radarthekat

It might not be crazy for Apple to buy an EV maker. 

What I learned from Warren Buffett and 30 years in the market

But mostly from Warren Buffett.

PART 2

CONCENTRATION VERSUS DIVERSIFICATION

With the above in mind, you also need to be able to follow, closely, your investments. To follow a business, you need to understand the business and its success factors, its marketplace, its competition, how it compares to that competition, what technological changes are on the horizon that might impact the business, the legal, regulatory, and political landscape associated with the business, etc. Even so-called professional analysts, because they attempt to cover multiple, often many, businesses, nearly always get it wrong on a large and well followed and reported-on business like Apple.  How many people can follow even three companies, in three different industries, with different metrics as measures of success? How many even know the metrics of success for even one company in which they take a position? Stock picking, itself, is for the vast majority of those who participate, casino betting. Diversification, in this context, is appropriate since you would want to limit exposure to any individual bet.

With the definition of investment in hand, it's a matter of screening for companies that are structurally sound; strong earnings at a relatively low multiple, solid balance sheet with net tangible assets not far below total stockholder equity (i.e., little of the company's assets represented by the Goodwill and Intangible Assets line items), and plenty of cash/cash equivalents to carry the company through downturns or changes in the direction of the business.

Also look for a history of organic growth versus acquisition-based growth, a strong brand and competitive position, no significant impediments to growth, no significant risks such as lawsuits or potential for lawsuits (think medical device manufacturers and the hip implant lawsuits that have cost them billions), and technological leadership (which can be associated with the company's product technology or associated with process technology or even marketing technology; you want some significant technology lead that gives the company a clear edge).

There are other things to look for, some that depend upon the particular business. I look for a business that excels in whatever metrics are most critical for success and growth in the industry/segment in which the business participates. And it should be comprehensible to a non-expert in the field; buy what you know.

The temperament and discipline to stay the course and not get thrashed moving from one stock to another can be bolstered by having strong confidence in the businesses in which you place your investable funds, so knowing the workings of each business and its competitive environment is key. And that leads to the question... how much can you know about 10 businesses versus two or three at-a-time?  The answer is obvious and points to the fact that you should consider concentrating your holdings only when you know a business cold, and diversify your holdings when you don’t.  And leave speculation to those who know how to win at that game.

This might be a good spot to drop a pair of essays I wrote back in 2013…

What I learned from Warren Buffett and 30 years in the market

But mostly from Warren Buffett.

PART 1

INVESTING VERSUS SPECULATION

It seems the first level of wisdom a prospective investor hears and integrates is the old saw about diversification. And that's about as far as it goes for many who casually participate in the market.  The problem with diversification is that, even if you are diversified, you'll still likely have in your portfolio several holdings that don't fit the definition of a good investment.

Those who go a bit farther in their studies begin to have a more nuanced comprehension and come to realize that not all businesses and opportunities represent investments. So what do these other businesses and opportunities represent if not investments? The answer is that anything that isn't an investment is speculation.  To be successful with individual stocks/businesses, you should carry in your mind a definition of these two concepts.  Here are my working definitions of the two terms:

"An investment is a commitment to holding a security as long as the underlying fundamentals and business prospects remain intact." 

Take Apple, for example. Apple shares are an investment as long as Apple continues to perform as well as it is currently performing. As long as it continues to generate the revenues and earnings it is currently generating.  Even if neither rise.

"Speculation is a bet on some future outcome, either positive or negative, that would materially change the fortunes of a business."

Note that the main difference here is that an investment relies upon the continuation of the status quo while speculation is a bet against the status quo.  

GT Advanced Technologies (GTAT), a maker of solar manufacturing equipment, is an example of a speculative bet, and one that went terribly wrong for those who made that bet.  In 2012 and 2013, GTAT saw its solar business collapse under the weight of competition from Chinese manufacturers.  Late in 2013, GTAT partnered with Apple to manufacture sapphire display glass, presumably for use on the iPhone 6.  GTAT needed that partnership to go well; it represented GTAT’s lifeline to a corporate reboot, a chance to reinvent itself in a new line of business in which it had little experience.  That reinvention, if successful, would materially enhance the value of the company.  If a failure, it would mark the collapse of GTAT as a viable business.  GTAT did fail, and filed for bankruptcy protection.  In the process, the share price went from a high of about $20 to about 40 cents.  Many of those holding the shares indignantly complained in online forums that their investment was wiped out by unscrupulous actions of GTAT's CEO and management team.  They weren’t wrong about the actions of GTAT’s management, but they were wrong in characterizing their GTAT holdings as an investment.  These people were speculating and paid a high price.

It's those who don't understand the difference between an investment and a speculative bet who always end up convinced the market is rigged. These folks likely put money into one or more companies with business models that represented a speculative bet on some unlikely outcome, lost their money and associated that experience with the entire experience of participating in the market. How many times have you heard someone say the stock market is like a casino? Well, I liken the stock market, at the hands of a participant who has done his/her research and applied appropriate metrics, to a casino where you get to see your blackjack hand and the dealer’s up card before you place your bet and where you have the option of betting big, betting small, or not betting at all on each hand. The odds are strongly in your favor, but you can still do something foolish.  If you get your head on straight, stick to companies that represent a valid investment according to the above definition, and avoid speculation, at least until you have learned the hedging and other strategies associated with successful speculation, you’ll increase both your chances of a successful investment career and your returns throughout that career.

Once you identify the best business, how much would you invest in the second best business?  

Apple has for many years invested in manufacturing technology that goes into the factories of its 3rd-party suppliers and assemblers.  An example from the early MacBook Air era is the 25 holes laser-punched into the screen bezel to allow light from an LED mounted behind the bezel to pass through.  This light is used to indicate that the webcam is ON.  With the indicator light off a casual observer cannot see the holes; they are too small and so the bezel looks to be solid aluminum in that spot.  Only when the camera indicator light is turned on does the magic become evident and a part of the seemingly solid aluminum bezel illuminates.