Mental Models discussed in this podcast:
- Operational Leverage
- Risk Management
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- Stock specific
- Price – I’m willing to compromise on my price target of less than 10x earnings in recent days. Now I’m willing to accept up to 15x earnings per share for high-quality businesses
- Growth Rate Estimates – I’m willing to accept being wrong on my estimate of growth. I’m usually targeting businesses that grow revenue/earnings at double-digit rates. If my pricing is right, I can be wrong on my growth rate assumption and still do fine.
- Operational Leverage – I’m willing to bet on and be wrong about operating leverage
- Balance Sheet Liquidity – I want a liquid cash-filling balance sheet
- Self Funded – I don’t want to buy a company that has to be funded by debt
- Bankruptcy Risk – No bankruptcy risk of any kind, which means I am unwilling to accept highly leveraged companies.
- Commodity Risk – I’m not willing to accept exposure to commodity prices.
- Related to your overall strategy or investment portfolio
- Non-stock or business-specific
- Illiquid stocks – I’m willing to accept lower liquidity in my stocks than other investors. I’m willing to spend months building my positions instead of just days or hours.
- Concentration Risk – I’m willing to hold fewer stocks than other investors. (3-5 companies)
- Tracking Error Risk – I’m willing for my results to be dramatically different from the results of an index like the S&P 500 or the Russell 2000.
- Unwilling to underperform inflation for long periods of time. (5-10+ years)
- Unwilling to underperform a 10% baseline absolute return over time
- Brings in decisions like how to address cash drag
- I have realized while preparing for this show that I don’t really know what my “unacceptable risks” should e on a portfolio-wide basis. So let me know what I’m missing. You can send me an email or DM me on Twitter.
As an investor, the risks you take can be categorized as either business risks or portfolio risks. In order to earn a return, you must take some risks from each type. In other words, how are you willing to fail?