What's Your Investment Strategy?

Sometimes in my writing for the Fool I proclaim that I'm one-part gem hunter and one-part Rule Breaker. For those new to the Fool, what this effectively means is:

a) I enjoy investing in individual stocks;

b) While I like being aggressive, nothing warms my investing heart like conservative growth stocks; and

c) I'm a sucker for calculated risks that can pay off huge.

But how do I know this about myself? After all, I didn't hike into the wilderness loaded with stacks of tomes by Graham, Fisher, Lynch, and the other investing greats, leaving only after achieving total understanding of the spiritual underpinnings of the P/E ratio. I never sought the meaning of my financial life in their masterful texts, either. And you'd be hard-pressed to catch me chanting anything, let alone mantras aimed at achieving better results for my portfolio. When it comes to investing, I'm just not all that spiritual.

So, again, how do I know? Easy. I finally sat for half an hour and wrote it all down.

You've done it before
Think about any financial task you've set forth to accomplish. Take budgeting, for example. If you're anything like most of us, you've developed 15 budgets...over the past 12 months. What about your retirement plan? That's got to be written down somewhere. Your will? Same deal. So why is it so easy to skip developing an investment strategy? I'll bet I'm speaking for most when I say simply that it just never comes up. That's why I didn't have one till this week.

The fact is I never fully appreciated the idea of committing a strategy to paper till I read Hewitt Heiserman Jr.'s It's Earnings That Count. He writes: "The poet E.B. White believed that if your thinking was clear, then your writing will be clear. The same is true of investing, so formulate a strategy and write it down. This discipline will help you zero in on the kinds of companies you want most and avoid getting distracted by situations that are of peripheral interest. Naturally, your investment strategy should match your personality."

In other words: If you've got a strategy you'll hold yourself accountable for your investing decisions. And that ought to make you far less likely to take a flier on that stock Uncle Joey says will be the next big thing but looks terrible on the merits.

One of my closest friends, whom I've known to be a pretty good investor and who was smart enough to write down a strategy awhile back, puts it slightly differently: "Writing it down helped me think through the strategy, consider if there was anything I was missing, and narrow it down to what I thought was important." He also got more than a little advice from his dad, one of the first superior investors I ever met.

I finally did it
It's that last sentence in Heiserman's argument for writing out an investment strategy that really caught me when I first started thinking about it: "Naturally, your investment strategy should match your personality." Exactly.

Being the exploring type who digs a good discovery it was an easy call for me to get in early on Tom Gardner's Motley Fool Hidden Gems. And seeing that I had worked in and around the tech industry for more than a decade, the idea of investing in unproven businesses with huge potential was like second nature to me. Would I commit my entire portfolio to a wet-behind-the-ears upstart? Never. But I'm as juiced as any Motley Fool Rule Breakers subscriber at the idea of getting in on the next big thing as early as possible. And that's really all I needed to know to start writing. Here's a sample of what I came up with:

I am an aggressive investor who believes the surest way to long-term wealth creation is through regular saving and investing in individual stocks. I seek to invest in companies that have large competitive advantages, growing sales and earnings, widening margins, and understandable business models. I only seek businesses run by management of the highest integrity who use plain language in their financial filings and press releases. I prefer stocks that have great growth potential but also pay dividends. Every time I invest in stocks, I do so with a three- to five-year plan. In most cases I'm seeking to at least double my money.... I also occasionally invest in special situations where other investment vehicles such as stock options or going short may be appropriate, but I always seek to have these instruments comprise no more than 10% of my portfolio. I also occasionally invest in Rule Breakers (aka, informed speculations) to help my portfolio earn market-trouncing returns.

Do I practice what I preach?
The first thing I did after creating my investing manifesto was to apply it to the stocks I already own. I figured it was worth knowing whether I have been investing according to my own rules. Let's take a look:

One of favorite stocks is AkamaiTechnologies (Nasdaq: AKAM  ) , which has what's called a content delivery network that brings Web content and applications geographically closer to users. I consider the company a Rule Breaker because it is the dominant provider in a fast-growing market and also because the stock trades for an extraordinary premium-to-earnings and cash flow.

Akamai went public during the height of the tech boom, crashed, and then began an impressive recovery in 2003 that has led to profitability and growing free cash flow today. I'm impressed by the turnaround, which I attribute to a skilled and committed management team that took steep cuts during the bust to get the company back on track. Though an informed speculation, I understand its business intimately, which all but eliminates the intellectual risk that has burned me in the past. Further, I believe the company is conservatively managed, witnessed by big improvements in sales, earnings, and margins. Is it still a good fit for my portfolio? Yep.

Another of my favorites is Oracle (Nasdaq: ORCL  ) . After researching the stock for a summertime duel here at Fool.com, I found its prodigious cash flows and growing margins too attractive to ignore. With its deal for PeopleSoft (Nasdaq: PSFT  ) , Oracle could still prove a conservative value on a cash flow basis, especially when compared with its peers. Risks still exist, of course. But Oracle is still the leading provider of database technology at a time when RFID and other emerging technologies are producing hundreds of terabytes of new digital information daily. I think it's still fair to call Oracle a conservative growth stock. Therefore, it still fits snugly in my portfolio.

Then there's Buffalo Wild Wings (Nasdaq: BWLD  ) , which I picked up from Hidden Gems. The company possesses many of the elements I love in an investment: substantial insider ownership, a young but growing franchise, good management, positive net cash on hand, and improving structural free cash flow. Mix all that in with an enterprise value of less than $250 million, and the stock appears to me as an above-average candidate to at least double in the next five years. Is it worthy of my portfolio? I only wish I had more shares.

Now let's take a look at Barnes & Noble (NYSE: BKS  ) . I bought the stock largely on the idea that it would do well with a raft of popular new books coming out, including President Clinton's autobiography. Plus, the stock was trading cheaply on a cash flow basis then and still is. A check of Yahoo! Finance pegs Barnes & Noble's free cash flow-to-enterprise value at seven, roughly even with its three-year free cash flow growth rate. Perhaps that's why insiders have bought shares recently. I'm also encouraged by yesterday's holidays sales report and figure the company will see a nice windfall from upcoming Harry Potter sales. Good growth, an understandable business, and management with skin in the game. Yep, Barnes & Noble remains a keeper.

Finally, there's the black sheep of the herd: Interpublic Group (NYSE: IPG  ) . Ironically, we've held stock in this holding company for advertising, marketing, and PR firms longer than any of the others, for more than seven years. But poor management and results have tainted the business. It really doesn't belong in my portfolio any longer, but our position is so small that I figure we might as well hold to see whether the firm's promised improvements take root.

Write yours today
Investing without a portfolio strategy -- sorry, "I want to get rich" doesn't count -- is like traversing the Arctic in winter without a coat and a compass. If you get where you're headed, it will only be because of sheer luck. Don't take that chance. Writing a strategy takes nothing more than a little study, a little introspection, and 30 minutes of writing and polishing your manifesto. And don't tell me you can't spare the time. I can see the reruns of Gilligan's Island playing behind you. So no more excuses, please. After all, you may find that in developing a strategy, you'll earn enough to retire to a tropical island. And isn't that better than watching one on TV?

Fool contributorTim Beyershas a lot of work to do before he and his wife can retire to a tropical island. But you can get a glimpse of how they'll get there by checking out his investment strategy, which he'll post in its entirety on theMisc. Investing Strategiesdiscussion board. Tim owns shares in most of the companies mentioned, including Akamai, Barnes & Noble, Buffalo Wild Wings, Interpublic, and Oracle. All this is listed is in his Fool profile, which you can findhere. The Motley Fool isinvestors writing for investorsand has a disclosure policy.

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