Based on my observations from years in cash management at a major Canadian financial institution, I saw that Corporate bankers would occasionally switch industry coverage. I can’t recollect, however, a Corporate banker transferring to or from Mining industry coverage or Real Estate coverage.
It just seemed like lending to companies in those spaces required a different mindset; the members of those coverage teams spent years developing the expertise required to properly assess companies within these two industries; I also viewed these industries as being cyclical and volatile. I wanted to avoid this.
Some readers might suggest that if I wanted to avoid cyclicality and volatility I should have also eliminated investments in the oil and gas sector. I, however, decided that companies like Exxon (XOM and Chevron (CVX) [both of which are Dividend Aristocrats]should not be excluded from my investment universe so I made an exception when it came to the world’s oil and gas behemoths.
I also excluded micro and small cap stocks from my universe of potential investments. While some investors reap outsized gains by investing in such companies, my risk tolerance level is such that I will lose sleep at night if I invest in this space.
Back in the 1990s, when I narrowed down the universe of companies in which I would conduct research, I had no idea what were Master Limited Partnerships, Business Development Corporations, Closed End Funds, REITs, and Equity REITs. Over the course of time, as I learned more about these types of investments, I also eliminated them from the universe of companies in which I would invest.
I have no interest in investing in entities in which a significant portion of cash flow is paid out to unit holders. I wanted to invest in companies which generate copious amounts of free cash flow (FCF) that can be used to grow the business (organic or acquisition), to repurchase shares, to repay debt, or to increase the dividend at rates well in excess of the rate of inflation.
In addition, I wanted to invest in great companies which are priced fairly. I had no interest in investing in mediocre companies which are priced well.
It also dawned on me that if Buffett or Munger, two of the brightest investors, rarely touch Master Limited Partnerships, Business Development Corporations, Closed End Funds, REITs, and Equity REITs… why would I?
Most recently I have also added marijuana and crypto currency companies to the universe of companies which have absolutely no appeal to me.
I was ready to build my portfolio once I had:
Eliminated certain types of corporate structures
- Identified the industries which hold the greatest appeal to me from a risk/reward perspective
- Determined the appropriate size of companies (market cap) for me
- Satisfied myself that sufficient shares are traded on a typical trading day (I avoid thinly traded stocks)
- Determined the key metrics I would analyze prior to making any investment (eg. credit ratings, free cash flow, dividend growth, dividend payout ratio, valuation metrics such as EPS, adjusted EPS, price/earnings)
Current Portfolio
While I disclose the FFJ Portfolio holdings on my site, the vast majority of my holdings are kept confidential.
On January 31, 2018, my wife and I held shares in 52 companies. The top 10 companies comprised 52.753% of the market value of our holdings.
Portfolio holdings
The next top 10 holdings comprised 21.216% of our portfolio. I strongly suspect that if I disclosed the names, you would be familiar with most, if not all, the companies.
There you have it. Twenty companies make up ~74% of our entire holdings.
The remaining ~26% is also made up of well known names although some readers may not recognize names such as Broadridge (BR), CDK Global (CDK), or Intact Financial (IFC). I am certain, however, everyone is familiar with Nike (NKE), United Technologies (UTX), FedEx (FDX), McDonald’s (MCD), and Microsoft (MSFT).
Volatility
The reason we selected our current holdings is not just because they have competitive advantages or because they generate strong free cash flow. It is because in days similar to those experienced in early February 2018 we really don’t care if the stock prices drop precipitously.
Just because 3M (MMM) and Johnson & Johnson (JNJ), for example, fell more than 5% in value on February 5, 2018 does it mean these companies are in jeopardy of going under. If anything, I WANT share prices to drop because they become more attractively priced!
I have been waiting for a correction. In fact, in several of my recent posts [eg. United Technologies (UTX), Stanley Black & Decker (SWK), Honeywell (HON), Bank of New York Mellon (BK), etc.], I came to the conclusion these companies were overvalued.
In my opinion, investors are better off to just ‘stand at the plate and to let the pitches go by’. Now, I think the pitcher is getting tired and the pitches are starting to come up in the strike zone… the sweet spot.
Final Thoughts
After catching a 7 AM train to work and a 6 PM train home, day after day, month after month, year after year…I don’t do that anymore! I think this is partially attributed to the fact that years ago I adopted the ‘Rifle Approach’ to investing.
By no means am I suggesting this approach is the ‘Holy Grail’. I just know that if I had ‘thrown mud against the wall’ and had invested in companies that fell outside my investment criteria I might have one day found myself in the predicament of having to confess to my better 50% that I did an investment “Ooops!”. I don’t need to mess up with our investments to create “Ooops!”. I have lots of other ways of creating them.
I wish you all the best on your journey to financial freedom.
This article was republished with permission from Value Walk.