Our Portfolio Heading into 2025
Part II of our "Strategy 2025" webinar - Why do we own what we own?
Welcome to the first discussion about our portfolio holdings heading into 2025. Our personal favorites (not that we have a crystal ball) can be found below.
2024 was a solid year for financial markets and our portfolio, but frankly: it’s already in the rearview mirror. Over the last years, financial markets have undoubtedly enjoyed the effects of ultra-loose monetary policy.
Therefore, we shouldn’t put too much attention to a positive outcome that occurred in a very favorable stock market environment. The long-term factor in compounding wealth is whether or not our companies managed to make wise capital allocation decisions. So, don’t confuse euphoric bull markets with brains; it’s oftentimes a consequence of rising retail participation, not the fundamental drivers of shareholder value creation.
An 8-Point Shortcut to Finding Great Tortoises
Talking about the fundamental profile of a “Compounding Tortoise”, it boils down to a company:
being transparant with its owners, as evidenced by a management team’s integrity and skin in the game;
posting positive organic growth;
investing in assets that generate secured cash flows (implies a high degree of economic resilience with little disruption risk);
looking for stable growth rates, based on a sustained return on capital;
having a large pool of potential investments, whether it be organic or acquisitive;
having a strong balance sheet to weather any economic downturn. You don’t want to see a declining ROIIC being made up for by borrowing for future investments;
distributing all leftover cash to shareholders;
and lastly, with no dilution of existing shareholders through excessive share-based compensation. Share-based compensation is a very handy approach to artificially growing your cash flow from operations (and free cash flow, by its theoretical definition). SBC-adjusted earnings are a perfect indication of a shortsighted management team trying to persuade the market of its (“adjusted”) value creation.
This concise 8-point list will certainly keep you out of a lot of trouble. Why is it so simple? It’s based on common sense. The only things we care about is ROIC (i.e. capital intensity), earnings and cash flow visibility, and a relatively fast payback on any growth iniatitives.
Avoid Unsustainable Growth
Chasing growth has always been the mantra of stock-market gold diggers: the faster a company is able to grow, the more investor enthusiasm it's going to attract. McKinsey’s book “Valuation, Measuring and Managing the Value of companies” is crystal-clear on diminishing revenue growth rates.
The median rate of revenue growth between 1963 and 2007 was 5.4 percent in real terms. Real revenue growth fluctuates more than ROIC, ranging from 0.9 percent in 1992 to 9.4 percent in 1966.
High growth rates decay very quickly. Companies growing faster than 20 percent (in real terms) typically grow at only 8 percent within five years and at 5 percent within 10 years.
Extremely large companies struggle to grow. Excluding the first year, companies entering the Fortune 50 grow at an average of only 1 percent (above inflation) over the following 15 years.
The investor treadmill is a very interesting concept we’re going to elaborate on in our next webinar. Buying shares of a fast-growing company won’t necessarily make you rich; it depends on the embedded terminal cash flow expectation and the moment at which the market counts on growth rates to fall off a cliff and/or to normalize.
Our 11-Stock Portfolio Uncovered
The below presentation (including transcript and slides) goes over our 11 portfolio holdings and why we own them. As we shared in last week’s webinar, optimism reached quite high levels at the end of last year, a bit similar to the end of 2021.
We’ve now started to witness some volatility, which could benefit our total portfolio strategy. This includes the use of defensive options strategies, which we talk about on our second Substack “The Theta Tortoise”. Interest in this new service has been unexpectedly strong, as 50 premium members have already joined us in just 3.5 weeks. Let’s head toward 100+ then 🐢. To celebrate that early success, there’s a 15% discount off annual plans till the end of this month.