61% 12.13%

General Reflections

Although I underperformed the index this year, I am relatively satisfied with the past two years. I don't expect to beat the index every year, and try not to worry about short term fluctuations - I can honestly say that I wasn't overly excited by my investment performance in 2018, nor am I unduly discouraged by 2019. In terms of value and potential for long-term returns, I actually felt much better about my portfolio of businesses in 2019 than in 2018, despite poorer nominal performance in the stock market.

More importantly, I feel like I've developed a good process going forward, one that I am comfortable with both quantitatively, psychologically and philosophically. I've remained focused on process vs outcome, learning as much as I can from others, and incorporating that knowledge with an approach that makes sense based on personal business experience.

The biggest evolution in my strategic thinking has revolved around personally appropriate levels of diversification, given unknown unknowns. Although I respect Warren Buffet's approach to extreme concentration (he frequently had 80%+ of his portfolio in 3-5 stocks), and note that his best returns came in years where he was heavily concentrated in stocks like Coke and American Express, I don't think it's the right approach for me.

I believe irresolvable uncertainty is greater than most people think, even in one's "highest conviction" bets. Of course, this is entirely subjective, but it aligns with all of my business, investing and general life experiences so far. That I was able to learn this lesson without catastrophic failure from excessive concentration was fortunate.

I also became more comfortable with valuing companies, and have learned much from a variety of sources. Here are some highlights:

  • Professor Aswath Damodaran was the biggest influence, both with his excellent book Narrative and Numbers, and with his excellent valuation class available online.
  • Damodaran's blog has also been an excellent resource for learning about valuation and business
  • Superforecasting: The Art and Science of Prediction and Michael Mauboussin's Base Rate Book have greatly influenced my thinking by helping me to factor in the "outside view"
  • Although I've read it before, it was worthwhile to re-read The Intelligent Investor by Benjamin Graham. In terms of human psychology (and Mr. Market in particular), it's illuminating to see how little things have changed.
  • Financial Shenanigans was a good overview of the malleability of corporate earnings and the general dishonesty of corporate management. Given the ease with which managers can manipulate earnings, and a general unhealthy obsession with optics rather than underlying health, I think it is even more important to try to find companies that resist the "institutional imperative", and which align management incentives with shareholder interests.

Patience

The theme of 2019 was "patience." During 2019, I did valuations for 86 different companies, but only made a handful of new purchases. Most valuations were cursory and didn't survive simple, common sense definitions of "fairly valued"; other opportunities were researched in greater detail, but for the most part seemed fairly valued or overvalued. I've had to constantly fight the natural impulse to "just do something." Fortunately, the surf has been pretty good all year, so it's been easy to find distractions 🙂.

Of the companies I examined, the median price was 130% of fair value. I have no idea if this means that the market is, in general, overvalued or if I am simply being too conservative in my projections. But at the end of the day, it doesn't change my strategy - I'm going to continue researching and valuing individual companies, one by one, on a conservative and common sense basis, until I can assemble a portfolio of 15-20 good businesses that I can buy with a sufficient margin of safety. This is the playbook that has worked for a generation of legendary investors - I don't need to reinvent the business model.

If it takes a few years to be fully invested, even with the drag on performance from cash holdings in the meantime, that's perfectly acceptable. What's important to me is sticking to a strategy and process that I believe in, so that I can generate repeatable results based on skill rather than luck or speculation.

Goals

In the spirit of the new decade, I have a few new goals going forward:

  • Instead of merely beating the S&P 500 index, my goal now is to beat it by at least 10% on an annualized basis, over the long term. This was Warren Buffet's goal with his original partnership, which he handily beat. This may prove to be too optimistic - it will be tough without his high degree of concentration, and if my cash holdings remain substantial. But if I'm going to have a goal, it may as well be a lofty one.
  • Continue to be disciplined in making investments. Don't compromise my process or investment strategy out of fear of "missing a rally", especially when the prevailing investment sentiment is "buy almost anything." Don't worry about holding cash if no opportunities present themselves.
  • Stick to diversification / risk guidelines, with a long-term target of 15-20 total portfolio holdings.
  • Spend less time reading political and financial news, especially articles about "general" market conditions or predictions. Focus more on "deep reading" for individual companies (10K's, earnings call transcripts, etc) and businesses in general (books, investigative articles, quality periodicals).
  • Publish more "valuation" blog posts on individual companies, even if they aren't "perfect", which will help refine and organize my thinking

Holdings

Here is a summary of current holdings, holdings I exited, and random notes if applicable. This section is somewhat disorganized and brief, but I wanted to capture my current thoughts somewhere, even if drastically simplified.

Current Holdings

  • ANET - Short term fears (Facebook delaying data center spend; concentration in cloud hyperscalers) depressing a "franchise" business with an excellent management team and quality organic growth, in an industry with a long runway.
  • NOK - Key lesson here: don't trust investor relations for anything beyond verifiable facts and clarifications. Asked them specifically about Intel 10nm / ReefShark, and they explicitly denied there were any issues: ("...we do not see ReefShark as a key factor driving our 2019 expectations"). Three quarters later: Surprise! It actually appears to be a fundamental issue impacting their cost competitiveness, the stock declines nearly 30%, and investor relations goes completely dark. While the company still seems significantly undervalued, keeping a close eye on this one - based on quantifiable facts, not representations from employees with clear conflicts of interest.
  • BKNG - Going to be hard for other online travel agencies to compete with BKNG's economies of scale and marketing efficiency. Wish their disclosures on revenue by geography were more transparent - but my sense is that they have a lot of runway left in Latin America and Southeast Asia, where, based on AppAnnie stats, they are dominating the local players. Personal opinion is that the greatest threat to their dominance is likely to come from Chinese companies (i.e. Ctrip), not Expedia, which has been historically mismanaged.
  • BIDU - Poor performance in 2019, but favorable long term prospects and a reliable cash cow in their search business, which, despite repeated predictions of its demise, seems to be doing fine.
  • CS - Many scandals recently, but hard to see how this affects the long term growth of their wealth management business. Need to do a little more research here, as I suspect the growth of the "wealth management" business may be based largely on grey area factors, especially in emerging markets, that are unsustainable long term.
  • LUV - Interesting company that is likely undervalued if you believe they can maintain share in an industry (US air travel) that will grow modestly faster than GDP over the next 20 years. Issues with 737 Max are causing short term headwinds, but are likely temporary. The fact that they have been able to grow without making their fares available to 3rd party online distributors (Google, Expedia, Priceline, etc) is remarkable, and evidence of a wide moat; this is pretty much what every travel supplier dreams of, but lacks the power to execute on.
  • IRBT - Recent purchase, might do a more detailed post about this company in the future. They are competing in an increasingly commodified industry (robotic vaccums), and lack pricing power; but seem well-managed, generate plenty of cash, have strong organic growth, and have an emphasis on R&D for long term competitive advantage. Even if they aren't as dominant in the future, they are unlikely to disappear; worst case, they get acquired by Google or a more traditional consumer electronics company. Current stock price only seems to make sense if you believe they have already entered terminal decline.
  • WFC
  • FCAU
  • CTSH
  • Cash (57% of current holdings) - See above. Not ideal or desired, but it is what it is.

Exited Holdings

  • LON:XPP - Decent return because it was purchased at a deep discount, but upon further reflection wasn't the type of business that I was comfortable holding longer term, especially after "fair value" was reached. The commodity nature of the business (power converters) doesn't seem to lend itself to a huge moat, limiting prospects for strong organic growth.
  • MRVL - Many new acquisitions, became hard to value. One of the key tenets of my investment thesis (that their ARM offerings would gain market share in the server space) has been hampered by AMD's more competitive x86 offerings. Acquisition driven growth has historically almost always generated poor returns for shareholders.
  • DESP - Became excessively overvalued and former CFO was put on the audit committee of the board of directors, which seems like a conflict of interest. According to AppAnnie, BKNG is outperforming in most of the key LATAM markets. They will probably get acquired by EXPE, but too speculative at current prices.
  • GOOGL - Should have held on to this one, but my valuation was too pessimistic and failed to factor in some of their longer term competitive advantages. Seems fairly valued now, keeping an eye on it for opportunities.
  • MU - Seems fairly valued now on a cyclically averaged basis. Not enough of a compelling moat (commodity industry) to justify holding beyond fair value.
  • CRNT - Likely still undervalued, but risks and uncertainty increased tremendously in the last few months, with no commensurate increase in upside. Sounds like they tried to shop the business around, but no takers - why? Also, significant management worries surfaced: many senior executives left, and CEO was uncharacteristically desperate in hyping 5G for future of business, when in the past he was relatively dismissive. At the end of the day, they were highly concentrated in a single product (wireless backhaul) in a single region (India), both of which I didn't fully understand, and this investment was too speculative.
  • VNTR - Extremely undervalued asset play. Bad business
    (Titanium Dioxide), but assets alone (based on public transactions for similar assets) were worth 2x what was being priced in. Stock nearly doubled when management indicated they were shopping parts of the company around. Still not sure how I feel about these types of classic "cigar butt" plays, as the "realization" of value was very fortuitous - luck in timing played a huge part - but may make sense if part of a properly diversified mix of similarly distressed assets.

Thanks to everyone who has followed this blog for the past year, and best wishes to all in 2020!

Updated Jan 5, 2020 to fix some errors with the calculation of time weighted return (TWR) in the original post. Annual TWR performance is now calculated using freely available spreadsheet template from Bogleheads: https://www.bogleheads.org/wiki/Calculating_personal_returns

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