In this article, I will discuss my philosophy for investing in individual stocks. I will present my current stock portfolio, built around my investment philosophy and will discuss how the portfolio has fared in the year gone by.

Investment Philosophy

My investment philosophy can be summarized succinctly as “contrarian value”.  My investments have historically geared towards businesses with strong financial history coupled with some form of near-term bad news, impacting the share price on the downside. In general, I look for companies that satisfy several  of the following criterion:

• history of high gross margin (>30 %)
• history of high return on equity (ROE) (>20 %)
• history of high return on invested capital (ROIC) (>15 %)
• businesses making intelligent use of debt vehicle that ultimately drive towards ROE > ROIC.
• Companies with history of operational efficiency as quantified by turnover metrics, in particular: inventory turnover and receivables turnover.
• Consistent increase in book value in atleast 5 of the last 10 years
• history of opportunistic share buy backs and
• at the time of investment, are trading at sufficient discount to intrinsic value

Except for some unwarrented circumstances, I have tried to construct my portfolio of stocks under the following constraints:

• concentrated (no more than 15 companies in the portfolio at any given time)
• holding period ranging anywhere from a minimum of one year to forever and
• equity holdings in any one stock limited to 15 % of total portfolio assets

I also expect to ocassionally partake investment opportunities in the derivatives markets. In a particularly frothy market, if gains in my holdings exceed my expectations, I may sell covered-call options. Similarly, if I find opportunities for large investments in equities that are not currently trading at my desired value, I may sell put options on the stock in anticipation of owning the stocks when prices fall to my expectation levels.

I may also from time-to-time engage in speculative investing opportunities, allocating no more than 5 % of my investible assets. These forms of investments will be limited to equity investments wherein I foresee an opportunity for >100 % returns on investment (ROI).

Expectations on performance of my Investment Portfolio

Now that I have presented a high level summary of my investment philosophy, let me make some observations on what outcomes I can reasonably expect from my investments.

For starters, I want to note that the most critical aspect of my investment approach is qualitative, i.e., analyze the impact of short-term bearish view surrounding an otherwise good business. This necessarily mandates viewing stocks as “part ownership of businesses” and paying particular attention to management of the business. A consequence of which is that when I invest in a particular business, I usually stay put for the long haul.

Macro measures such as Price-Earnings (PE) ratio do not matter much to my investment style. It is quite possible that my approach may identify stocks trading at high Price-Earnings multiple but still can be considered fairly valued from future-earnings potential point of view.  In that sense, my investment style is strongly influenced by the modern Buffet-Munger approach of seeking out good businesses trading at fair value.

Given that I tend to purchase recently-out-of-favor stocks, for my method to succeed, it is very important to estimate the impact of negativity surrounding a given stock and determining how much of the negativity is baked into the stock price. Momentum on the down side plays a big part in timing the purchase of these stocks. There is a signficant chance that after I pull the trigger on stock purchase, driven by momentum, the share price may slide down significantly below my prior purchase price.  In situations such as these, I may average on the downside, upto a point of reaching the maximum allocation limit described above.

In a raging bull markets, as the one we are currently experiencing, my style of investing is expected to fair poorly in relation to broader markets (S&P 500 index), though the market tailwinds may still produce net positive return on investment. However, I fully expect to beat the general markets in down market cycles.

Another problem that I for surely will face in environments such as the one we are currently experiencing, is that investing opportunities will be far and few between. The consequence of which is that I may end up with large cash position in my portfolio.

That said, let me now summarize my stock portfolio:

Investment Portfolio as of Dec 31st 2017

Some comments on my positions as it stood at the end of 2017:

1. Cash portion of my portfolio is quite high. In the current market environment, new investment ideas for me are hard to come by. I am therefore willing to sit on the sidelines and wait for opportune moment to be fully invested again.
2. One of my holdings, Chipotle currently stands at the upper limit of my threshold for investment in any one equity asset. I will elaborate on this situation further below.
3. I have one short position in Wells-Fargo at stike price of $60 (shown in red).
4. My position in Fitbit is a speculative bet.

Chipotle… Its been a tough year

Chipotle is currently my biggest investment position.

Given that my investment in Chipotle currently stands at the very high threshold of investments for any one company, I want to share some insights into my thinking for investing in Chipotle.

I first started investing in Chipotle in the 3rd quarter of 2016, about a year into the e-coli breakout at several of Chipotle restaurants. The impact of the breakout was that the shares of Chipotle shed nearly 50 %  in value, falling from a high of about $750, to around $360 in late Nov of 2016.

This precipitous drop in share price attracted my attention. As I dug into the numbers, it did not take much effort to realize how profitable Chipotle had been. It produced excellent margins and ROIC for several years prior. The book value per share had consistently increased and there was a significant potential for growth in the upcoming years, but for the e-coli incidence. For example, Chipotle has fractional number of stores relative to McDonalds and had (at the time) strong plans to increase the store count significantly. Chipotle also had  no international presence nor until recently, online presence as well. Furthermore, the brand name is a premium in the fast-casual food-industry. Not to mention, I love eating at Chipotle. In Nov of 2016, it seemed the e-coli incident was history, the blood bath had stopped and the stock had stabilized around $360.

All of the above fit perfectly into the type of stock that I would want to put my money into. For the first 3 months of the year, it seemd my decision was spot on.  The stock rose in the early part of the year, rising to a peak of $499 by end of first quarter of 2017. But then things turned ugly rather quickly. The first piece of bad news coming out from Chipotle management was that they were increasing spending on advertisements. Later on, their well-publised forey into queso received muted response. And to top it all, Chipotle continued to struggle with  random food borne illness issues through the year. All in all, the stock took a beating through 2017, reaching a nadir of $263 at one point in time.

In the spirit of Buffet quote, “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”, I kept on investing into Chipotle stock through the year. I echo the views of Bill Ackman, in that Chipotle’s current problems are eminently fixable and that the Chipotle brand and the Chipotle concept is still alive and kicking.