Low Risk, High Return
This article is a bit technical, but we’ll start with some basic principles. You don’t need to absorb all the (slightly) technical details in the next few sections. The principles behind the small technical stuff, however, are timeless and (at worst) are good reminders in your investing journey. This is not a laundry list of best practices; this is just a simple explanation of our Investability Ratings and, by extension, our investment process. We’ll start with a bit of a ramble – to keep things real.
We practice Sleep-Well-At-Night (SWAN) Investing. This means we abhor Risk. But we also want High Returns. And we don’t think that’s too good to be true. What is Risk? The probability and magnitude of permanently losing money – this comes from “thesis risk” OR the risk of getting our investment thesis totally wrong OR the risk that we invest even though we don’t know what we’re doing. What are high returns? We shoot for 10-15% annualized returns over the long-term (5 years or more). So far, so good. So, again, low risk, high return. But this is impossible, you say. No, it’s hard but not impossible. We’re looking for Positive Optionality – paying very little for the believable chance of high returns. If we don’t generate high returns, we shouldn’t lose much money. And so, we sleep well at night.
The concept of Positive Optionality is not new. It’s basically about access to high returns at low cost – like Options on stocks. Every sane investor in the world wants this profile – high return, low risk. But quantifying this profile is not straightforward in the plain, old, boring, vanilla equities world. But we this tradeoff make it tangible through our investment process. We start by reducing Risk. That starts with Thematic Thinking.
Thematic Thinking ensures that we don’t play the wrong sport. Essentially, we don’t want to invest in the best buggy-whip company when a horseless carriage is right around the corner. We look for opportunities in high-growth vectors – global forces that are (almost) certainly bound to enhance our civilization exponentially over the next few decades.
The problem with Thematic Investing is that companies (and their stocks) within those themes are often overpriced. There is so much exuberance about some of these high-growth vectors – like Artificial Intelligence or Autonomous Vehicles or Renewables – that it is (somewhat ironically) risky to invest in them. That’s why we’ve developed the Buylyst Investability Ratings system – to make sure we keep our risk low while keeping the doors open for high returns.
The Buylyst Investability Rating is NOT about finding the cheapest stocks in the market. Most stocks that are cheap…are cheap for a good reason. And stocks of companies that are the prime agents of change – of spearheading these high-growth vectors that promise to significantly enhance our civilization – have a lot of froth built into their price. So, we designed our Investability Rating system is about finding those rare agents of change that don’t have froth built into them; because these cases are rare, our portfolio is, unsurprisingly, limited to 20-25 stocks of companies that we believe are SWAN (sleep-well-at-night) investments.
“Invert, always, invert.” – Charlie Munger
Our system is built upon the principles of Expectations Investing – a term conceived by Investment Research guru Michael Mauboussin. He suggested that instead of making precise forecasts of revenues and earnings in a deterministic valuation model, it’s better to flip the question as ask: “what does the current market price have baked into it?” The question our Investability Ratings system aims to answer is: “How much Revenue Growth do we need to believe to buy this stock?”
Our Watch List is based on this key question. This is how our Watch List looks inside:
In the next few sections, we’ll pop open the hood and show you how we do it. Subscribers have full access to our Watch List. For a full, detailed bedrock of principles on investing that we’ve acquired through reading, observing, investing, and blood, sweat & tears, please consider reading 10 Hard-Earned Lessons in Investing.