As much as I love the S&P 500, my portfolio would be pretty boring if I didn’t invest in anything else. With that said, I like to invest 10% of my portfolio in different stocks that I come across from time to time. That’s not to say that every idea is great. I am not a perfect investor, and even the best fail. I still think it is fun to diversify my portfolio with different stock ideas.
While there is no one right way to invest, there are plenty of wrong ways. For instance, people have been trying to emulate Warren Buffett for decades now. He is a “buy and hold” investor that identifies high performing companies that he plans to hold on to forever. There are other people like Peter Lynch, who buy companies that they base on knowledge and gut feelings. Lynch use to say if his back started to hurt that he knew it was time to sell.
In terms of my own investment philosophy, if I buy a company, I need to personally like the company and feel comfortable with their management. There are companies out there that I would never frequent, even if the financials look promising.
A good example of this is Harley Davidson. Although an iconic motorcycle brand, I don’t know anything about motorcycles nor am I interested in them, which makes it difficult to determine the long-term prognosis. I also don’t know anyone who drives a Harley. I’m not sure if that’s because I run in a small circle or because this brand appeals to people twenty years older than me. Like I said, I understand that this criteria may limit me, but that’s okay. I’m only risking 10% of my portfolio, so I’d rather feel good about the risk I’m taking.
In some ways, investing is like legalized gambling. I have had friends that have asked for my advice on which stocks to pick and how to make quick money in the market. So, I’ll share my strategy for selecting stocks and also give a couple specific examples of stocks that I am currently invested in.
I read as much as I can about the company and what people have to say about it. I even read reviews on Glassdoor to read what employees say about the company culture and their views of management. If people hate going to work for a company or the CEO has a poor reputation, I am much less prone to investing, even if the numbers look good.
Now let’s consider financials, which is what most professional investors focus on. I love companies that pay dividends, so that I can reinvest the cash into more shares. I also make sure the company can afford to make the payment each quarter. There are some companies that unfortunately need to borrow money to make the dividend payment. To me, this is robbing Peter to pay Paul. I believe it is too risky of a strategy, and I’m not comfortable with it.
I look for companies that have zero debt or as close to zero as possible. I personally do not like debt and therefore favor companies that can grow without the need to take on debt. This may be a really stupid criteria to some people, but it has worked well for me.
Downturn in the Market
The last thing that I want to see is a downturn in the market and for the company to go bankrupt or to see their shares drop significantly because they are running out of cash. If you remember in 2008, Warren Buffett was lending companies tons of money when the banks couldn’t due to the cash crunch. Remember the deal that he made with DuPont? DuPont was in a cash crunch and agreed to borrow three billion dollars to finance a purchase of chemical makers Rohm and Haas. Warren Buffett received preferred shares and a 8.5% annual payment. This payment was suppose to go away when DuPont stock reached $53.72 for 20 days during a 30 day trading period. In the seven years since, DuPont stock has not traded above this mark. Remarkably, DuPont is still paying him a interest payment of $225 million each quarter, or $8 per second of the day. Like they always say, “cash is king”.
Another criteria that I look at is how the company survives during downturns in the market. I like to see the balance sheet, income statement and cash flow statement. Were they able to still be profitable during this time? Did they take a dip in their sales and revenue and by how much? While I understand that this past performance is not always indicative of future performance, it gives me an idea of what the market thought about them during volatility. I don’t make a decision solely on this information, but it gives me more of a complete picture of the history of the company.
Finally, I like to see what the company has done as a benchmark against the stock market. Again, I’m a broken record by saying past performance is not indicative of future performance. This just gives me a benchmark to see how the company has performed relative to the broader market. If the company has beaten the S&P 500 each year for the past five years by two percentage points, I dig further to understand why.
For instance, there was a company that I was researching called Cal-Maine (stock ticker CALM) that owns 25% of the fresh egg market. I was trying to understand why they were doing so well compared to the S&P 500. In my research, I found that the Avian Flu had wiped out much of the hen population. This caused a spike in egg prices and caused CALM stock price to shoot up. As I continued to read, I found that the hen population was slowly rebuilding and that while it may be a great long-term stock to own, the stock price could stay down for the foreseeable future.
While those are the criteria that I look at, by no means do I encourage anyone to invest like I do. I simply wanted to explain why I invest the 10% of my portfolio the way I do. With that said, a couple of years ago after I had significantly funded my retirement portfolio, I decided to learn more about the stock market. After reading tons and tons of books like The Intelligent Investor and Motley Fool Million Dollar Portfolio: How to Build and Grow a Panic-Proof Investment Portfolio, I decided that I wanted to be like Warren Buffett and buy a near monopoly with a huge moat that wouldn’t get disrupted by changing technology. But then again who doesn’t 🙂
Rollins & Chipotle
In my reading and researching more stocks than I’ll ever remember, I stumbled across two pest control companies that basically own the pest control market. During my research, I could not find a disruption for pest control. People are constantly looking to combat rodents, insects and especially mosquitos nowadays. After scouring through the financials of Rollins (owners of Orkin) and Servicemaster Global Holdings (owners of Terminix), I felt comfortable with the direction of Rollins, specifically because they do not incur any debt. While it’s only been a short while, I hope Rollins continues to outperform the competition for years to come.
With that said, I did make a mistake when I bought Chipotle. I thought the stock was oversold during the E. coli outbreak and thought that traffic would quickly bounce back based on previous E. coli outbreaks at Jack in the Box, McDonald’s and Taco Bell. While all of them took a hit at one point, I bet today you don’t think of E. coli when I mention these companies. At the time I bought, Chipotle shares were down more than 33% of their highs. I thought this would be a good time to buy a quality company for a discounted price. However, in the short-term, this has not been the case, as Chipotle shares have fallen another 20%. While I am glad I am not a short-term investor, I am unfortunately gun shy about buying anymore shares in Chipotle at this time.
Now, here is the full gambit of “fun stocks” that I own:
|AWK||American Water Works|
|AWR||American States Water|
|NNN||National Retail Properties|
|QQQ||PowerShare QQQ (ETF)|
|XLE||Energy Select Sector SPDR (ETF)|
Yes, utility stocks like water and energy are “fun stocks” to me. You might wonder how I am doing with these stocks. I’m actually doing pretty well. I am currently beating the market, as you can see below. While history will say that overtime I should theoretically lose, below are my returns from this year and last year. Keep in mind that I only allocate a small percentage of my portfolio to this endeavor.
This Year’s Returns
Last Year’s Returns
Do you invest on your own? Do you pick out your own “fun” stocks? How are you doing compared to the S&P 500? Share your thoughts below.