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My goal is to invest in a handful of cheap companies that together can outperform broad indexes over periods of 3-5 years. My investing focuses on inefficient areas of the market—mostly small companies that many investors aren’t willing, or able, to look at. Large institutional investors (e.g. mutual funds, hedge funds) ignore these companies because they’re too small for the amount of money that they manage. Many individual investors avoid small companies because they can be illiquid and volatile. With fewer people watching these stocks, the market is much slower to respond to significant news. In general, stocks that aren't followed by thousands of Wall Street analysts are the ones most likely to be mispriced.
Within the small-cap universe, I look for durable businesses that have a competitive advantage. One of the main things I worry about is new technology making one of my companies obsolete. With technology advancing at such a rapid pace, a lot of perfectly good companies will go the way of the do-do bird in the not-too-distant future. One imminent example is fully electric, self-driving cars. Not only will these cars change transportation forever, they're going to have a ripple effect on oil demand, car insurance, unemployment rates (fewer truck drivers, gas station attendants, auto mechanics) and a host of other things.
Finally, I only look at companies where the CEO owns a lot of stock. It is human nature to act in one's own interest. If a CEO owns a small amount of stock and is paid a bonus based on revenue growth, he or she is most likely going to grow the company at all costs. On the other hand, a CEO who owns a lot of stock and whose bonus is based on profitability is more aligned with shareholders. The majority of my net worth is invested in Wiedower Capital and I like to see a similar commitment from the management of this firm’s holdings. Knowing management’s incentives are aligned with my own helps me sleep at night.
Wiedower Capital aims to have around ten holdings at any one time. I prefer a concentrated portfolio for two main reasons. First, selectivity creates a high hurdle for portfolio inclusion. Second, being this concentrated gives me more time to research other potential investments. On the other hand, the benefits of diversification (decreased volatility) are subject to the laws of diminishing returns. An average portfolio of ten stocks has a standard deviation of around 24% vs an average portfolio of 1,000 stocks that has a standard deviation of 19.2%.3 Therefore, owning 30 or 100 stocks creates significantly more work, but only decreases the portfolio's standard deviation by a few percentage points. In my opinion, a small decrease in volatility is not worth the significant amount of increased work that comes with owning more stocks.
Small and micro-cap companies have been shown to outperform all other size companies over the stock market’s history.1 Likewise, companies run by managers that have significant stock ownership outperform those with little or no ownership.2 Therefore, my investing universe (small companies run by managers that own a lot of stock) is likely to outperform the broad market just by itself. From there, my job is to find the best investments within that universe.
Concentration has been shown to outperform diversification3 and focused money managers outperform diversified money managers.4 Because of this, I invest in only my very best ideas and I know them like the back of my hand. Diversification leads to investing in less optimal situations and having less time to dedicate to each stock.
All client accounts (including my own) are invested in the same strategy. I am solely focused on maximizing the long-term returns of this one portfolio and that's it. Wiedower Capital is long only (no leverage or margin) and is mostly focused on US and Canadian companies.
To learn more about my investment philosophy, view my marketing materials below or visit my investing blog at traviswiedower.com.
