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.
- Demutualizations -- The CME Group
- 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.
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.