I wrote up a little “whitepaper” on my investing strategy (the “ROIC Strategy”) in the latest edition of our premium ROIC-only newsletter Making Cents. But I also received feedback that it should be made publicly available so everyone knows what our investing philosophy is about. So here is part 1/3 of our investing philosophy. As a side note, I will be covering the new stocks on the Big Board in the next issue of Making Cents.
The problem with pure “growth” or “innovation” investors that chase transformational 10x+ companies is that they tend to get too optimistic and get “lost in the clouds”…
- Return Profile: If you look at early stage growth investing, most investments are inherently losers, but outsized returns come from picking a handful of monster winners to make up for the rest.
- Over-valuation: Being too optimistic and assigning too much value and probability to cash flows far out in the future leads to overvaluation and “bubbles”. We want to avoid these. Remember that bubbles are generally formed by optimism about actually great things, but overvaluation ultimately destroys returns by either popping or trading sideways.
- Liquidity and diversification: The reality of earlier-stage growth companies is that only a few “make it”, while the others provide poor risk-adjusted returns or straight up fail. As a result, many innovation-minded investors over-commit themselves to many different types of growth companies, and the ones that fail meaningfully drag down their performance. As individual investors we don’t have the liquidity to lose a lot of high risk bets.
- Unknowability: Because growth trends are so far into the future, it’s very hard to consistently pick many companies that will hit it big. Big winners don’t come around all that often. Also, it’s hard to tell the winners from the losers in the early days.