VDL Bucket Approach
My approach to managing the portfolio
This is a quick outline on how I run my portfolio…
Some of my core tenets:
Smaller is better (generally) — Small and micro caps are my focus — less competition and more opportunity for mispricing
Look for underfollowed, undiscovered, or oddball situations — I love it when no one has heard of a company or the general reaction is “why would you own that?”
Cash flow focused investor — This is almost always the first place I look when considering a new investment — How has a business been generating and spending its cash?? You’ll see my cash “sources & uses” analysis frequently.
Concentration not mandatory — After reviewing previous investments over the years, I’ve had at least one stock with a large weighting (10%+) each year but otherwise I typically spread my bets between 20-40 stocks — Don’t expect me to own as few as 10 stocks or as much as 100.
Cheap — I’m a cheap person and I like my stocks that way too… Maybe it’s a dying trend since the data is so easily available but I still like to pay low multiples. My goal is to recognize something that others don’t… I don’t live or die by a single valuation metric — I like to look at them all depending on the situation. I do prefer stocks trading at discounts to their own historic multiples (i.e. a typical 15x PE stock now trading at 10x)
My goal first and foremost is to find slam dunk returns. Slam dunk in the sense that it’s highly likely to produce good returns, not necessarily slam dunk returns! The simpler the better as I don’t like to work too hard. Oftentimes, I’ve found a simple thesis and a simple business to be best. The more complicated it gets to explain, the further you’re likely drifting from a good idea.
When I look at any new idea I put it into one of three buckets — core, general, or option. This is really my secret sauce when building my portfolio…
Core
There’s so much talk of “compounders” and “quality” businesses but these are truly few and far between when trying to buy at fair (or cheap) prices…
To me, this means a cash flowing company with a decent runway for growth/improvement and good capital allocation that I can own for a long time — hopefully at a reasonable price. You could refer to these as “set it and forget” investments where you just know that the company is destined for good things…
My idea of a “core” holding vs. some of the compounder ideas you see will vary widely. Mine may not be a sexy business or high flyer. Typically, they are plain vanilla businesses generating good cash flow and spending it wisely.
Generally, I’m willing to make these large positions (potentially 10-30%) but they’re fewer in quantity since they don’t come around often. I may only have one position in any given year that makes it to a 10%+ portfolio weight… Some may refer to these as the “fat pitch” ideas.
Holding period for stocks in this bucket are multi-year.
General
Cheap stocks, event driven stocks, special situations, short-term trades, growing businesses but not core-worthy… Some may have a catalyst and others not.
Owning cheap stocks for cheapness’ sake can be a somewhat difficult game to play. I like to see something happening in the business that makes it worthwhile — growth, capital allocation inflection, changing trends, etc.
These will usually be the highest quantity of positions with various position sizes — maybe 1% up to 10% depending on the situation.
Holding period for stocks in this bucket range from a few months (catalyst-driven) to multi-year.
Option
Some may not like this bucket… These can be speculative, highly levered businesses that are trying to dig out of a hole… Or they could be net-nets or cash shells with no operating business. I try to keep the weightings on these bets small (ideally 1% or less) so they’re likely higher in quantity but lower in overall weight. The goal is to keep these mainly cash/NOL shells and call spreads.
The theory here is that 10-15 bets cobbled together for ~10% of the total portfolio will provide some large returns as some of these payoff and others falter.
It’s hard to make a large investment in a net-net without knowing what management intends to do with the cash/business… It’s much easier to see things squander than to do the right thing. This makes them much more suitable for an “option-like” weighting in the portfolio.
Stocks can certainly “graduate” from one bucket to the next. A general that undergoes a spin-off of a high-quality business may turn into a core holding. Or a cash-shell in the option category may purchase a business that moves it into the general or core buckets!
This isn’t my method of analyzing an individual stock idea but rather how I group them in managing the overall portfolio. Not every investment is the same and I’m not a believer in simply equal-weighting the 10 best ideas and calling it a day. I have no problem owning 20-50 stocks with weightings ranging from 10% down to 1%.