My Strategy to Beat the Market

This article is part of our Rising Star Portfolios series.

I approach investing from a risk-management perspective; I may not know how to make money at times, but I know how not to lose it.

Rather than own a little bit of everything, I am willing and able to concentrate my capital into my best ideas. These bargain-priced opportunities are picked one at a time, bottom up, which provides a margin of safety in case of error, bad luck, or disappointing business results. However, I am always conscious of whether these different investments involve essentially the same bet or very different bets.

Example: If each of my holdings turned out to involve similar bets (inflation hedging, interest rate sensitivity, single market or asset type, etc.), I would be exposed to dramatic and sudden reversals in the entire portfolio should investor perceptions of the macroeconomic environment change.

These days, other investors' idea of "risk control" is to own literally hundreds of small positions while making no sizable bets, a strategy that might also be labeled "return control." It is clearly an advantage, but by no means without risk, to be able to concentrate our positions. I work exceptionally hard to ensure that our largest positions are indeed our most worthwhile opportunities on a risk-adjusted basis.

My strategy is a go-anywhere strategy, which could be described as concentrated value, with roughly 13-20 holdings at any time. I plan on utilizing equities, LEAPS, puts, and holding cash at times. The types of investments that usually attract me are:

  • Cheap cash generators, which I define as trading at less than 5 times free cash flow.
  • Special situations including:
    • Demutualizations  -- The CME Group (NYSE: CME  ) has risen 561% since its demutualization in 2002.
    • Spinoffs -- Bristol-Myers Squibb's (NYSE: BMY  ) spinoff of Mead Johnson Nutrition (NYSE: MJN  ) has gone on to return 120% since being spun off by its much larger parent.
    • Index deletions -- MBIA (NYSE: MBI  ) has returned 255% since being removed from the S&P 500.
    • Broken buyouts -- Huntsman (NYSE: HUN  ) returned 284% after earning a billion dollars in reparations due to a failed buyout by private equity firm Apollo.
    • Cash hoarders -- Both InteractiveCorp (Nasdaq: IACI  ) and Infospace (Nasdaq: INSP  ) have 50% or more of their market cap made up of cash.
    • Any time there are forced sellers is a great time to be a buyer.
  • Undervalued asset plays, companies trading for 50% of their easily determined value.

How do I define success?
The purpose of my strategy is to make money, not just to own stocks. I expect to accomplish this and to compound our money at the highest rate possible without taking excessive risk.

How will I manage risk?
I define risk as the permanent impairment of capital, none of this beta nonsense. I utilize pre-mortems, quarterly reviews, and checklists to guard against bad decisions. The most important aspect of risk management, though, is a large margin of safety.

What's next?
Over the coming months, you can follow me here as I invest the Fool's money. I'm not one of the more verbose writers, so feel free to ask any questions you may have in the comments section below and I'll be happy to answer them.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Dan Dzombak recommends you read The Best Investment Advice You Will Ever Get If You Have Under $100k. His musings and articles he finds interesting can be found on his Twitter: @DanDzombak

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 01, 2010, at 2:44 PM, howie1pt5fool wrote:

    With a broken buyout like Huntsman (HUN) once it makes its move is the story over and time to sell? You've told us when to buy but not went to get out.

  • Report this Comment On November 01, 2010, at 8:40 PM, Notfooled1 wrote:

    Without proof, I am very skeptical of your claims.

  • Report this Comment On November 02, 2010, at 11:12 AM, daveandrae wrote:

    My strategy is a go-anywhere strategy, which could be described as concentrated value, with roughly 13-20 holdings at any time. I plan on utilizing equities, LEAPS, puts, and holding cash at times.

    Huh???

    Why don't you just cut the long winded crap and just say "My strategy is to SPECULATE with my money."

    Contrary to popular belief, the hardest thing to do in this business after a security has been purchased, is nothing at all! I'm up 23.60% over the last 12 months on six figures of capital on zero percent turnover.

    I only hold five stocks.

    Investing isn't difficult. HOLDING equities. Leaving your portfolio undisturbed. Not trying to constantly "tweek it" with crap like puts and LEAPS, Now that's difficult.

    The entire business of wall street has been built on the idea of getting you to "DO" something all of the time. It is only when you become slothful, that you begin to see the truth.

    "Wall street makes its money on activity. You make your money on inactivity" - Warren Buffett

    Thomas Edmonds

  • Report this Comment On November 02, 2010, at 7:54 PM, btinter1 wrote:

    daveandrae,

    23.60%!!! WOW... how did u that? that is very

    impressive. oh wait.. thats right... any small or mid cap index fund would have got u 28-30% return in that same period. LOL LOL

    Maybe u just dont know what a put or leap is or just dont know how to use them...maybe as a hedge in times of uncertainity. I just got a 35% return on a put written against REE in the matter of 2 days. Maybe u should just be quite about things you dont understand and try to be a little less critcal.

    23.60%!!!! wow (in 1 year)

    Mike

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