Happy New Year everybody. I hope you all had a fantastic holiday and have returned refreshed and ready to navigate the markets in 2015.
It’s that time of year to calculate performance returns and reflect on what went right in 2014 – and what wrong..
I only allow myself a handful of days at year end to do this. Anymore than that and I start pondering ways I can boost the number (which can be quite dangerous). I think Warren Buffett put it best with this quote: “Games are won by players who focus on the playing field –- not by those whose eyes are glued to the scoreboard.”
Alright, let’s get into it. Here’s how 2014 turned out:
My rate of return (XIRR function in Excel) in 2014 was 53.61%. This brings my cumulative return since I started seriously tracking my investments in 2012 to ~220% – significantly above the S&P 500’s return of ~75%. I must qualify these numbers by saying I am not working with a large capital base. I don’t think I could generate anywhere near these returns investing tens of millions. My strategy is simply not scalable.
Here is what my portfolio looked like on Jan 1 of 2014:
I always find it interesting to see how the portfolio would have fared had I not made a single trade in 2014. The average return for my starting positions was about break-even and given the weightings, I probably would have returned in the negative single digits.
Fortunately, I made some adjustments along the way and ended the year with a significantly different portfolio:
The ending portfolio consisted of all micro-caps – generally simple, cheap, profitable, and growing businesses. All qualities at the core of my strategy.
Also note the concentration. I ended with 7 positions and the three largest – HTLZF, MBXBF, and XPLT – comprised 75% of the total portfolio.
The concentration is largely a result of starting with ~10% allocations and seeing them appreciate throughout the year. I’m happy to hold as long as the fundamentals remain intact, but this is about as much concentration as I can get comfortable with. Once I have a new compelling idea, I’ll likely trim these positions to raise funds.
The last part of the story are the closed positions:
I closed 8 positions in 2014, which I consider an acceptable amount of turnover. Many of the closed positions were to get out of international stocks and focus on ideas I felt I could understand better. Most of the closed positions evened out with no effect on performance. But one- OPRX – resulted in a massive loss. I took this loss for 2 reasons: 1) I was overly optimistic about the fundamentals of the business and 2) to raise cash for investing in HTLZF.
I learned a lot this past year, but three lessons standout:
1) Avoid Losses
We’ve heard Warrant Buffet say it a million times: avoid losses. Easier said than done. XPEL Technologies was my largest position for most of the year – and one of my largest winners. But every bit of gain I had in XPLT was negated by a 45% loss on OPRX.
With OPRX, I relaxed my standard of investing in high-quality management teams. I became enamored with the business model and overlooked some major warning signs. With a concentrated portfolio, comprising standards is just not an option. OPRX is a story for a different day but for now, I’ve chalked this one up to expensive tuition.
2) Sell Losers to Buy Winners
Value disciples may find this one a bit controversial I suspect. But I think this strategy was the single biggest factor in achieving outsized returns this year.
Many investors do the opposite – trim winners to average down in losers. I certainly did. At one point in 2014, I sold some XPLT at $1.77 to average down in OPRX at $1.45. This was a big mistake.
Intuitively it makes sense to average down. After all, Mr. Market is offering you a better deal in a stock you like. But what I have learned is Mr. Market is gets it right ~90% of the time. Mispricings are the exception – not the rule.
In a way, buying a losing stock is an audacious act. You are essentially saying, all those other market participants are wrong – and I’m right. I’ve learned to think hard about why a stock is undervalued and what the future path to value realization is before investing.
The ideal situation is a stock that is rapidly increasing its intrinsic value. Stocks like these can go up a lot and still be undervalued. XPEL Technologies is the best example I can think of. These are the ones you want to average up in.
3) Invest Where You Have an Edge
Very few investors will beat the market over the long-run. Time will tell if I can. We really need to see how my strategy performs over a full market cycle (5-10 years) – including a bear market.
Those that do outperform, probably do two things well:
1) Stay disciplined
2) Invest where they have an edge
Number 1 comes largely from temperament. Much of it is inherent. Some can be learned through practice.
Number 2 will differ for every investor. For me, it has meant focusing entirely on one space: the non-resource, Canadian microcap market.
I like micro-caps because many investors investing a significant amount of money can’t touch them. And I like Canada because the entire brokerage system is built around financing these ventures – leaving most of the non-resource plays shrouded in obscurity.
Add to this an informational edge from pooling due diligence with a network of talented Canadian investors and I think I have found an attractive space to play in.
There are many places to make money, but this space has consistently provided 6-8 ideas that meet my strict investment criteria. 2014 marked the year I put my focus on this space.
Overall, I’m pleased with how 2014 turned out but trying to remain vigilant and disciplined heading in 2015. There are always the “unknown unknowns” out there. I run a concentrated portfolio and a few poor judgements could eliminate much of the excess return I have generated over the last few years.
The market has been on a tear these last few years and one might wisely consider fortunes turning in the future. But I can’t predict what the market will do and have to stick to my strategy of investing in:
1) Micro-caps that are early on in the “discovery process”
2) Simple businesses that are showing steady growth and cash flows
3) Compelling valuations with a large margin safety
Thanks everyone for reading and supporting this blog over the last year and a half. Your comments and contributions have made this blog a joy to write and helped me improve as an investor many times over. I really appreciate it.
Here’s to a prosperous 2015!
Disclosure: Long everything in the ending portfolio