Portfolio Update 1 - 2022

How my way of tracking performance is different than most.

Introduction

Let’s cover my portfolio updates for 2022 so far. This might be different for most people. Why?

I don’t care what the stock prices are year to date. I view prices are short-term noise.

Many people get down on themselves because they are negative for a day, a week, a month, a quarter, or even a year(s). When Buffett said he didn’t care whether the stock market closed for 5 years or not, I took that to heart. What the stock price does is largely irrelevant to a true investor. The most important thing to track is going to be the fundamentals of the business.

Let me give you an example. If you had to say what an asset was worth in the public market, what metric would use? Price-to-earnings (PE) ratio would be popular. Say an asset is earning $100 million a year. The public market gives it an evaluation of $1.5 billion, meaning it’s trading at a 15x PE multiple (15 x $100,000,000 = $1.5 Billion). Now, let’s throw a wrench into the hypothesis by asking what it’s worth on the private market?

Generally, the private market sells cheaper than the public market. So let’s say the same company earning $100 million sells for $800 million in a private market. Now you would be paying an 8x PE. Here you can see that the valuation changes based on if you are public or private.

If you held privately, how would you then determine performance without a public market constantly evaluating shares of your company? You would have no idea what the public market is valuing it at. You wouldn’t instead look at other metrics in your business to track performance. You might start by paying attention to the following:

• Revenue

• Income

• Operating Income

• Free Cash Flow

• Equity

• Cash

• Debt

If revenue, income, operating income, free cash flow, and equity are increasing, you’re going to be happy with the state of your business. Increased cash on the books isn’t a horrible problem to have, and if the debt is shrinking, then you know you are doing things right.

So by the same token, if we own an asset in public markets, why change the way we evaluate our business? Nothing has changed other than there are other people telling us what they will pay us for our company when we are in an open market. For this reason, I track the performance of my holdings on fundamentals, rather than stock price appreciation.

This isn’t a cop-out to underperformance. I know I’m in the red this year along with 99% of everyone else. What matters is that over the long term, the divergence in price and value will close. If I hold companies with strong, improving fundamentals, the value of the company can only go up over time.

My Holdings

Let’s get down to my holdings! Even though I do own some crypto, I will not be including it in my holdings for this.

• 8909.T Shinoken

• ATZ.TO Aritzia

• BABA Alibaba Group Holding Limited

• BHC.TO Baush Health Companies Inc.

• DRM.TO Dream Unlimited Corp.

• INMD Inmode Ltd.

• MU Micron Technology, Inc.

• QFIN 360 Digitech, Inc.

• TCEHY Tencent Holdings Limited

• TOI.V Topicus.com Inc.

I’ve made a deal with myself to hold a maximum of 10 holdings. This is because I don’t think I can understand a lot of companies very well, and over-diversification equals poor returns. I’m also following the advice of the great Thomas Phelps, that every sale is an admission of error. And I want to keep my errors as minimal as possible, meaning you will see minimal turnover.

As I follow the news on all my holdings, I have general KPIs that I follow and also follow how competitors are performing in those KPIs. The ones I listed above are pretty ubiquitous, but certain companies are more heavily weighted to specific ones. For instance, Topicus is a company where Free Cash Flow generation is more important than Net Income. You should also use FCF multiples rather than Earnings multiples to value this company. If you don’t know which metrics to use to value your companies then you don’t understand it well enough and shouldn’t own it.

Portfolio Additions

Topicus - I began this position this year and am still building it. Anywhere below $80 is a steal. I will be adding here as more cash comes in until I’m comfortable with position size.

Tencent - I began this position in late 2021. The price is even better now, but this is already my largest position on a cost basis. Not afraid to add more, but need more dry powder.

Portfolio Divestitures

I don’t trim positions and I plan on keeping this section blank as often as possible.

I can tell you that I do have a divestiture in mind. It’s BHC.TO. This is a pretty mediocre pharmacy business that has an extra value from Solta and Bausch and Lomb. I bought it in 2020 because I saw the parts were greater than the whole.

It was a good idea, and probably still is, the issue is that it’s taking a lot longer than expected to spin off the companies. They have a specific amount of capital they want to be raised from the spinoffs so they can remove the debt from their books. Since markets are depressed, it’s not a good time to IPO the value unlocking companies. So I’m stuck holding it. Or I sell it (at a decent profit) and then re-allocate it to other holdings. The issue with that is that I think I can make a better return from the spinoff over other options, so I’m still holding on. But the longer I hold, the lower the return, so I am always keeping my mind open on this.

Just wanted to add a quick update to this. The Bausch and Lomb IPO happened last Friday. The share price is around $20.00. But no share price appreciation was passed to BHC.TO even though the parent owns 90% of their shares. The hope here is they can do a secondary offering when the price goes up and raise more money to pay down debt, then spin off the shares to BHC.TO shareholders. Given the glacial pace of this company and the mediocre management decision on the spinoff, I’m not holding my breath.

Interesting Updates On Holdings

I’m very happy with all my holdings. The companies keep doing better and better, showing they have a moat and are reaping the benefits of that moat. I’ve had a few big runners, INMD and ATZ.TO, but as I said previously, I won’t sell until the fundamentals change, even if the share price is optically overpriced.

INMD at one point was a 5x for me at its all-time high (ATH) but has dropped precipitously since. I have no issues with that. Look at how well they’re still going. Despite the share price dropping by over 60% their fundamentals keep chugging on.

Other than BHC.TO, the only company in my portfolio that hasn’t had steady increases in my KPIs is Shinoken. I am more than willing to wait and give the amazing management team a chance to recover from the COVID-induced issues. Even as the growth has slowed down, they’re seeing increased recurring revenue from management segments and have some big international growth plans. I still think management will come through in a big way and reward patient shareholders.

They have been allocating capital very intelligently for a long time. Even now, with the share price essentially at a standstill, they are returning capital back to shareholders via dividends and buybacks. I don’t mind if the share price stays depressed as it gives management even more time to buy back shares and increase my fractional ownership of the company.

I still think there is a massive growth runway for this company in Japan and internationally. I plan on holding until early 2024 to see what management can do. If fundamentals haven’t improved at that point, I’ll look at other opportunities, but I believe the company is going to be in fine shape. Until that time, I’m a partner with Hideaki Shinohara and am a proud shareholder in his company!

That’s it for this installment. I’m going. to try and update this each quarter. At the end of the year, I’ll publish my price appreciation/depreciation, and a bunch of other metrics I use to measure my performance like:

• Operating Margin

• FCF Yield

• Leverage Ratio

• Interest Coverage

• ROIC

• Retained Earnings Growth

• Look Through Earnings

Until then, I won’t put that info on here as 1. It takes a lot of work to compile the data and 2. I prefer to keep it out of my mind until the end of the year!