Q3 2023 Portfolio Update
Top Posts From Q3 2023:
After an accommodating start to the year, Mr. Market had a change of heart in the third quarter (specifically in September). As I reflect on what we’ve seen as of late, my main thought on the current environment is how much impact it has had on my ability to sit still (the urge to do something). It feels like a mistake to sit idly by as prices swing wildly, particularly on names where Mr. Market continues to express dour sentiments. These situations call for action.
How that conclusion fits in with the investment approach of someone who desires to be a long-term owner is somewhat less clear to me; what does an effective decision look like over the long run with that added consideration?
I can tell you how it has impacted my approach over the past few years: in both directions (investments that are working and investments that are not working), I’ve generally been slower to make changes than I would’ve in the past. Largely, that has come from the realization (learned experience) that letting these short-term, price-driven “answers” take the lead on portfolio construction can be a slippery slope. As an example, assume you own two securities at a 5% weighting. Each time “A” goes up 5% - 10% and “B” goes down 5% - 10%, you make the sensible decision for a price-driven investor (assuming an immaterial / no change to their FV estimates): you sell 100 – 150 basis points of “A” and buy 100 – 150 basis points of “B”. If that trend continues for some time (“A” is up ~30% and “B” is down ~30%), you’ll find yourself with “A” of immaterial size / out of the portfolio, while “B” will now be a decently sized position (maybe ~50% larger as a percentage of the portfolio than where it started). If you apply that thought process to a portfolio of 10, 20, or 50 stocks, you start to see how that way of thinking, with enough time, can get to a place that may be far afield from what you originally intended.
Is there anything wrong with that approach to portfolio construction? On its face, no (and on the way up, this strategy will help to lessen the subsequent pain on a company like Dollar General, where you may have overstayed your welcome and now find yourself living through difficult times). On the other hand, if you truly want to find businesses and management teams to partner with for 5, 10, or 20 years, you’re highly unlikely to end up with a sizable position, if any position at all, in companies like Microsoft or Netflix as you employ that approach (in the above example, Microsoft would’ve been in the “A” bucket for the past decade or so). As we think about that, I’d also remind you of the one lesson that I’ve heard repeated over and over again from knowledge and experienced investors: selling high-quality companies run by managers they believed in for reasons other than the underlying business performance is an oft cited cause of regret. (“Selling winners too early has been a persistent problem for me. No matter how much I tell myself I’m going to learn and let them run, I still begin trimming way too early. Letting winners run is the most common shared trait amongst great investors.”)
As I wrote in “The Evolution Of A Value Investor”, I think about the various investment approaches within the “value investing” framework in terms of trade-offs (as opposed to my more assured, younger perspective of “right” versus “wrong”); these value investors all hope to become residents of Graham-and-Doddsville, while “calling their ‘flips’ in very different ways”.
The approach that I’m personally trying to employ has its fair share of downsides, the most notable of which is exposure to short-term price and business volatility on a position that has grown to a meaningful size. I’m cognizant of that risk and I (largely) accept it. All I can tell you is that this approach, despite its downsides, is the one that I think best fits my mindset, time horizon / cash flow considerations, and skill set; it also offers the prospect of attractive outcomes when well executed over the long run.
As highlighted in the example above, it also influences how I think about position sizing in the face of discouraging price action. While it has been unenjoyable to largely sit on the sidelines as DG’s stock price has fallen from ~$250 to ~$100, drip by drip by drip (with each new decline looking, in the moment, like “now is the time to load up” ), that simply reflects a tweak in my process; I’m waiting for something akin to proof that the thesis is still valid, not just price action alone. (As discussed in the latest DG update, the primary “proof” I’m looking for is on the comps gap with key competitors; I can accept the short-term profit pressures if that concern is adequately addressed).
If that day comes, I’ll be ready to make a meaningful decision (one that may justify the wait). As I think about other considerations like the risk associated with averaging down into a value trap and my desire to keep large allocations to companies delivering great results, this approach seems logical to me.
Here’s the updated portfolio as of Friday’s close: