Swan Fund is a family fund to protect and grow my family's wealth. I'm a regular person: 40 years old, with a full-time job, 2 kids. While I definitely have an interest for investing, I value other things more: spending quality time with my family, playing tennis with a friend, having a good laugh or watching a thriller with my wife.
Swan Fund is the fund that allows me to do all of these fun things, while Sleeping Well At Night, knowing that our savings are hard at work. If I can do this, you can probably do too and if this site can help you along the way, that would make me very happy.
After all these niceties, let's get right to it.
I invest for the long-term in high-quality businesses that have the potential to 10x. By nature of things, 10x is more likely to be found in small and mid-cap stocks. I am not aiming for a specific return every year and rather aim to double the portfolio every 5 years.
My approach is strong influenced by Terry Smith principles of buying good companies, don't overpay and do nothing. This means that I adopt a simple buy and hold approach and don't aim to second guess myself of when is the right timing to sell. The main difference with Terry Smith is that he invests much larger sums of money that I ever will, so he's looking in the highly competitive space of large caps. I am to replicate this approach while being agnostic to the business size: from small-caps to large-caps.
My holdings are diversified in 10-15 stocks for which I follow the fundamentals: reading and dissecting the financial statements, listening to the earnings calls, follow the competitors and market environment. Because of this diversified portfolio, a 50% drop in price in one stock means a 3-5% drop in my overall portfolio. This is something I can live with, and if I have extra cash to invest, I use the opportunity to reinvest in the stock at a lower price.
What is a high-quality business? It is a business that is generating high returns on incremental invested capital, has a clear runway for reinvesting all of these returns (instead of distributing dividends) and can be bought at a decent price.
The simple equation sums it up for me:
High ROIIC x High reinvestment rate x Decent FCF yield
More specifically, I look for the following attributes:
- An incremental return on invested capital (ROIIC) above 20% based on recent financial statement - The market is a second-order system, which is why I look for the incremental return and not for the average return on invested capital. A consistent incremental return of 20% is a great indication that the average return on invested capital will anyway converge towards 20% in the long-term. Sometimes these companies already start from a high average return of invested capital. Sometimes they start from very low average returns but are hitting an inflection point, which allows me to acquire them before they've gone too expensive.
- A reinvestment rate above 100% - I look for companies with a clear secular trend (e.g., change in demographics, change in consumption patterns) or that have a clear market opportunity to grow. This biases me towards compounders riding large trends (ex: Microsoft) or serial acquirers, a type of company which predominantly grow by acquisitions of smaller, private businesses.
- A FCF yield below the median historical FCF yield of the company (or its competitors). While the first two criteria (high ROIIC and high reinvestment rate) are non-negotiables, I see an attractive valuation as a nice to have. As Munger states, the long-term return on an investment will converge towards the return of the underlying business. A multiple expansion is a nice sweetener of returns but this shouldn't come at the expense of buying a lower quality company.
- A moat advantage - the moat is what will allow to high return on capital to be sustained over the long-term, despite the headwinds and market competitive pressures. Moats can take the form of network effects, high switching costs, high brand loyalty or unique access to a physical ressource. If the moat is not strong currently, I am looking clear signs of a widening moat over the last few years.
- Management with skin in the game and with clear incentives focused on long-term value creation (such as return on capital). I tend to stay away from companies that incentives short-term goals (such as revenue growth) or tend to have excessive stock-based compensation (which is a hidden cost to shareholders and should be factored in)
- A culture of high-integrity. This is much harder to assess but I look for companies that value hard work, simple and direct communication, and have fun along the way. Clues of this might be found in founder's podcasts, glassdoor rating reviews and other random website links.