• Brett Schafer

The Too Hard Pile

Charlie says we have three boxes: “In,” “Out” and “Too hard.” You don’t have to do everything well. At the Olympics, if you run the 100 meters well, you don’t have to do the shot put…” – Warren Buffett

Investing in individual companies is easy to do but hard to be good at. Online brokerages with zero commissions have made it so you can buy stocks at the click of a button. But it doesn’t guarantee you will make money doing it.

Statistically, very few investors will outperform the indices. And that is okay! The goal of investing (at least as an individual) is to build wealth so you have financial security later in life. Most people will either choose to invest with the market (through ETFs/index funds) or underperform the indices by buying mutual funds and bad stocks. Some, through either luck or skill, will end up outperforming it.

I hope (yes, maybe naively) I can be in the latter. As far as I know, the best way to do that is to buy and hold quality businesses for the long-term. But what is a quality business? That, my friends, is the million-dollar question we all want to be answered.

There isn’t a simple formula for identifying a market-beating investment. However, in the immortal words of Charlie Munger, if you invert the situation and ask “What stocks are possibly not market-beating investments?”, you can eliminate a ton from consideration.

This is what Buffett means by the “too hard” pile. These are companies you may like. They may be held in plenty of other respected portfolios. But for whatever reason, you don’t have enough conviction to put it in yours.

Here are some reasons companies have gone in my “too hard” pile in the past.

Bad Sector/Industry

If the unit or macroeconomics of a business makes it tough for executives to obtain a high ROIC (the long-term driver of shareholder value), it always goes in my “out” or “too hard” pile. Even if the CEO is top-notch with strong growth and industry leadership, bad businesses rarely, if ever, produce good returns.

One example is energy. All energy companies are influenced by the price of oil. I can’t control the price of oil, and neither can industry executives. So why would I ever invest in these businesses, when the chance for profit is up to chance, politics, and global economic trends?

One unit economics example is ride-sharing and food delivery. Both are structurally unprofitable and have been since inception. The only reason they have been able to grow to billions in GMV is that they sell their products for less than what they cost. Why would I invest in any of these companies, even if they have industry leadership, strong executives, and solid top-line growth?

If the unit economics don’t work, the business never will.

Tough to Understand

This criteria is more nuanced and is probably the toughest one to follow (I know it has gotten me in trouble before). But if you run a concentrated portfolio it is imperative you understand, backward and forwards, each stock you own.

This can be tough in highly-technical industries. Take DataDog. When their S-1 dropped last year, I was all over those strong margins and absurd growth numbers. Everything looked great. The only issue is, I still don’t know what DataDog does.

Sure, I read through their filings and some in-depth blog posts on the company, but for whatever reason, I never comprehended what they offered customers. This doesn’t mean DataDog is a bad business, or that I’ll never understand enough about what they do in order to feel confident about investing in them, but right now I don’t and that is why they are in the “too hard” pile.

In a Region I Can’t Trust

An easy, timely reason, and the initial inspiration for writing this post.

After the latest surge of Chinese frauds (more detail here), every stock from the country has gone in my “too hard” or “out” pile. Even JD.com, whose financials and growth trajectory I love, is now out. I don’t believe all Chinese companies are frauds. That would be silly. But I have no idea which ones are (and trust me, they’re still some out there), and therefore will not risk any capital going into that country. Especially when my money is buying shares in a Cayman Islands shell corporation.

Other regions that go into my “too hard” pile are Africa (politically and economically volatile), India, and Southeast Asia. It’s not that I am biased against these regions, I just don’t have the expertise to invest in companies located there, no matter how enticing the individual situation.

Followed Too Closely

Last up we have criteria that most investors inherently don’t follow.

I believe the larger a following a company has, the more efficiently it is traded. This shouldn’t be a controversial belief, but I want to make note of it so you understand my reasoning. Amazon, for example, might be the most talked-about and analyzed stock on the market. Thousands of people every-single-day follow what the company does and try to predict where the stock is heading.

How do I find any edge investing in this business? If all these analysts who are smarter and more experienced than me (plus tens of thousands of retail traders) have cumulatively priced the stock, it would be arrogant of me to think I’m right and they’re wrong.

Some examples include big tech, Netflix, Berkshire Hathaway, the big banks, and any “hot” stock the financial media can’t stop talking about. Zoom Video has been studied with excruciating detail over the past month, with everyone either turning into a bull or bear. For me, it has gone right into the “too hard” pile.

So what do I try to invest in? Well, mainly small-to-mid cap technology, consumer-facing, retail, and financial businesses with long runways for growth. It also is a benefit if they are underfollowed. I’m not super strict about these rules (I do own Altria at the moment), but do try to adhere to them for the majority of my buy-and-hold positions.

Disclosure: The author is not a financial advisor, and may have an interest in the companies talked about.


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