Though we would like to think that most of the time we are objective and rational investors, behavioral finance has shown that our brain is not so simple. If left unchecked, our conscious and subconscious biases derail us from rational investment analysis. One such illusion or bias is our tendency to anchor on the price we paid for a stock. While analyzing the stocks in our portfolio, if we own the stock, the price we paid for the stocks is a factor that impacts our analysis of the value of the stock. For example, if we are losing money on a stock, we want to wait for the stock to rebound so that we can avoid realizing the loss. In reality, the stock price is dependent on the future of the company and not dependent on what price we paid to buy the stock.

So, here is an exercise I do at least once or twice every year — assume that you sold all your investments and you are 100% in cash. Now, one by one review the list of stocks that you had in your portfolio. What is the investment thesis? Is the original investment thesis still intact? If the original investment thesis has changed, did it change for better or worse? Will you buy at this current price with a reasonable expected return on your investment in coming years?

The idea of the exercise is to make sure that you are holding the stocks because of the conviction in those companies, their business models and future prospects, and not because of inertia, anchoring, or biases from our past actions. I just completed such exercise with the stocks in my portfolio and I am comfortable that my portfolio is well positioned to meet my long term investment objectives.

So, go ahead… do a virtual detox of your porftfolio in this first quarter of 2012 ! It is good for the health of your portfolio

The post Virtual Detox of Your Portfolio first appeared on The Free Investor.

The post The Double-Trouble with Market Timing first appeared on The Free Investor.

Though the ending was boring with almost 0% return of S&P 500 for the year 2011, the drive through the year 2011, especially the last 2 quarters, have been one of the most volatile times in the market with the all stocks moving widely in one direction on a certain day and in the opposite direction the next day.

Using the Power of Volatility

I like the writings and philosophy of Nassim Nicholas Taleb. In one of his recent Facebook posts he shared a draft version of the prologue of his new book. Here is an excerpt from the beginning of the section that stuck with me —

Wind extinguishes a candle and energizes fire.

Likewise with randomness, uncertainty, chaos: you want to use it, not hide from it. You want to be the fire and wish for the wind….

Similarly, I think, as investors we need to adopt strategies by using volatility to our advantage rather than being scared about it. There are few things investors can do –

• Accumulate stocks of favorite companies and building a full position over multiple tranches during down cycle of volatile markets. We can use the volatility as our friend and reduce the cost basis of a position.
• Keep enough cash in the portfolio to take advantage of irrational down days and buy high stock of high quality companies at a cheap price.

Happy New Year ! Hopefully 2012 will bring a lot of exciting time for investors. I am definitely looking forward to it

The post Opportunistic Buying in Volatile Markets first appeared on The Free Investor.

Merry Christmas everyone !

It has been a wild year for individual stock investors. Especially for last 2 quarters, the entire markets has been moving in lock-step in response to macro news — European sovereign crisis being the latest market mover. With all the volatility and heartburn through out the year, the S&P is hovering near the same level as it was at the beginning of the year. If someone went under a rock at the beginning of the year and came out of hibernation today, he/she will notice that nothing has changed at the index levels ! In long term, I continue to believe, the business fundamentals will drive the stock price of companies. So, yes, volatility may continue till dust settles in the Euro drama. But, if you are investing for long term then the volatility may be an opportunity to pick up some of the great company stocks at bargain basement prices.

Enjoy the holiday season !

The post Merry Christmas ! first appeared on The Free Investor.

This is my third post in the Lessons from My Investing Journey (LMIJ) series. Here is the link to the previous posts in the series. This is a story of one of my favorite long-term investments in lifestyle brands category.

Premium Lifestyle Brand with an Addictive Product

I have been an avid drinker of Starbucks (SBUX) coffee for almost a decade now. When I reviewed Starbucks as a potential investment in early 2006, I was very impressed with the strength of the brand. Three things about the business really struck a chord with me –

1. No credible competitors in the premium coffee segment
2. An addictive product (coffee)
3. Well recognized and respected brand

With all the above listed points comes pricing power and competitive advantage. Once I was convinced that the business has a lot more growth potential, competitive advantage and a well-fortified brand, I decide to own the shares in this company and hold it for many years. Over years, learning from Warren Buffett’s comment about missing out on investing in Wal-Mart in its early days, I have come to conclusion that when you are buying a strong business with a well protected turf, it is better not to haggle over price too much. Again, in Starbucks history as a public company, it looked pricey most of the time before that. So, in Feb’06, I purchased few shares of Starbucks a starter position.

(* click on the chart for larger view)

At first glance, the chart above looks like a nice cozy mountain… but, it is actually the stock price chart of Starbucks for the last decade. As you can see from the chart above, my purchase was right at the top of the peak ! Nice timing. Within a year was down about 10%-15%. So, in early 2007, I bought another large chunk of shares despite caution from some of my friends. At that point, Starbucks was one of the top five positions in my portfolio.

A Painful Test of Conviction

Once I had a large part of my portfolio invested in Starbucks, the stock price promptly plummeted all the way down to less than $8 a share by Nov’08. That’s was a paper loss of about 75% on my original investment. The reason for the price drop were a result of many factors — uncontrolled stores expansion by the management, lofty valuation, loss of pricing power due to economic slowdown, growing competition and brand dilution etc. However, over all those years, I held on to my stocks even with those massive paper losses because one of the key test of a hold-decision for me is to ask myself the question — “If I didn’t own this stock, will I be a buyer today”. Even with the falling stock price and all the operational problems the company was having at that time, I couldn’t find a credible threat to Starbucks brand in long-term. And with a strong brand comes pricing power. I was confident to some extent that it is more likely that the company will operationally right the ship sooner or later. Of course, at the same time, in those dark days of recession and downturn of 2008, it was difficult to be highly convinced about any investment.

Once Howard Schultz returned to the CEO role and global economic outlook improved a bit, things started to turn around and in last couple of years, the stock has recovered to its earlier glory days. Looking forward, I am hoping that this time Starbucks will manage its growth better than last time.

Final Thoughts

The lesson I learned from my investment in Starbucks and the painful roller coaster ride is that when you are confident about the business model of a company, the best investment strategy may be  “intense inactivity” after you build a full position. As long as, the business model and original thesis of investment isn’t broken, there is no need to do anything. I believe, this holds true for many of the lifestyle brands, e.g., Starbucks and Whole Foods (WFM) etc.

Do I know if Starbucks will continue to do well and holding the stock from now will generate great returns? No, I don’t know that for sure. But, the thesis of investment hasn’t changed much from years ago when I bought my first position. So, I don’t see any reason to sell at this point and hoping that it will be one of those stocks that I will hold for years more and potentially decades more.

Related post:

LMIJ #1: Netflix (NFLX): Survival and Success of an One Trick Pony

LMIJ #2: First Marblehead (FMD): Blinded by Macro

(Disclosure: As of the publication of this post, I hold long position in SBUX, WFM, and NFLX. Please read the full disclaimer on this website.)

The post LMIJ #3: Starbucks (SBUX): Investing in Lifestyle Brands first appeared on The Free Investor.

In past three months, as the market bounced around violently in lock step with the news from Europe, I bought / added to few of my positions and liquidated some of the residual holding where my investment thesis didn’t play out for years. The only new name in my portfolio is Mako Surgical (MAKO). The company sells the RIO (Robotic Arm Interactive Orthopedic System) for use in less invasive knee replacement surgeries. Recently, they have expanded the usage of RIO to hip replacements too. The ramp up in hip replacement has been unexpectedly rapid. As an early stage company, it is still losing money. But, I am betting that the product and the razor-blade business model will be profitable in few years. In addition, the volatile market presented some good bargains and I used the opportunity and added to my existing positions in Amazon (AMZN) Aflac (AFL) John Lang Lasalle (JLL) National Oilwell Varco (NOV).

I sold few industrial stock positions — Precision Castparts (PCP), TranDigm Group (TDG) and Hurco (HURC). Both PCP and TDG have gone up significantly and seem to be fully valued right now. HURC is down significantly since I purchased. At this potin, I think, I have held Hurco long enough and I don’t see many positive catalysts. Similarly, I sold my position in PAC because  of the lack of progress in the investment thesis after more than 5 years of holding the stock. Finally, I sold the serial acquisitive company — Nuance Communication (NUAN) based on valuation. With all the rumors of being part of iPhone flying around, I think the stock is valued high right now and I am happy to take the tripling of my investment since 2006 and close out the position. If the iPhone rumors are confirmed, the stock might go much higher. But, with just a small tracking position I had, I am happy to close out the position now.

(Disclosure: As of the publication of this post, I hold long position in AFL, AMZN, JLL, MAKO and NOV. Please read the full disclaimer on this website.)

The post Activities: Recent Stock Buys and Sells first appeared on The Free Investor.

Technology companies have come a long way from the early fast-growers in 70s and 80s to a wide spectrum of companies with varying characteristics and across all the phases of business cycle. A case in point is the recent disclosure by Warren Buffett that Berkshire Hathaway bought a significant position in IBM (IBM) and a small position in Intel (INTC). In case of Intel, it is unclear whether it was Buffett’s decision or that of one of his two newly hired money managers.  But, from the chat on CNBC, it seems like he has been following IBM for a long time and finally decided to buy the stock.

Buffet is known for investing in companies that he expects to stay the same for a long time — railroads, , insurance companies, Coca Cola (KO), American Express (AXP) etc. So, his investment in IBM and Intel points to a segment of the technology industry that is now grown to become stable and mature, just like the dominant players in any other industry.

Till the mid 2000s, technology companies were bucketed under a single group and labeled as high-growth, fast-changing, uncertain-future companies that sported pretty high multiples. Internet dot coms were the face of high tech companies. Though that characterization is still valid for some segments of the industry, the breadth of the types of companies has increased significantly. You can find mature, slow growing, stable companies like IBM, Intel, Cisco (CSCO) to cutting edge early start companies disrupting more and more industries across the economy.

I have a large dose of technology companies in my portfolio. But, I believe even with the high level of exposure to technology, my portfolio is highly diversified. The range of technology companies in my portfolio include a diverse set of companies, e.g., disruptors of different segments of entertainment world, gaming, outsourcing, energy efficiency, retails/eCommerce, networking services, business services automation, Chinese travel services and social media.

It has been an interesting journey to watch and profit from the evolution of the technology industry from a small silo to a diversified ecosystem of companies. I can’t wait watch it grow further.

(Disclosure: No position in any of the companies listed above)

The post Technology Companies: The Widening Spectrum first appeared on The Free Investor.

I have been thinking about a good way to describe my portfolio strategy. When you ask ten investors about their portfolio strategy, you will get ten different answers about value, growth, income, core, and core plus etc etc. Most of these terms mean different things to different people and way too obscure for a regular person on the street. So, to describe my portfolio strategy, I tried to come up with a metaphor that everyone, including my daughter, will understand — “Sprinkle Cupcake” !

Let me explain. Just like sprinkle cupcakes, my approach to portfolio construction has three distinct layers — a stable cake base, a delicious icing and colorful sprinkles. Now, let me dig into each of the layers.

1. “Stable Cake Base”: Stable, high quality companies

This layer is the foundation of my portfolio. It consists of relatively stable and high quality businesses, e.g., Berkshire (BRK.B), Disney (DIS), Aflac (AFL), Precision Castpart (PCP), Bed Bath and Beyond (BBBY) etc. I will stay away from the traditional investing terms like “value” or “growth”. What matters more to me is that each of these businesses are high quality and relatively stable businesses. Though some pay dividend, it is not one of my criteria for categorizing these as stable companies. I don’t expect these type of companies to double in few years. But, in long-term, I believe they have great growth potential and have some significant competitive advantages. Over the years, these companies have generated market beating cashflows and income for their shareholders. I am betting that for next few years that trend of superior performance will continue and, in long term, stock price catches up with business performance.

2. “Delicious Icing”: Disruptors, innovators and thematics

The companies in this layer make up the bulk of my portfolio. These include innovators, disruptors, and companies riding an emerging theme. Typically, most of these companies are growing faster than most of their competitors by disrupting current industry top players, innovating and creating new markets or better executing an emerging theme. My long list of companies among the innovators/disruptors include Netflix (NFLX), Amazon (AMZN), Whole Foods (WFM), Starbucks (SBUX), Apple (AAPL), Ctrip.com (CTRP), Chipotle (CMG) and Buffalo Wild Wings (BWLD). Some of these companies, e.g., Netflix, Amazon, Apple and Ctrip.com has been growing rapidly, changing the landscape of their industry, and in some cases, creating new industries. Others, e.g., Whole Foods and Starbucks are lifestyle brands that can be both be considered as innovators and thematic leaders. Chipotle is one of the leaders of the fast-casual restaurant concept. Similarly, among my other thematic companies, the prominent names include Cognizant Technology (CTSH), Fedex (FDX), National Oilwell Varco (NOV), Discovery Communications (DISCK) and Dolby (DLB). Cognizant has been a top player in the IT outsourcing space since 90s and continuing to deliver solid growth. As digital entertainment continues to proliferate to multiple devices and channels, I am betting that Discovery and Dolby will benefit from this theme.

3. “Colorful Sprinkles”: Early stage companies, turnarounds and event-driven

Just like the sprinkles on a cupcake, these companies are the smallest layer in my portfolio. As I wrote before, recently I have been adding some early stage companies, e.g., EnerNOC (ENOC), Sina (SINA), Lululemon (LULU) and Infinera (INFN). The market verdict on these companies may not be clear for at least few years. But, I am ready to wait. The event driven investments in my portfolio are just that — investing in companies that are hammered down by market myopia due to a headline-news type negative event. The GOM oil spill last year was one such event in recent past. I bought a few oil and gas related companies on the cheap, e.g., BP (BP), Transocean (RIG), Noble (NE) and ATP Oil and Gas (ATPG) during that time. The last part of this layer are turnarounds. Investments in turnaround situations have not been very successful for me in past. I am hoping this time it will be better — Aeropostale (ARO) is my latest investment in turnaround situation.

There you have it. That’s my portfolio strategy — Sprinkle Cupcake. Of course, with time, business environment and experience, my strategy continues to evolve. So, if I adjust my approach in future, I will surely write about it. But, I doubt it is going to change drastically.

Hop over to the portfolio page for a closer look at my portfolio or to the watchlist page to see what I have been watching recently.

(Disclosure: As of the publication of this post, I hold long position in all the stocks mentioned above. Please read the full disclaimer on this website.)

The post “Sprinkle Cupcake”: My Portfolio Strategy first appeared on The Free Investor.

This is my second post in the Lessons from My Investing Journey (LMIJ) series. Here is the link to the first post in the series. As promised in my first post, this is a story of one of my investment failures.

Interesting Stock in a Unique Industry

I started investing in First Marblehead (FMD) from early 2006 and kept building my position all the way upto October 2007. By that time, FMD was one of the top five positions in my portfolio. First Marblehead was in the business of processing and securitizing student loans for large banks, e.g., JP Morgan Chase (JPM) and Bank of America (BAC) — these two banks accounted for more than half of FMD’s revenues. The private student loan market was growing at a breakneck speed and the future looked bright for FMD. In addition to upfront cash, FMD was expected to receive residual income many years later after the securities hit parity. The Education Resource Institute (TERI) was the gurantor.

It sounded like a pretty good story — rapidly growing company in a fast growing industry. Well, when the financial meltdown of 2008 hit, the entire student loan ABS market froze up. The Education Resource Institute (TERI) filed for Chapter 11. With in few months the entire business of FMD dried up. Gone.

I lost approximately 90% of the original investment by the time I sold the stocks in the second quarter of 2008.

Importance of Diversification and Asset Allocation

The significant loss of my investment in FMD and couple of other such stocks reinforced the value of being diversified. Though I lost significant amount of money, it didn’t permanently impair my portfolio as I had more than 20 stocks in my portfolio. However convincing the investment theory appears, it is always possible that some external shock will obliterate the investment.

Second lesson from the FMD episode was about asset allocation — be very careful about going overweight in any stock. You never know what unexpected external factors will hit the company. As long as you have a diversified and holding disciplined and pre-determined weighting in the stocks you own, if something unexpected happens, you are less likely to lose sleep. Since that time, I make sure that I invest pre-determined level of capital in any stock and not go too overweight. The only overweight positions that I allow in my portfolio are the stocks that have run up significantly since I bought the stock.

Final Thoughts

Loss on FMD was one of the biggest losses I ever had in my portfolio. Though I was blinded by macro factors (i.e., credit crisis of 2008), I could have minimized the loss by controlling my position size.

So, the bottom line is — diversify, diversify, diversify ……

Related post:
LMIJ #1: Netflix (NFLX): Survival and Success of an One Trick Pony

The post LMIJ #2: First Marblehead (FMD): Blinded by Macro first appeared on The Free Investor.

I have been continuing to buy small positions as my favorite watchlist stocks get hammered in these volatile markets. I don’t know what will happen with these stocks in coming days or months. But, I am buying these stocks with the intention to hold it for a long time. So, I am going to measure my success/failure in years to come. Here are the two stocks I added recently.

Disney (DIS): As you can see in my post on Digital Entertainment Trend, I love Disney as one of the top content creators in the world. Till the recent market volatility, I didn’t find a good price point to open a position. Finally, last week I took advantage of the market turmoil and added some house of mouse a.k.a Disney stock to my portfolio. Probably I don’t need to write a lot about the story of Disney’s origins as even a child, or especially a child, knows the core business of Disney. Micky Mouse and rest of the Disney characters have dominated the imaginations of children for decades. Over the years Disney has built a large entertainment powerhouse that includes

• Media properties: ABC Network, Disney Network, and crown jewel ESPN
• Parks and Resorts, including cruise Disney Dream
• Movies, including the PIXAR studios: Pirates of the Caribbean series, Toy Story series
• Consumer products from merchandising and interactive media

Here are some of the reasons I like Disney –

• Widely popular iconic brand
• Long useful life of its audio-visual content
• Great assortment of best in class Franchises — Pixar, ESPN, Theme Parks

Currently, the stock is trading at only 13-14 times earning. I believe, the current price combined with more than 1% dividend yield underestimates the competitive advantage and value of Disney’s irreplaceable contents.

Lululemon Atheletica (LULU): My investment in Lululemon is a good example of Peter Lynch style of investing — buy what you know, go to shopping malls and use family/friends recommendations for investment ideas. Lululemon’s yoga inspired apparels are one of the fastest growing retail concept. My wife has used Lululemon products and highly recommends it. I like their unique approach to marketing by engaging local community of runners and yoga enthusiasts. Recently, Lululemon reported a 16% same store sale growth ! They have one of the highest revenue per square feet number in the industry. The company has a lot of room to grow in US and, other than Australia, the entire international market is untapped (except Canada where the company started its operation). It has a lot of characteristics that I like –

• Passionate and engaged customers who tacitly advertise the product/concept
• Great product and a growing lifestyle-oriented brand (similar to Starbucks, Whole Food etc)
• Differentiated product and business model compared to other retail concepts
• Founder driven ownership culture

At almost 50 times earning, the stock is definitely not cheap. But, if the company continues to grow rapidly, the current price will look justifiable in few years. I am happy to open a position at this level and will be looking to add more if the stock price keeps sliding down.

(Disclosure: As of the publication of this post, I hold long position in DIS, SBUX, WFM and LULU. Please read the full disclaimer on this website.)

The post Activities: Recent Stock Buys first appeared on The Free Investor.