Capital preservation is the main priority, followed by the compounding of that capital at an above-average rate of appreciation over the long-term, while minimizing the risk of permanent loss of capital.
To achieve this, I strive for superior security selection and analysis, by finding inefficiencies that provide both high returns and limited risk, which will be assessed by an ever-improving rigorous investment process. This, coupled with a more aware control of temperament, will allow us to cut losers when we need to and let the winners run.
I will not attempt to make predictions about the direction of the stock market. My focus is in looking for value, and buy securities when there is a mismatch between their intrinsic values and market prices. João Alves 22/7/18
Investment Philosophy
My philosophy of investing is based on the following five core principles:
1. ALL INTELLIGENT INVESTING IS VALUE-ORIENTED – What I view as value investing is based
on the perennial idea of buying stocks that are trading at substantial discount to their intrinsic value, and holding them over the long term. Indeed, a value philosophy encompassed many elements. To simplify, the building blocks behind my value mind-set are the following: a. MARGIN OF SAFETY – My approach is rooted in the eternal concept of margin of safety. Successful investing in my view is mainly a function of price paid; however, quality of assets can also act as a margin of safety. The key here is to look at downside first; offense may win games, but defence wins championships. By avoiding the losers, the winners should take care of themselves. b. THINKING AND BEHAVING AS AN OWNER – It is important to think as an owner. Stocks are claims of ownership in a business, not only pieces of paper. So, I focus on thinking long- term, emphasizing on business economics and paying close attention to incentives. I want to be aligned with management teams that are interested in growing the company’s value over time. c. RISK-CONCIOUS, NOT AVERSE– Low expectations, which the general market views as risky, is where the best investment ideas lie. When these low expectations differ from what my assessment of reality appears to be, the irrationality around the security presents an opportunity. Therefore, successful investing comes from managing risk, not avoiding it. d. DEAL WITH FACTS AND EVIDENCE, NOT HUNCHES – Opinions matter insofar as they illustrate evidence and facts about other peoples’ expectations. This has a direct and meaningful impact in any valuation. Ultimately, the stock price should follow this rigours assessment of the underlying business’ fundamentals over the long term. e. MARKETS ARE EFFICIENTLY INNEFFICIENT – What his means is that most markets are generally efficient, but at times short-term mispricings happen. Embedded in this belief is the faith that in the long-term, stock prices converge to the underlying business’ fundamentals. To that end, investors must always be prepared to be opportunistic to capitalize on short-termism.
2. CLARITY & SIMPLICITY RULE IN INVESTING – The idea is to translate complex concepts into simple statements. Over-complicated thinking and calculations, do not always equate to superior returns. It is my belief that successful investing comes from identifying the 2-3 key variables that will move a stock, and focus my research efforts on understanding whether I have an advantage in understanding them, or if I can build one. If the answer is yes to a misvaluation and to my advantage potential, then the stock becomes a worthy candidate. By doing this, I hope to reduce the number of decisions that I have to make - make them well - and thus, avoid unforced errors.
3. THINK PROBABILISTICALLY TO STAY AHEAD – Every investment should be measured on an
expected value basis; mainly, how much can be earned, how much can be lost, and the probabilities associated with each outcome. I like to invest in stocks that have erroneous low expectations and unusual asymmetric risk/return profiles. To me, asymmetric situations with underappreciated assets and substantial upside is far more important to me than solely focusing on metrics that suggest cheapness.
4. EVERY BATTLE IS WON, BEFORE IT’S EVER FOUGHT – The art of investing lies in idea generation. Knowing where to look is already an advantage. I like to hunt for ideas within buckets that have been statistically proven to offer above-average return potential, and where I have a high probability of acquiring an edge in. Figuring out what you’re looking for, then trying to figure out how to find it, and finally, thinking about different/better ways to find it than the rest of the market, will put us ahead of the competition.
5. COMPARE OFTEN, COMPARE WELL – Investing is about comparing. I allocate time each day/each week devoted to searching new investments, studying them, and testing them against my current holdings. I compare them in various different ways; from expected returns and expectation values of the bets, the theme that they represent in the portfolio. This has various benefits: helps increase my circle of competence, helps me learn more, helps with comparing, which in turn helps understand my positions and conviction better, to know whether my biggest holdings are the correct ones or if other companies should occupy their place in the portfolio. João Alves 22/7/18
Investment Approach
My strategy is rooted in a commonsensical and disciplined methodology towards investment analysis and decision-making, in order to enforce my investing philosophy in a disciplined and repeatable fashion.
Search Strategy: The heart of the approach is the pursuit for significant short-term mispricings that have a high probability of being corrected over the medium- or long-term. I look for mismatches between perception and reality to being my work; be it around an investment theme, industry, or individual company. These mismatches are usually found in areas that are neglected or out-of-favour, or under appreciated.
Broadly, the sort of companies I search for fall within one or more of the following categories: • Deep Value: companies with solid balance sheets trading for less than their replacement asset value or liquidation value. • Compounders: high-quality, defensive businesses run by management teams with owner-operator mind- sets. • Miscategorised Firms: these are companies that have been bucketed into a specific sub-sector or industry, and thus is often valued homogenously by analysts, but which may carry assets or other characteristics resembling a completely different industry. • Special Situations: stocks trading at large discounts to intrinsic value with a path to realizing value, catalysts. These include: o Spinoffs o Risk Arbitrage – M&A o Restructurings and turnarounds o Recapitalizations o Post-bankruptcies o Activist campaigns • Capital Cycle Opportunism: this is based on the idea that prospects of high returns, attract more capital and competition to that market – and vice versa - resulting in a reversion to the mean.
I believe that the combination between our small size and unconstrained mandate, we can claim a structural advantage that will allow us to invest in the neglected but highly profitable area of international, illiquid small- cap stocks.
Research, Analysis & Valuation:
I venture into research and analysis in a very methodical way. The objective is to achieve clarity and simplicity as to the realistic and forward-looking view of the business’ underlying economics. This is achieved by closely analysing business fundamentals, and translating reported earnings to what Buffett calls ‘Owner’s Earnings’. I then spend time analysing the company’s and competitors’ corporate filings and financial reports, arraying, analysing and interpreting financial data, and even, when appropriate and accessible, conducting field research. This supports to my multi-year projection of financial statements, which will help clarify the reliability and durability of business’ operational and capital allocation strategies, and judge whether the mispricings observed are temporary or structural.
The next step is to value the business. My approach is entrenched in the assessment of value versus price. I have designed a checklist to ensure discipline in my investment analysis. Although, it’s impossible to eliminate behavioural biases, the use of a robust and written investment framework, combined with a detailed and always evolving investment checklist, will help us control them better.
Further, my philosophy in regards to valuing businesses is that valuation is an imprecise endeavour, and so should be performed to arrive at a range of possible, plausible and probable values. The methods I use to value businesses range from: DCF valuation, asset valuation, earnings power value analysis, sum-of-the-parts valuation, relative/comparable valuation, precedent transactions/private market value analysis, and free cash flow yield. Overall, the value of a business must be looked at in many different ways, where depending on the specific industry, situation or business, I can assign specific weightings to each method and scenario.
Portfolio Construction I aim to build a concentrated portfolio of 7-15 carefully valued securities, where the expectation value is asymmetric to the upside, intending to hold for over a year, and analysing with 5-10 years in mind. João Alves 22/7/18
The level of confidence held by me when analysing the expected value, risk/reward ratio and predictability of a specific investment idea, determines its portfolio weight. The minimum position size is 5% of the portfolio to offset transaction cost issues and to ensure a commitment of capital exclusively to my best ideas.
Conviction and patience are the bedrock upon which intelligent risk management operates, and it is built through deep and continuous knowledge accumulation of industries, businesses and management teams. Because of this reason, I am always reading closely and broadly.
Risk Management: Risk management governs my investing decisions. My view of risk follows that of value investing practitioners – volatility is inherent; true risk is the possibility of permanent impairment of capital.
I only allocate capital when I find opportunities that I have a high conviction of decent expected returns and a sufficient margin of safety. Otherwise, my default investment is cash to capitalize on opportunities when they appear.
My risk management process is broken down into the following components:
• Diversification: I do not over-diversify in the expense of lower returns. In my view, as an individual analyst, knowing more about fewer companies is a better approach knowing little about more companies. For this reason, I do not diversify in terms of numbers; there have been studies that have shown that adding more than eight stocks of different industries to one’s portfolio does little to reduce volatility and risk. I only diversify in terms of portfolio weight assigned to different geographies, sectors, market capitalizations, and investment category. • Time-Arbitrage & Patience: The ability and freedom to invest over a longer time horizon than most of the other investors is a beautiful advantage. It allows us to use volatility instead of the other way around. It is critical to be proactive, not reactive, in investing. • Downside-Focus & Margin of Safety: I follow a very systematic and transparent valuation discipline.
Review and Monitoring:
Temperament is perhaps the key to successful investing. Indeed, biases are inevitable. But with time and targeted effort, we can become more aware of them and thus control them better.
I will to catalogue, monitor and control my temperament and biases by using the following tools: • I will use Excel spreadsheets and Trello boards to catalogue my idea selection and vetting, and my thought process when looking at ideas, both at a starting stage, but also later on after having done some research on the idea. • I produce detailed investment write-ups on every position of the portfolio. I date them and update them so that months later I can objectively know where I was right and where I was wrong. • I will consistently be updating models, and re-evaluating probabilities as new data come to light. • I will produce quarterly letters, monthly commentaries and weekly journal entries to communicate and share my thought-process, as well as monitor the developments and risks of current positions.
Investment Process Characteristics:
1. Absolute value investing: I invest on the merits and value assessment of the individual security and its idiosyncratic return stream. 2. Unconstrained mandate: I will invest across geographies, industries and market caps, in an effort to increase the probability of avoiding losers and finding winners. 3. Concentrated holdings: Most of investors’ returns come from their top 10 ideas. Accordingly, I expect to only commit capital to investments that I have the highest level of conviction in. Therefore, I just invest in my 7-15 best ideas. 4. Long-term orientation: I look to hold securities for usually over 1 year. This varies when referring to event driven plays, where the holding period might be around a few months. But the idea is to have a larger time horizon that the rest of the market in order to, (i) stomach the inevitable volatility without being reactive to it, and (ii) increase my chances of being right on my theses. 5. Fundamental research-driven: All sensible risk management starts with long hours researching all the sides of the arguments and cementing a well-thought out view.
