I bought my first stock when I was 19. Fast forward a few years to 2018, I had full reign of my family’s stock portfolios. In the five fiscal years that ensued, I produced a return of 25% per year, including a 19% return in 2022. The portfolios grew from $200k to over $600k. My goal, since I began, is to take the portfolios over $30 million, retire my parents, and hopefully have a family of my own by then. So far, we are on trajectory (minus me having a girlfriend – that I haven’t quite figured out yet).
DocShah Capital’s 2022 Portfolio Performance
This past year, I beat the Nasdaq by 50%, which would not normally be anything to mention, however in 2022, the Nasdaq was in a bear market down (30%). My portfolio performance was consistent with the prior years and I want to break down my exact process and the way I think about stocks. For reference, I am ranked in the top 1% of analysts on TipRanks with an average return per rating of ~40%.
My goal for the article is that the reader will walk away with actionable steps to make better investments and feel more confident in those investments.
You Are Not Dumber Than To Wall Street
We have to address the limiting belief many retail investors possess in that they are simply not intelligent enough to make good investments. Limiting beliefs become self-fulfilling prophecies.
Wall Street analysts are bright and they have access to an endless number of resources, many of which provide granular and up-to-date information. However, what big institutions tend to do is inadvertently push stocks to unusual highs and unusual lows. These extremes represent opportunities to retail investors to open positions; they are gifts.
For five years, I bought stocks Wall Street dumped, due to the short-term nature of the industry, where analysts are more focused on next quarter than the next decade. For example, DICK’S Sporting Goods (DKS), Target (TGT), Ruth’s Chris Steak House (RUTH), and Bank7 (BSVN) are all stocks which I bought at extreme discounts because the market oversold them to extreme lows.
You do not need a degree from a prestigious university nor a $5,000 suit to be a good investor. What you need is discipline, a set of principles, a sound strategy, basic knowledge of financial statements, patience, and optimism. Last time I checked, all of these can be acquired without a college degree.
The Essentials
Here are five basic principles an investor must consider in order to create a portfolio which produces consistent returns:
1. Know What You Own
It amazes me when I ask someone, “why did you buy that stock?” They usually respond with, “Oh I have a friend who knows the industry and he told me this thing is going up.” Usually, a long discussion ensues where I set them straight.
If an investor likes a stock at $6, he better love it at $3. So many times, investors buy a stock at one price and sell it at a much lower price. Why? Because they did not know what they owned. If you have no clue what the company you own does and you see its stock price fall, you don’t know any better but to sell it. When you know exactly what the company does and you see the stock price fall, you get excited because you get to buy more shares.
The Doc’s 10/10 Rule
I have a simple rule for buying a stock and it’s called the 10/10 Rule, which is: an investor has to be able to explain to a ten-year-old in less than ten seconds why he owns a particular stock. For example, when I was an investor in Ruth’s Chris Steakhouse from $6 to $24, I would have told a ten-year-old: “They make great steaks, people love eating there, and they’re making a lot of money.”
2. Be Logical and Emotional, but Mostly Logical
Great investors separate logic from emotion when making decisions. Oftentimes, we become emotionally attached to a stock or company, but wishing it would do well is far from an investing strategy. Instead, we must apply logic to a company by analyzing it rationally. Only then we can draw a conclusion on its stock.
The Doc’s 90/10 Rule (90% Logic, 10% Emotion)
However, we also need emotion to invest successfully because ultimately, when you buy a stock, you need to be optimistic that the future will be better than the present.
In my opinion, this is why geniuses oftentimes do not make great investors. It seems counterintuitive, but if you are exclusively logical, then you are likely to be too pessimistic to be a good investor. You lack belief in the future because it is hard to apply logic to something which does not yet exist. The future requires faith, not logic; and investing is about the future being better and more productive than today. Therefore, we need a blend of logic and emotion in order to be great investors.
3. Basic Financial Understanding
I have a shocking revelation… all the math you need to know to be a good investor you learned by the 9thgrade because we simply need to be able to draw arithmetic conclusions on an absolute and relative basis (whether that is Y/Y, Q/Q, or a competitor comparison). Anything beyond that is icing on the cake.
The Doc’s 10 Checklist
Here are some basics on what to look for in a company’s financial statements and/or online:
- Is revenue going up each year?
- What is the company’s market share and is it increasing?
- How do the gross/operating margins measure each year?
- Is EPS increasing each year? If net income is negative, is it moving in the right direction?
- How much debt does the company have and when does it mature?
- How much cash does the company have and what is the cash burn rate?
- Does the company pay a dividend? Is it increasing?
- How do the company’s ratios compare to its competitors (you can use few or many; I like the asset turnover ratio as it reveals company productivity).
- Are employees happy at the company? See Glassdoor.
- Are insiders buying shares? See the SEC website.
These ten questions, when answered, depict a comprehensive overview of the business. If everything checks out, then we assign a price we feel comfortable buying the stock. I personally like stocks that have a P/E under 10.
Note: Investors who use solely emotion would analyze the same company in this fashion:
- The stock is going up. I can’t sell it now.
- The stock is going down. I need to hold until I breakeven.
- Everyone is talking about this stock. I have to own it.
- This company makes futuristic products. I need to get in on it.
- I like the company’s branding. I am going to buy its stock.
You will notice that none of these statements are based in actual research or fact. Investing based on emotion is the primary reason why investors buy at market highs and sell at market lows. In the stock market, both fear and greed will get you slaughtered. Here is a great article by Vanguard discussing money and emotion for further information.
4. Diversify or Don’t, Just Don’t Mix Strategies
Diversification is an insurance policy against losing money (or as Warren Buffett put it, against ignorance). Investors have to be honest about two things:
- What is their level of risk tolerance?
- How much time they will exert researching and keeping up to date with their stocks?
Diversify
On one end of the spectrum, the investor who is risk averse and has no inclination to spend time on stocks would benefit greatly from index fund diversification, where he owns hundreds of stocks and does not need to analyze any specific one.
Actively Managed
On the other end is the investor who is risk tolerant and has ample time and desire to research stocks. If he also exhibits other necessary qualities for good investing, then he will greatly suffer from diversification by way of opportunity cost. This investor has the ability to generate above-average returns, but will stifle his progress by diversifying his portfolio. This investor is better concentrating his efforts in 3-10 high-quality stocks which he has purchased under a margin of safety and extensive knowledge of the business.
Do Not Mix Strategies
Both strategies can be great, but you cannot blend them. Investors who try to actively manage 11-30+ stocks are having an identity crisis – they are attempting to combine diversification with active investing. It is unrealistic to be an expert on thirty different stocks. Instead of generating solid returns, these investors are quickly disappointed when they produce poor results due to the nature of their strategy. They are trying to actively manage too many stocks, don’t know what they own, and wind up losing money.
You have to pick: do you want to actively manage a few stocks or passively own many? Either can work great, but you can’t mix strategies.
The Doc’s Magic Number 10
I have only been writing articles for five years and in that time I have only written on twelve stocks. That should give readers perspective on how many to own and that I practice what I preach. Currently, I only own three stocks: Hims & Hers Health (HIMS), Devon Energy (DVN), and Bank7.
For investors who seek to actively manage their portfolios, I encourage them to own no more than ten high-quality stocks at once. Even ten is stretching it, but any more than that and it becomes challenging to be an expert on so many companies. The time and research required to consistently stay up to date would be demanding once we own a double-digit amount of stocks.
5. Tune Out the Noise
The economy always sucks according to someone.
Never forget this sentence. There will be a million reasons to sell stocks perpetuated into oblivion by perma bears. Peter Lynch once said, “the bear argument always sounds smarter.” The stock market has gone through over one hundred years of terrible events, including a Great Depression and two World Wars (not to mention 0% interest rates, going off the gold standard, other wars, stagflation, the housing crash, 9/11, the brink of nuclear war, Republicans, Democrats, etc.) and it is still higher than one hundred years ago. When you buy a stock, it has to come with the understanding that in the short-run the market goes through ups and downs.
The Doc’s 10-Year Rule
Here is what you focus on: buy a great company at a good or better price. Then ‘x’ out of your brokerage account and come back in ten years. In that time, follow your passions, spend time with your family, and give back to the community. That way, even if your stock crashes, you will still be happy. Just kidding.
Takeaway
If there is one thing you take away from this article, it is that you have the ability to be a great investor if you follow some basic principles and have discipline. Wall Street pushes stocks to unusual highs and lows, which offer opportunities for individual investors to buy great companies at good or better prices.
If you know what you own, use mostly logic with some emotion, have a sound strategy, assess the company’s financials, and tune out the noise, then you will be in a successful position. You will be able to sleep well at night knowing you own high-quality stocks that will produce solid returns into the future. Investing is a long-term game and one in which individuals can score points just like Wall Street.
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