TWTR – Page 2 – Paul Vs The Market

The Freedom Portfolio – January 2019

January 1, 2019 paul.essen Comments 15 comments

Ouch.

It’s hard to think of any other way of describing the start to the Freedom Portfolio. It’s also hard to think of a better way of describing the performance of the stock market over the past month. As of the time of this writing, the all-time high for the S&P 500 was September 20th, 2018. That was about a week and a half before the official start of me tracking the performance of the Freedom Portfolio. I couldn’t have picked a worse starting time if I tried.

The S&P 500 opened at 2926.29 on October 1st and closed at 2506.85 on December 31st. That’s a return of -14.3% over the quarter, which is a pretty extreme downturn. During that same time, the Freedom Portfolio is down 22%, which is obviously even worse. Here is a breakdown of the performance by position:

Ticker	October 2018	January 2019	Percent Change
TSLA	305.77	332.8	8.84%
TWTR	28.51	28.74	0.81%
TCEHY	41.04	39.47	-3.83%
OAK	41.54	39.75	-4.31%
DIS	117.28	109.65	-6.51%
KSHB	5.965	5.37	-9.97%
MKL	1195.79	1038.05	-13.19%
GOOG	1199.89	1035.61	-13.69%
MELI	343.84	292.85	-14.83%
AABA	68.54	57.94	-15.47%
ISRG	575.15	478.92	-16.73%
SHOP	166.44	138.45	-16.82%
BLX	21.02	17.3	-17.70%
ILMN	369.15	299.93	-18.75%
JD	26.03	20.93	-19.59%
RDFN	18.56	14.4	-22.41%
AMZN	2021.99	1501.97	-25.72%
AX	34.89	25.18	-27.83%
NFLX	375.85	267.66	-28.79%
BIDU	230.81	158.6	-31.29%
NVTA	16.75	11.06	-33.97%
NVCR	52.94	33.48	-36.76%
BZUN	49.3	29.21	-40.75%
TDOC	86.78	49.57	-42.88%
SQ	100.8	56.09	-44.36%
ATVI	84.18	46.57	-44.68%
IQ	27	14.87	-44.93%
NVDA	284.16	133.5	-53.02%

I would be lying if I said that I wasn’t disappointed to be starting off this way. Obviously I would have preferred to have been up versus the market, but at the same time I am absolutely not worried at all. I have a 20+ year investing time horizon in front of me before retirement. Measuring the Freedom Portfolio’s performance after one quarter would be like judging an NBA game after 30 seconds of play or a baseball team two games into the season.

In fact, not only am I not worried, but a part of me is glad to use this opportunity as a teaching opportunity. While it has been hard to tell for the past 10 years, the stock market is risky. It doesn’t always go up. Sometimes it goes down, and sometimes it goes down a lot and goes down fast. Taking on that risk doesn’t just mean getting higher returns, it also means accepting the fact that sometimes you will get negative returns, and that can be painful. Nobody likes to see their money disappear into thin air, no matter how much they accept that it’s the trade-off for higher returns.

Measuring the Freedom Portfolio’s performance after one quarter would be like judging an NBA game after 30 seconds of play or a baseball team two games into the season.

Okay, so losing money might be expected, but how does that excuse the Freedom Portfolio not only losing money but also losing to the market? Doesn’t this prove I would’ve been better off with index funds? Not at all. I believe that the same reason why stocks outperform other investments over the long term (risk vs reward) is the same reason the Freedom Portfolio will ultimately outperform the market. Yes, stocks under-perform during down periods, but they over-perform during up periods, and thankfully those up periods outnumber the down ones. I believe the case will be the same with the Freedom Portfolio. When the market is down, the Freedom Portfolio will do even worse, but my hope and expectation is that when the market is up, the Freedom Portfolio will do better, and over the long run those up periods will more than make up for the down ones.

In fact, I even predicted this a few months ago:

Furthermore, I entirely suspect that in a down year, I would see my individual companies drop more than the market by virtue of the type of companies I tend to favor. I fully expect that there will be years where I lose to the market, sometimes badly. The hope is that over the long term, those years are more than made up for by the up years.
– What is Paul vs the Market? by Paul Essen, September 6, 2018

So while this start is certainly disappointing, I can’t say it’s entirely surprising. We were in the midst of the longest bull market in US history, and while I still don’t believe in trying to time the market, it does seem safe to say that we were overdue for a downturn. My confidence is completely unshaken and it won’t be shaken even if there is another quarter or two where the Freedom Portfolio under-performs. Risk goes both ways, and times like these are the price we pay for out-performance in the good times.

Notable performers

Worst performers

nVidia (NVDA): Remember the cryptocurrency craze around 12 months ago when everybody was trying to work “blockchain” into their business model and people were losing their mind over things like bitcoin and ethereum and ripple? Well, prices eventually fell back down to Earth and not too many people are talking about cryptocurrencies anymore. So it probably wouldn’t have been great to have invested in a company that was in any way related to cryptocurrency, huh? Well, unfortunately, nVidia got caught up in the cryptocurrency craze. How? Because it turns out that the GPUs that they are so good at making are great to use for “mining” cryptocurrencies. So while the craze was building, their product was flying off the shelves faster than they could restock them. Once prices crashed and it no longer was profitable to mine for cryptocurrencies (and yes, I realize I’ve used that word a lot and I am looking forward to not having to type it again for a while), demand dried up in a hurry, which caused a giant inventory headache for nVidia as they now had a bunch of GPUs that they couldn’t sell. That’s why their market cap has been cut in half (and then some) over just this past quarter.

I actually got pretty lucky with nVidia in that I had sold roughly half of my position earlier in 2018 (before the formation of the Freedom Portfolio) because I was concerned about what the collapse in cryptocurrency prices would do for demand for their chips. Even I didn’t see a 50%+ drop happening, though (otherwise I would’ve sold my entire position). I still think nVidia is a compelling company, though, and they very clearly still have a lot of growth opportunities ahead of them in that have nothing to do with cryptocurrencies. I’m not necessarily interested in buying here, as I want to see evidence that they’re working through their inventory problem first, but it’ll be on my watch-list for potentially adding to later in 2019.

Square (SQ): One thing that I think the world needs more of is for people to be willing to say, “I don’t know” instead of wildly speculating on things. I’ll go ahead and start: I don’t know why Square is down so much in the past few months other than to point out this interesting fact: Despite being down 44% in the part quarter alone, Square is still up roughly 50% for the year. The best explanation that I can come up with is that the stock had gone up too much and gotten too detached from the business fundamentals, and so when a downturn came it also got hit the hardest. As near as I can tell there are no meaningful changes to the underlying business, so I’m excited to see what Square does when the market turns around again.

iQiyi (IQ): Another one where it is a little hard to separate changes to the business from general market craziness going on around it. iQiyi has had quite a year. It started off with a disappointing IPO where it ended up down around 13% when most IPOs end up with a strong first day. Within the next three months, though, it would go on to nearly triple from its lows. Since then, it’s been a long, slow decline basically back to where it was shortly after the IPO. I suspect the craziness with the US/China trade war and general unease over the health of the Chinese economy might be having a stronger effect on iQiyi’s stock price than any fundamental changes in the business. This is another one where I am excited to see where it goes when things calm down some.

Amazon (AMZN): This might be a surprising pick for being mentioned among the worst performers. Why pick on Amazon (down 25%) when there are bigger losers like Activision Blizzard (ATVI) or Teladoc (TDOC)? Simple: Because as the only Babylon 5 level position in the Freedom Portfolio, Amazon has an outsized impact on my performance. Amazon alone accounted for 20% of the losses of the Freedom Portfolio this past quarter, or more than twice the amount that nVidia accounted for. I hate to sound like a broken (ignorant) record, but I’m a bit at a loss as to why Amazon lost a quarter of its value over the past few months (other than some strange sense of literal symmetry of losing a quarter over a quarter). If it wasn’t already such a large position in the Freedom Portfolio, I would absolutely be looking at adding more. As it is, I’m looking forward to Amazon leading the charge when market conditions do improve.

Best performers

Tesla (TSLA): What a wild ride for Tesla the past few months have been. While they did have an awesome third quarter where they were surprisingly profitable, Tesla’s relatively good performance over the past quarter is honestly more due to lucky short term timing. At the start of the quarter Tesla was suffering from a lot of negativity around Elon Musk’s notorious “Funding Secured” tweet and potential SEC actions as a result. While the stock has been all over the place, at the end of the year it ultimately ended up virtually unchanged from where it was at the beginning.

Also, while I am still a big believer in Tesla over the long term, I worry that 2019 could be a tough year for them. Federal tax incentives to buy electronic vehicles get reduced in 2019 and Tesla made a big push to pull forward as much demand as possible before the end of 2018. They no longer have a massive backlog of demand to fulfill and international expansion could be complicated by the trade war. I wouldn’t be surprised to see a short term struggle for Tesla in 2019 similar to what nVidia went through in terms of dealing with the cryptocurrency bubble.

Twitter (TWTR): Just barely squeaking in with a positive return, 2018 was a weird year for Twitter. Halfway through the year everything seemed to be going great and sentiment finally seemed to be turning around. Then, Twitter seemed to get unfairly lumped in with Facebook and seemed to get punished in unison. I’m still pretty bullish on Twitter’s future, although I am starting to worry about the daunting task in front of them in terms of balancing free speech while also curbing harassment and making twitter a less toxic environment. I know it’s an incredibly difficult task, but management seems to have made some missteps so far which makes certain groups of people feel like they are being censored and that Twitter is taking sides. It’s a potential stumbling block to keep an eye out for.

Disney (DIS): Disney’s 6% loss might not look all that great, even in comparison to the S&P 500, but I think Disney is set up for a big 2019. Much of the past year has been spent preparing for a big transition to video streaming and also dealing with the acquisition of Fox. While there is still work to be done, I’m hopeful we’ll start seeing the fruits of some of those labors in the coming quarters. I’m expecting some big things from Disney in 2019.

Changes in the portfolio

I consider myself a long term, buy-and-hold investor, but that doesn’t mean I’ll never make any changes to the Freedom Portfolio. This quarter had more turnover than I expected due to a lot higher volatility than I expected. In the future, I hope to have fewer buys and sells to report on.

Sells

Alphabet (GOOG) – Sold entire position: There have been a lot of negative headlines around Google the past year or so. It started with James Damore’s memo and the resulting controversy over if Google has a problem with diversity, both ideological and otherwise. Then there has been a lot of scrutiny (both internal and external) about the secretive Dragonfly project and how Google might be considering trying to re-enter the Chinese market with a censored search engine. Google elusiveness over addressing whether or not it was planning to re-enter China along with their strange decision to de-emphasize their “Don’t be Evil” motto certainly did little to allay fears. Next came accusations that Google hasn’t always handled accusations of sexual misconduct in the best way. All of this happened with the backdrop of co-founder Larry Page’s strange absence.

None of these issues alone would’ve been hugely concerning, but taken together it’s certainly worrisome. Perhaps even worse, though, has been the response to them. I like to invest in companies which I believe have strong management, and I’ve been underwhelmed by Sundar Pichai’s handling of most of these incidents.

Lastly, and perhaps most importantly, is that I just don’t know if Google is quite the revolutionary disruptor that it once was. They’re playing catch-up in the fields of cloud computing and home voice assistants. Google Glass was a giant flop and nothing earth shattering has seem to come of any of their moonshots yet. Considering its head start, YouTube feels like it should be a bigger player along with Netflix and Hulu and Amazon Prime. Waymo might still be a game-changer, but it seems like rivals like Tesla and Uber are quickly catching up.

Oaktree Capital (OAK) – Sold entire position: This one should have a bit of an asterisk next to it. Why? Because while I did sell all of my shares of Oaktree Capital in the Freedom Portfolio, I ended up buying some outside of the Freedom Portfolio as part of my emergency fund. You might recall me writing about emergency funds a few weeks ago. The resulting discussion got me to thinking about the idea of mixing some stocks into my emergency fund and Oaktree’s dividend yield of around 7% made it look like an enticing stock to experiment with. So while Oaktree is out of the Freedom Portfolio, I do still hold some shares.

Twitter (TWTR) – Sold small part of position: The sell was motivated by the fact that there were other things I wanted to buy and I had no cash available. Twitter was chosen for two reasons: (1) It had held up better than most during the recent volatility and (2) the concerns listed above about the balancing act between free speech and reducing harassment. My confidence in Twitter took a tiny hit the past few months and this seemed like a good way of representing that.

Tencent Holdings (TCEHY) – Sold some: Like Oaktree, this one should also come with an asterisk. Why? Because while I sold half of my Tencent holdings in the past quarter, I did it basically to keep my exposure to Tencent even while I bought…

Buys

Naspers (NPSNY) – Started a position: this. The following description of my trades gets a little into the weeds, so if you want the TLDR explanation, just know that this isn’t an indictment of Tencent at all and my exposure to Tencent should ultimately stay roughly the same.

The longer story is that Naspers is a South African company that has made a number of investments in various internet and media companies. Back in 2001 it made what is considered to be one of the most successful venture capital deals of all time by investing $32 million in Tencent, which was then a startup. That investment has now ballooned to be worth over $100 billion. Currently, Naspers owns about 31% of Tencent stock. Interestingly, even though Naspers owns more than simply their stake in Tencent, their own market cap is around $85 billion which is significantly less than just their Tencent stake alone.

This isn’t a completely crazy situation (another Freedom Portfolio holding: Altaba, trades at a similar discount to its stake in Alibaba) and there are some good reasons why that discount exists that involve factoring in taxes that might need to be paid if and when the companies liquidate their positions. There is certainly no guarantee at all that the gap between Naspers’ market cap and the value of their Tencent holdings will ever narrow. However, I liked the idea of taking a small chance on Naspers both to see if the gap does narrow, and to see if any of their other investments takes off in a similar fashion. They caught lightning in a bottle once with Tencent. Maybe they can do it again?

2u (TWOU) – Started a position: I’ve long believed that we’re in some sort of bubble in terms of higher education costs and I’ve been wondering if there is a way to profit from the inevitable bursting of the bubble. I’m still looking, but in the meantime, I’ve had my eye on companies trying to disrupt the education market. 2u is a company that had been on my radar for a bit now, but it popped back up when I heard it mentioned on a recent episode of the Rule Breaker Investing podcast. I was amazed to see how far it had fallen (even before the recent market drop) without any clear reason why, so I decided to dip my toe in and start a small position.

Uxin (UXIN) – Started a small position: I believe I first heard about this recent Chinese IPO on the Motley Fool’s Market Foolery podcast. I don’t want to go too deep into Uxin right now, so let me leave you with 2 important things to know about it: (1) It is the leading online used car platform in China and (2) it has been as low as under $3 a share and as high as over $8 a share in the past month alone. I bought my position two weeks ago and it is already down over 40%. This is an incredibly volatile stock right now and not for the faint of heart.

Square (SQ) – Added to my position: As I mentioned earlier, I can’t figure out any good reason why Square has plummeted so much during this downturn. I’m still a big believer in the long term prospects of the business and saw an opportunity to add some shares on sale so I took the opportunity.

iQiyi (IQ) – Added to my position: Pretty much cut and paste from above. I like the cut of iQiyi’s jib, and it’s inexplicable to me how this could’ve been run up to $45 and is now a third of that.

Teladoc (TDOC) – Added to my position: Teladoc was down over 40% this quarter, and unlike some positions down that big, there was a compelling reason why: their CFO resigned after some misconduct allegations. While it’s obviously not ideal and not a good look, I do think the business fundamentals remain unchanged and so I added some to my position.

THE FREEDOM PORTFOLIO – JANUARY 2019

So how does the Freedom Portfolio look now? Not too dissimilar, although there is a new Enterprise level position (hello Disney!). Need a reminder of what these terms mean? Check out: Defining my Terms.

Ticker	Company Name	Allocation	Performance*	vs S&P*
AMZN	Amazon	Babylon 5	300.84%	246.14%
NFLX	Netflix	Enterprise	443.28%	396.47%
SHOP	Shopify	Enterprise	209.96%	195.14%
DIS	Walt Disney	Enterprise	77.15%	-1.50%
TSLA	Tesla Motors	Serenity	53.76%	30.03%
MELI	MercadoLibre	Serenity	119.80%	92.46%
SQ	Square	Serenity	-11.62%	-3.23%
AX	Axos Financial	Serenity	148.98%	80.17%
ILMN	Illumina	Serenity	121.39%	96.05%
ATVI	Activision Blizzard	Serenity	21.39%	-5.95%
RDFN	Redfin	Serenity	-25.05%	-15.71%
TWTR	Twitter	Serenity	26.99%	-3.12%
JD	JD.com	Serenity	-21.44%	-8.01%
ISRG	Intuitive Surgical	Serenity	-11.55%	1.18%
AABA	Altaba	Serenity	-14.09%	-0.29%
IQ	iQiyi	Serenity	-29.97%	-22.34%
MKL	Markel	Serenity	-11.32%	2.49%
TWOU	2U	Serenity	-0.54%	7.62%
BIDU	Baidu	M. Falcon	-27.16%	-13.36%
TDOC	Teladoc	M. Falcon	-7.06%	-0.91%
NVDA	Nvidia	M. Falcon	35.87%	25.77%
BZUN	Baozun	M. Falcon	-39.24%	-25.82%
NPSNY	Naspers	M. Falcon	-1.26%	-2.91%
BLX	Bladex	M. Falcon	-33.72%	-27.60%
NVTA	Invitae	M. Falcon	-33.87%	-20.27%
KSHB	KushCo	M. Falcon	27.86%	39.41%
NVCR	NovoCure	M. Falcon	-25.64%	-12.61%
UXIN	Uxin	M. Falcon	-43.29%	-41.81%
TCEHY	Tencent	M. Falcon	-2.21%	12.11%

*: Approximations. As of 1/1/2019

That’s all for now. Looking forward to checking back in a few months down the line. Thanks for following me on this journey.

Recklessly Bold Predictions for 2019

December 20, 2018 paul.essen Comments 2 comments

I enjoy investing and think it’s a lot of fun, but sometimes responsibly buying and holding a diversified portfolio of companies can admittedly get a little dull. Fantasy Investing can help with that a little bit, but sometimes I just want to make utterly irresponsible and recklessly bold predictions without having to actually risk any money on them because, well, they’re most likely going to end up being wrong.

With the new year coming up, this seemed like as good a time as any to throw out some predictions for 2019. To be clear, I think most of these are long shots, but I also am not just picking these to be random or contrary. I do actually believe that there are non-zero odds of these things happening. Just don’t go running to your bookie to make any bets on these unless you are getting really good odds.

Here are my three predictions, in decreasing order of likeliness:

The race to $1 trillion – again

There was a lot of talk during 2018 about the race to become the first public company to reach a $1 trillion market cap (not counting PetroChina for some reason). Would it be Apple (AAPL)? Amazon (AMZN)? A dark horse like Microsoft (MSFT) or Facebook (FB)? Ultimately, Apple would win the race, with Amazon crossing the finish line not too long after.

With the recent market pullback and both companies now under a $800 billion market cap, that seems like an eternity ago. In reality, it’s merely been a few months. I don’t try to time the market, and while I am confident that this bear market will turn around, I have no idea when.

But this isn’t “sober, rational, and well-informed predictions”. This is “recklessly bold predictions”. So let’s do a Babe Ruth-esque called shot on what, where, and when.

My first prediction? That these three companies (what) will make it to a $1 trillion market cap (where) in 2019 (when), with two of them making a return trip:

Amazon (again)
Microsoft (first timer)
Apple (again)

Not bold enough? I’ll take it one step closer and say that the order listed above is the order with which those companies make it to $1 trillion in 2019. That’s right, despite being the first to break the seal, Apple doesn’t make it back to $1 trillion until after Amazon and Microsoft make it there first.

Tesla doubles

It’s hard to think of many CEO’s or publicly traded companies that better encapsulate “reckless” and “bold” more than Elon Musk and Tesla (TSLA), and so I simply had to have a prediction for the real life Iron Man and his disruptive car (and energy?) company.

Tesla has weathered the recent market volatility pretty well and is up while a lot of other stocks are down big. Can this continue into 2019? I’m recklessly predicting that not only can it continue, but that Tesla will hit a market cap of $100 billion in 2019, which would make it bigger than the current size of General Motors (GM) and Ford (F) combined.

How? Over the past few years, Tesla has routinely been one of the most shorted companies, and with good reason. The company has been burning through cash and by Elon Musk’s own admission has come close to bankruptcy. Even now, with a profitable quarter in its rear-view mirror, there are still plenty of red flags. What happens once the model 3 backlog is exhausted? Can Tesla still sell as many cars with the federal tax credit starting to get phased out? Will the trade war completely wreck plans to sell outside the US? Can the Model 3 be made profitable at the promised $35k selling point?

I don’t know the answers to many of these questions, but I do think that Tesla has managed to make it through the darkest clouds that it will have to go through. Yes, there are still many hurdles to overcome, but none seem as daunting at the model 3 production ramp up. Assuming Tesla continues to remain profitable in 2019, it just might be time for the shorts to start cutting their loses and a short squeeze just might cause the stock to rally.

Twitter gains on Facebook

As of the time of this writing, Twitter (TWTR) is about 6% the size of Facebook (FB), but their stock price has been going in the opposite direction. Twitter is up around 34% this year despite being down 30% from its 52 week high. Facebook, on the other hand, is down nearly 30% on the year and down almost 40% from its 52 week high.

So what is my boldest and least likely call of all? I think this trend not only continues, but accelerates as a combination of Facebook continuing to fall and Twitter continuing to ascend leads to Twitter getting to be half the market cap of Facebook. For that to happen would require massive movement by both stocks, frankly. Facebook would have to be cut in half and Twitter would have to quadruple in order for this to happen. Honestly, I think it’s fair to claim victory even if Twitter just gets to a third of Facebook’s market cap.

What’s your prediction?

So, what do you think? Have a favorite prediction? Think I’m way off base? Have any reckless predictions of your own? Let’s hear them in the comments! Maybe we can work out a little side bet.

The Freedom Portfolio – Oct 2018

October 3, 2018 paul.essen Comments 7 comments

Welcome to the first ever installment of the Freedom Portfolio! As a reminder, the Freedom Portfolio represents my attempt to beat the market (represented by the S&P 500 index) by buying and selling shares of individual companies. The portfolio represents the vast majority of individual publicly traded companies that I am invested in. I’ve been managing this portfolio since 2003.

The Freedom Portfolio will be the primary way that I will measure how I am doing in my quest to beat the market, and October 1st, 2018 represents the starting point of where I will be measuring. My plan is to check in every quarter with an update on both the Freedom Portfolio’s return and the return of the S&P 500.

A few important points about the data below:

M. Falcon? – Can’t remember what those crazy allocation terms stand for? Check out: The Freedom Portfolio – Defining my Terms for a refresher.
Performance – The last two columns measure the performance of the given position since I bought it both in absolute terms and relative to the S&P 500. For example: Disney has gone up 89% since I purchased my shares in 2013, which might sound good, except it’s actually under-performing the S&P 500 by 18 percentage points during that time.
Start Date – While October 1st, 2018 is the official start of the Freedom Portfolio, many of these positions have been held for me for years prior, which is what the performance numbers are based on. I included them simply to provide some context on which positions might’ve grown to the size they are currently (Amazon, Netflix, Axos Financial, for example) and to give a striking visual of the power of holding quality companies for the long term.
Serenity Now – As of this moment, the portfolio is a little heavy on Serenity sized holdings. I don’t expect this to be the case moving forward. In preparation of launching this portfolio (and so I could make the claim that it represented the vast majority of my investment in individual, publicly traded companies), I had rolled over a 401(k) from a previous employer. As a result, I entered into a few new positions and added to some smaller ones, which coincidentally resulted in a lot more Serenity sized holdings than normal. Eagle-eyed viewers can probably identify the new positions by virtue of their 0% return so far. I expect this Serenity imbalance to remedy itself by the next check-in, as certain companies over-perform and others under-perform.
Lots of positions – There are 28 different companies that make up the Freedom Portfolio right now. That’s a little on the high side for me, and I wouldn’t be too surprised if I ended up trimming one or two companies over the coming year.

Without further ado, here are the current companies in the Freedom Portfolio:

Ticker	Company Name	Allocation	Performance*	vs S&P*
AMZN	Amazon	Babylon 5	423%	343%
NFLX	Netflix	Enterprise	669%	598%
SHOP	Shopify	Enterprise	261%	227%
DIS	Disney	Serenity	89%	-18%
ATVI	Activision Blizzard	Serenity	116%	68%
AX	Axos Financial	Serenity	255%	158%
MELI	Mercado Libre	Serenity	166%	117%
SQ	Square	Serenity	59%	52%
TSLA	Tesla	Serenity	36%	-7%
ILMN	Illumina	Serenity	166%	119%
TWTR	Twitter	Serenity	27%	-23%
NVDA	Nvidia	Serenity	193%	165%
IQ	iQiyi	Serenity	25%	18%
RDFN	Redfin	Serenity	-8%	-14%
OAK	Oaktree Capital	Serenity	2%	-2%
JD	JD.com	Serenity	-5%	-6%
GOOG	Alphabet	Serenity	0%	0%
ISRG	Intuitive Surgical	Serenity	3%	2%
AABA	Altaba	Serenity	0%	0%
MKL	Markel	Serenity	0%	0%
TCEHY	Tencent	Serenity	-12%	-19%
BIDU	Baidu	Serenity	0%	0%
KSHB	KushCo	M. Falcon	38%	35%
NVCR	NovoCure	M. Falcon	16%	14%
TDOC	Teladoc	M. Falcon	58%	50%
BZUN	Baozun	M. Falcon	-7%	-7%
BLX	Bladex	M. Falcon	-19%	-28%
NVTA	Invitae	M. Falcon	-10%	-10%

*: Approximations. As of 10/3/2018

I’ve already written about one company in the portfolio (KushCo) and I plan to write about a handful more over the coming months to explain why I am optimistic about the company. In the meantime, I wanted to open the floor to you. Any companies above that you have questions about? Some that you wouldn’t want to invest in or would even consider shorting? Let me know!

The P.A.U.L. System

September 17, 2018 paul.essen Comments 5 comments

I gave an overview of my investing style in “What is Paul Vs The Market?”, but I thought it might be helpful to do a deeper dive. For a few months now, I’ve tried to hone in on the key attributes in terms of what I look for in companies that I invest in. There are always things unique to certain companies that make me excited about them, but I was looking for factors that I wanted to see present in every company, no matter the industry.

Ultimately, I managed to boil it down into four distinct attributes that I look for. Clearly, in order to make these attributes memorable, I would need a catchy name for them. Who likes to be overly clever and force things into acronyms and has a name that has four letters? Two thumbs pointing at this guy.

Below, I’ll explain the four factors that I look for in a company and for each, I’ll give two companies as an example. The first example is a company that I have owned (and maybe still do) which I feel best exemplifies that specific factor. The second example will be a company that I owned (and probably no longer do) which turned into a mediocre investment because it failed in that area somehow. I’ll be using this system going forward to score investment ideas. I will be ranking each company by the four attributes on a scale from 1-5 and totaling it up for a final P.A.U.L. score.

Let’s go.

P is for “Protected”. Since I believe in investing in companies over the long term, I like the businesses that I invest in to have a durable competitive advantage. This can take many forms: It can be a network effect, where a network gets stronger the more people that join it. Maybe it’s a software ecosystem that encourages people to stick to a certain company’s products instead of buying a competitor’s. It could even be as simple as being in an industry which has a high cost of entry. It’s a lot more expensive to create a new airline from scratch than it is to make a hot new mobile app.

There are some competitive advantages that I don’t put much stock in (pun intended), though. I’m always leery of “brand” as a competitive advantage, because all it can take is one bad news story to ruin a previously sterling brand. I’m similarly wary of government regulations as an advantage because all it can take is a new administration for the entire political landscape to change and for a previous advantage suddenly disappearing or even becoming a disadvantage.

Example: Twitter (TWTR) is a good example of a company that has a strong competitive advantage because of its network effect. People want to be on Twitter because lots of their friends or famous people that they find interesting are on Twitter. As more people join Twitter, it becomes more compelling for the holdouts to join up as well because there’s a better chance that somebody they find interesting will be there. A competitor is hard to start up because nobody wants to be on a social network that nobody else is on.

I’ve yet to find a restaurant that has a strong and durable advantage that differentiates itself from its competitors over the long term. I learned that the hard way with Chipotle (CMG). I thought they had a brand and a loyal customer base that gave them a leg up on their competitors. But it turned out that once people were scared off by some stories about people getting sick, there were plenty of other fast casual restaurants where people could get a decent burrito.

A is for “Alternatives”. Confusingly, I don’t mean alternatives in the sense that there are alternative places to get a burrito. No, this is a positive use of the term. I mean alternatives in the sense that the business has many different revenue streams that it could go after in the future and has shown a willingness to pursue them. Some of my best investments have been in companies whose businesses have changed drastically since their founding. While there’s certainly a danger of a company wasting money trying to expand to an area outside of its core competency, I think it’s far more dangerous for a business to get complacent and rest on its laurels.

I get nervous when a company, no matter how dominant, is overly reliant on a single business line, with no sign of being willing to try branching out. That’s a prime recipe for turning into a dinosaur that will get disrupted by a newer, more agile competitor. A company that has stopped trying to innovate to me is a company that is just inviting competition. Alternatives also means not being too reliant on a single customer. When a single customer is responsible for the bulk of a company’s sales, it gives them too much negotiating power over them.

Example: To me, Amazon (AMZN) is the king of being unafraid to try new things and reinventing itself. They started out only selling books online. Then they moved into selling music and movies. Now, it’s almost impossible to count all the different things Amazon does. They’re a leader in cloud computing with Amazon Web Services. They’re in the hardware space with the kindle, kindle fire products and alexa enabled products like the echo. They do streaming video. They have physical grocery stores thanks to the Whole Foods acquisition. It’s mind-boggling.
Under Armour (UA) is an example of a company that tried to make bold moves into new areas with its connected fitness initiative when it purchased a variety of apps like MyFitnessPal and Endomondo. It’s an initiative that seems to have largely failed so far, and now Under Armour is back to being “just” an athletic wear company. Under Armour is a good cautionary tale that it’s not just about taking chances, but also being able to succeed on some of those chances taken.

U is for “Understandable”. Many of my worst investments can be traced back to businesses that I either thought I didn’t have to understand, or thought I did understand but really didn’t. The less that I understand a business, the more that investing in that company feels like gambling, and I prefer to restrict my gambling to the lowest minimum bet blackjack tables in Vegas. Put simply, if I don’t understand what a company does or what gives it a competitive advantage, I can’t be confident that it will outperform the market.

Examples: All things considered, Activision Blizzard (ATVI) is a relatively easy company to understand. They make the majority of their money by selling games, whether to retailers like Gamestop or directly to consumers by selling digital copies. They can also make money by selling downloadable digital content for existing games. That doesn’t mean that Activision Blizzard’s revenue will always be so easy to understand, though. In recent years they’ve begun dabbling in both movies and eSports, which could complicate their business in a hurry.

I find pharmaceutical companies much more difficult to understand. It’s hard for me to feel like I can make any kind of educated decision on which drugs that a company is working on are more promising than others. At one point, I had read articles about how Ionis Pharmaceuticals (IONS) had a deep pipeline filled with promising drugs, but I couldn’t at all explain why their pipeline was better than any others. As a result, when some of those drugs faced setbacks during trials and the stock dropped, I felt helpless in deciding what to do next and overly reliant on the opinions of others. That’s not a position I like being in.

L is for “Long Runway”. This might be the last letter in my forced acronym, but in many ways it feels like the most important. What do I mean by long runway? I mean the potential upside that a company has. Are they a tiny player disrupting a huge market with lots of business that they can steal from competitors? Is it a company tapping into a previously under-served niche? Is it creating a whole new market? How many potential customers are there for this new product or service? If the domestic market is getting overly saturated, can they expand overseas? I get excited seeing companies that only have tiny slivers of market share because it provides them so much opportunity to grow.

Examples: Redfin (RDFN) is a great example of a company with a potentially huge runway ahead of it. As of the second quarter of 2018, they only have 0.83% market share of U.S. existing home sales by value. That’s incredibly small. They could grow 50% a year for the next 5 years and still have under 10% market share. I like seeing that potential in front of them.

Starbucks (SBUX) on the other hand, is already so ubiquitous in the United States that people joke about them opening a Starbucks inside another Starbucks. Their market share among coffee shops in the US is around 40%. There do have some opportunities for growth overseas and in the home market, but their runway looks a lot shorter than Redfin’s.

What do you think?

That, in a nutshell, is the system that I use for evaluating companies to add (or remove) from the Freedom Portfolio. What do you think? Questions? Comments? Suggestions for improvement? Let me know! I look forward to hearing from you.

Paul Vs The Market

One Man's Quest to Beat the Market

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