This post outlines the rules of the game I’m playing. I’m sharing this for two main reasons. Firstly, it’s to formalize my approach as a constant reminder for myself of the parameters I’ve established. Secondly, I’ve learned a great deal from materials generously shared by other investors I admire, and I’d like to give back in the hope that this helps others. Many of these principles are drawn from other investors whose approaches resonate with me. However, each of these has been acquired through my personal experiences—knowing what works well for me and aligns with my personal investing style.

Where to Hunt

The first important factor for me is understanding my own playing ground. What I’ve found to be the most enjoyable and rewarding is analyzing mispricing that often presents itself around special corporate events. These events could be anything from M&A, spin-offs, demergers, liquidation events, tender offers, and others. I find it much more reassuring to invest in something that might appear optically cheap knowing that there’s a significant 'catalyst' anticipated to affect the price movement of the underlying.

However, this approach inherently requires that my inputs are complete and accurate. Accuracy is of utmost importance, which means I need to stay updated with business news, carefully read public filings, and thoroughly analyze any potential value gaps. This approach almost turns investment research into an intriguing puzzle to solve, making it quite enjoyable.

The Six Rules

If I can’t put a price on it, I can’t buy it

In other words, when something appears to be undervalued, I need a clear understanding of why this particular asset is deemed 'inexpensive.'  I’ve found that assessing the viability of the typical well-established profitable (or bluechip) companies—where projecting future cash flows and discounting them to their present value is the norm—are harder for me to accurately evaluate. For instance, knowing the returns and final value of a bond over upcoming years until maturity, I can calculate its present value with precision. However, personally, forecasting future cash flows for most companies is much harder and error-prone. Moreover, these companies also usually sell for a hefty premium which I can’t stomach paying. 

However, I’ve found that scenarios like liquidations or securities trading at a negative enterprise value, combined with specific special corporate events, offer a clearer landscape for valuation. This clarity makes it more feasible for me to establish a price.

Opportunity Cost

Nearly every decision I make is influenced by its opportunity cost. Time and the available amount of money are the two finite constraints within my framework. Consequently, every decision becomes an equation of these two variables. If I have a range of “good” ideas, my responsibility becomes assessing which one warrants the greatest allocation of my time and funds. This perspective also simplifies selling decisions at times; if I anticipate another asset to yield superior returns within my expected time horizon, it might be logical to sell and redistribute funds.

Margin of Safety

Nearly all my investments come with a perceived margin of safety. I approach my position sizing by considering how much downside protection I have—essentially, how much I could potentially lose if things were to go bad. Fishing for a substantial margin of safety almost always makes this decision simpler.

Shareholder Oriented Management

The previous point sets the stage for this one. Misaligned management incentives can significantly erode value. When management takes actions that don't align with the best interests of shareholders, it diminishes the perceived value gap; a situation I aim to avoid. This is also why I value indicators like insider ownership and near-term management pay structures, as they often reflect the alignment between management and shareholders.

The Rare Birds

I borrowed this terminology from Michael Burry’s strategy blueprint. Essentially, ever so often (think Netflix or Adobe in 2022), companies with strong durable advantages and a history of delivering high returns on invested capital emerge at attractive prices. I think of these as companies that could fit on Chuck Akre’s “three-legged stool”. These opportunities might arise due to pricey acquisitions or temporary capital expenditures, but if they don’t seem detrimental to the company’s long-term prospects, I’m happy to include them in my portfolio.

Managing the Portfolio

Given the nature of my holdings, managing my portfolio becomes just as crucial as selecting stocks. While investing in a company on the verge of a special corporate event, it becomes imperative to keep up with the company news and SEC filings and reevaluate the thesis incrementally. If the actions taken by the management deviate from my thesis, I’m happy to sell and move on.

On Selling

I’ve found selling particularly difficult to do and it is something I’m still learning and trying to get better at. Buying has just one objective, you lay out some cash today to get more in the future. However, selling involves a range of considerations––taxation, trimming an oversized position, selling to buy a different enterprise, and more. Looking back, I've sometimes sold prematurely or held onto positions for too long.  While there’s no easy answer to this one, I appreciate Joel Greenblatt’s tip: “Trade the bad ones, keep the good ones”.