Wealthyness Weekly — 2: Stocks and Valuation

Welcome back! I will be starting each week with a quick review of changes in value and composition for my portfolio. If you are interested in the composition of my portfolio, review my week 1 post! I will be periodically (likely once per quarter) be updating composition details for those that are not following weekly. I will also be talking about how I approach stock investing. Happy reading and happy Wealthyness!

Week 2 in Review

Updated Totals and Change for my portfolio

Stock Investment Account (-$2K)

Not a lot of change this week as markets were generally flat. There were some notable outliers like Tesla Motors (TSLA) which saw a large dip after announcing Q2 shipments but in general, the markets were uneventful. The next big catalyst for my portfolio will be around Q2 earnings (mid-July to mid-August). The entire drop in my portfolio this week was around my Walmart call options. I may have been slightly trigger happy in intiating my position but since my option expires in January of 2018, I am planning on re-evaluating them after Walmart posts their Q2 earnings.

Cash (-$5K)

My cash account saw some changes, and more than the $5K change would suggest. On a more personal note, I am planning to get engaged with my GF and purchased a ring! I am also going through the process of closing on a rental property (probably talk about this when it closes). The negative outflows of those two activities were partially offset by my salary.

My Philosophy on Stock Investing

If you took a look at my stock portfolio composition, my major investments (MELI, NFLX, TWOU) are primarily “blue sky” opportunities or companies that are changing how consumers behave. They are also very long-term. I have very infrequently dabbled in more short term investing/trading and have not done very well. I think this is due to my “edge”.

What is “edge”?

The father of value investing, Benjamin Graham famously said “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” I find his quote to be a very good analogy and mirrors my understanding of the stock market.

I see the stock market as millions of investors that each have their own sources of information and decision making processes that results in their view of the price for any asset. The “market” combines all of these prices together to get the market price. As more information is obtained (through in depth research, current events, earning announcements etc), the price each investor will pay starts to shift and the market price shifts in response. I define an “edge” as when someone has a better information, better analysis or something that makes their price prediction more accurate than other market participants.

As an individual investor, I do not have the best access to information or in depth research, or even information from earnings announcements. There are tens of thousands of professionals (buy-side, sell-side investors etc) that spend 12 hours a day keeping up to date on each stock. I also do not have the most sophisticated decision making processes (eg portfolio management, hedging strategies, risk management etc). How can I compete when I maybe dedicate a few hours every week? These are all areas where I do not have an “edge” over other market participants.

So where do I have “edge”?

From my experience as a sell-side analyst on wall-street, I noticed a very obvious pattern. Hedge funds generally care more about current events and every single news item relevant to a stock. They are also more active in changing their portfolios and hold stocks for a shorter amount of time. Mutual funds, on the other hand, care a lot less about current events and news, and are more focused on market analysis, competitive analysis and business model analysis. They are also generally less active in changing their portfolios and hold stocks for a longer amount of time. Both models have very successful examples (E.G. SAC and Fidelity).

Given how much time I have to spend on stock investing (not a lot), I have decided to focus more on long-term investments. Spend time on analyzing markets, consumer behaviors and business models and other analysis that could be relevant and valuable for multiple years. I want to develop my “edge” here.

A Brief Example: NFLX

So what does this look like? Lets take Netflix as an example. I start with some core assumptions based on my view of the video market:

  • Catalog viewing model is more compelling than linear programming. It gives viewers more freedom and allows them to extract more value from their service.
  • Content purchasing costs are somewhat fixed and benefit from scale
  • The market can sustain more than 1 dominant player
  • Traditional cable companies are disadvantaged in online video services due to (1) company culture, (2) inability to attract digital talent (3) burden from existing content agreements (4) smaller scale and (5) a need for higher price service longer-term as it is replacing an existing high prices service.

You will want to create assumptions on your own, based on data and analysis. For now, if we take my assumptions as a base, it seems like Netflix is well suited to (1) take subscribers from cable companies, who will be slow and ill-suited to compete, (2) be resilient to competition due to scale benefits and (3) be okay even if competition increases unless they are 3+ viable players in any market.

Given these conclusions, I can make a subscriber model for Netflix, estimate average revenue per subscriber and a rough operating margin assumption and come up with a price for the stock.

My “edge” in this process lies in the underlying assumptions. Those assumptions come from working in the tech industry and in a company, my background in finance, and my experience as a consumer of video services.

That is it for this week. Leave a comment if you liked the read and/or have any questions. Looking forward to seeing you all next week, where I will be talking about how I am approaching real estate investment.