Thursday, May 19 2022

Vertigo3d/E+ via Getty Images

So, first off.

This article is not a piece where I convey a “Hah! My portfolio outperformed the market and yours/that other guy’s didn’t”.

In actuality, I consider this sort of performance more “fluff” than anything else. However, I realize that many readers care a great deal about this – and I understand why.

What I want to share are the reasons why I managed to grow my portfolio by 44.30% in 2021, to make you understand how you can replicate similar results.

DAX vs my portfolio returns

Nordnet, Author’s 2021 portfolio performance (Nordnet)

Those of you who follow me know that I’m always trying to be transparent with my readers. I share my net worth and my portfolio sizes.

I share my investments.

I share my dividend payors.

2021 was a big one. A very big one.

It was the year I, as a private individual, became a USD and EUR millionaire, in terms of liquid cash – not “liquidity” or net worth(as opposed to a company owner). In cash. I currently hold around $1.4 million in investable cash (in a mix of stocks/uninvested)- not assets or net worth. That number is over $2 million.

What this means to me is that I’m years ahead of my original plan that I made when I was 27 – I’m now 36.

2021 was also the year when I decided to quit my full-time consulting job and focus on running different sorts of business endeavors. It has become the year I joined a great writing team at iREIT on Alpha/Wide Moat Research LLC, becoming one of their senior analysts with a European Focus.

My focus in this article will be helping you understand why my portfolio outperformed the market.

Because I know why.

I want you to understand why.

Disclaimers

A few disclaimers first.

  • My portfolio’s performance includes FX – it’s near-impossible for me to exclude this, and FX impact for 2021 has been noticeable, both in terms of lows, as well as highs.
  • My portfolio is more diversified than most investors’ portfolios due to my investing interest and coverage. I’m aware that less diversification, in many cases, may be preferable, but I choose to run with a portfolio with this degree of diversification. That does not mean you should.
  • I invest based in Sweden. That means that the tax laws/dividend withholding laws governing my investments, including international ones, are categorically different than the laws you are likely subject to. My tax on capital investment gains in Sweden is 0%. My tax on Swedish dividends is 0%, as long as I have tax deductibles (which I do because I have mortgage interest payments). My tax on non-Swedish (including NA) capital investment gains is technically 0%. I get taxed on a flat basis for the size of my non-Swedish investment account and this tax includes any capital gain and all dividend payouts, and this tax is around 3.4%. While I don’t believe most investors consider taxes before presenting their annual returns, I do believe tax implications are a driving factor in investment decisions – and I am under the consideration here in Sweden.
  • The returns include dividends.

So consider these factors prior to making comparisons.

1. Portfolio Construction/Diversification

Let’s not waste any time, and jump straight into the portfolio strategies that I believe you should adopt in order to generate the sort of returns you’re seeing here. They are in no particular order, meaning that I consider each of them equally important – not more or less important than the next.

The first point is portfolio diversification. In my work where I also help others with their investments, I often see investors focused on even just 5-9 stocks, often in only 1-2 segments. Often in just 1 or 2 countries. While I do believe there are companies that could make this work, I don’t see the long-term advantage of this approach, because all sectors have their ups and downs eventually.

While it may seem like it, today at least, that things like tech or quality companies such as Apple (AAPL) will never have a bad year or valuation, I assure you, that time may come.

This point obviously is related to the others – valuation, expertise, and quality – but it stands on its own.

Diversification reduces investment risk. Specifically, it’s a tool for handling unsystematic risk. For those of your unfamiliar with these market concepts, systemic risk/market risk can generally be considered an unavoidable side effect of investing including factors such as inflation, geopolitical instability, interest rates, and other macro factors. You cannot invest without facing this sort of risk, and it cannot be diversified away

Unsystematic risks, on the other hand, can be diversified away. It’s specific to business risk, sector risk, financial risk, and similar factors. The goal of diversification is to lessen the overall financial impact on your assets or portfolio in case of a crash.

Examples are good – so let’s give you one.

I had a client, a retired CEO, who approached me during COVID-19 and told me that he needed help looking over his investments, because of the effects that the pandemic had on his dividends and investments. He had an impressive pension, but he relied on his interest/dividend incomes to fund his and his wife’s “luxury” lifestyle beyond their common expenses. However, his portfolio was primarily focused on what he had worked in before retirement – construction (not real estate). He had zero international diversification and no sector diversification. Every single company he invested in either eliminated or lowered their dividend during the pandemic, and his annual NTM dividends were down 83% for the year. Together, we identified the companies that weren’t undervalued and rotated them, and step by step he now has a diversified portfolio with a yield similar to the one he had when he approached me, but one that’s 23% USD, 18% EUR, 10% NOK and 3% DKK. His dividends are more spread out and quarterly, from companies from 8 sectors that do not rely on a volatile industry that changes its dividends often. The client and his wife are very content with their new portfolio.

This is an extreme example, but it illustrates the advantages of diversification.

As investors, we can address unsystematic risk through diversification, with investments that will counteract one another. This isn’t something I or other “value” investors have invented – this is math, specifically, calculations of covariance (Covariance is not correlation, though they are related), which is the quantification of how closely investment A and Investment B move in tandem to one another. I’ll be the first to admit that I’m not a math major or Ph.D. – but I do use the formulas and basic concepts in my valuation work and understand enough to be dangerous.

If you’re interested in delving deeper into risk management and portfolio variance, I recommend this free article (fair warning, this is relatively heavy for laymen).

Why My Portfolio Significantly Outperformed The Market In 2021

Author’s Portfolio (Author’s Data)

What I want to leave you with is; Diversification is important, and it’s one of the reasons that my portfolio outperformed the market, because I’ve diversified away from sectors I’ve viewed as overvalued, and into sectors, I view as undervalued. What you see above is the sector-by-sector-diversification of my portfolio which generated the returns you see here.

How much diversification? This is a subject many investors often discuss. Some say as few as 10-15 stocks. Some say 40-50. I would go as far as 40-60, but obviously, you know I own over 100 (though only 50-60 of them is above 0.3% of my TPV)

Consider your diversification.

2. Expertise/Knowledge

Expertise and/or Knowledge is no joke. You need it.

When I started investing around a decade ago, I quite literally had nothing beyond what basic skills I brought with me from high school and university – and I never studied investment.

I was very lucky that I found people to “follow” (blindly) that were somewhat knowledgeable and helped me avoid bumbling head-first into the biggest brick walls. That’s not to say I haven’t made mistakes and will continue to make them, but it took me years to become knowledgeable on the topic of investing money.

Years.

Many readers ask me how I cover so many stocks and investments. Time investment. Years.

Investing without having knowledge or expertise in your corner is an absolute nightmare. You will probably second-guess a large portion of the decisions you make because of your insecurity (and who could blame you?). You may not even know what the people you follow have in terms of goals and targets. Do they want growth? Income? A mix? What’s their risk profile? Any sector expertise or specific knowledge?

All of these questions aren’t just considerations you need to consider on the surface, but deeply.

I have seen so many people lose basically their entire invested amount because blindly following people they really shouldn’t have listened to in the first place. I see so many people not understanding what investment actually is. Members of my own family are, to this day, partially convinced that the market is essentially a Casino without rhyme or reason.

I see this sort of blind following without rhyme or reason too much in today’s market, especially when it comes to some of these overvalued and inflated companies. What I often wonder when reading these articles, is if the investors are really aware of the extent of risk they’re taking or are as knowledgeable as they should be about the investment.

The good news is, you’re on Seeking Alpha. You’re reading this article.

That fact alone means you’re ahead of the curve. Because when it comes down to it, getting Knowledge and Expertise in a subject isn’t hard – it’s just time-consuming. Want to learn more about real estate in Scandinavia? Print out a dozen-or-so reports and start reading. You will learn. It’s like any subject – just spend time with it.

There are two solutions to the knowledge/expertise conundrum.

  • Learn, or
  • Surround yourself with knowledge/expertise you trust.

Ideally, you want both, because take it from me. It’s impossible to learn everything you want to learn. There isn’t enough time. You have to either ignore certain segments or investments, or you have to lean on other, capable individuals.

When you do trust someone, make sure:

  • His/her investment targets mirror your own, as well as your own risk profile.
  • His/her knowledge is well-established and confirmed.

This isn’t even to say you should follow me or the people that I follow. I will be the first to tell you that there are sectors I stay out of, and I would never write articles for people to “BUY” a certain stock. Cryptocurrency is one. Pure Software/tech is another. For these segments, even I use other experts.

I often come back to something my teacher said to me when I was younger.

Be a master of what you do know – however little or much that may be.

I know what I know – and I know what I don’t know, and where I need help.

Do you?

3. Quality & Valuation

This one’s more familiar. The two concepts of company quality and valuation go hand in hand.

To me, company quality is a fundamental requirement for even seriously looking at an investment. While I have been known to say that I’ll buy anything at the right price – and I do mean that – realistically, I will likely not invest in what I view as “garbage”, on a quality basis.

Quality can be measured in a number of ways. I do my measuring, and we do different types of measuring here on iREIT on Alpha and Dividend Kings, and others use other methods of quantifying quality. I view the important thing as having a way to measure investment quality.

Valuation is similar. I have ways of viewing a company valuation that might not be accurate if applied to another company. Valuation, to me, is situation-specific, sector-specific, and sometimes company-specific. Two investors may end up at a vastly different, or slightly different valuation for a company, though they don’t necessarily disagree on much.

Let me take an example.

Equity analysts from AlphaValue consider BASF (OTCQX:BASFY) to be a “BUY” with a collective, weighted (DCF, SOTP, Yield, Peers, EV/EBITDA, P/BV) price target of €85.9/share for the common share, with a DCF target of around €77/share.

Alpha Value BASF targets

Alpha Value BASF targets (Alpha Value)

These analysts are extremely knowledgeable – I’ve spoken to them, and I respect their opinions and industry knowledge greatly. But my price target for BASF on a DCF basis is currently €74. How can that be? Because I apply a slightly higher discount and consider slightly lower margins to be both more conservative and realistic based on what I consider to be likely for the company. Our numbers differ very little in the end – but you will find small variances in many analysts’ targets such as this. Maybe Analyst A considers a higher CapEx/sales ratio to be likely, based on what the company has done in similar situations historically, despite management assurances and guidance. Maybe he/she sees a higher impairment risk. Maybe they see a slightly higher margin pressure. Maybe they have reasons for considering a more conservative terminal growth rate if we’re talking DCF.

I can explain my variances and why I use the numbers I use for companies I analyze. Any value investor or analyst worth his/her salt should be able to tell you why they apply certain expectations to valuations, or why they do not apply certain premium valuations to models.

Quality and valuation are absolutely central to my success as an investor, and in outperforming the market over time. If I didn’t follow these rules, I can say with certainty that my returns this year would have underperformed the market, because I wouldn’t have ideas of where to enter, where to increase, or where to reduce/exit.

You need these ideas – that is my view. And that is why valuation and quality matter so much. If you buy the right quality at a cheap price, you can see your returns soar beyond your wildest dreams. However, if you hop a bandwagon without understanding valuation implications, you can just as easily crash and burn without understanding what exactly went wrong.

4. Exit multiples/valuations & Reinvestment

This is gonna be a bit of a controversial one, given the Buy & Hold-forever mentality that I often try to convey.

I still believe that good companies are essentially Buy & Hold-forever.

However, this belief/stance is complemented by the very firm stance that every company can become excessively overvalued. Overvaluation is not something we should make a habit of holding onto. That’s why I say that every investment – yes, even those conservative super-stocks such as Apple and Microsoft (MSFT) should have reduce/sell targets.

No company is immune to a downturn. I know that it can currently feel like certain stocks will “always” be high and inflated, but history would suggest, and at least historically prove otherwise.

I can’t tell you when these stocks will fall – I won’t attempt to. What I will tell you is that I’m not going to buy Microsoft at 40X P/E. I will not buy Apple at 32X P/E, and I certainly won’t touch Tesla at 180X P/E. You may, and that’s perfectly fine. Readers know from the get-go that I’m not the analyst to ask about such equities.

I’m an investor who actively manages overvalued stocks in my portfolio, and sells them when I deem it necessary. 2021 has been an excellent year from doing so. I managed to not only sell stocks at excellent valuations but buy the “right” companies with that money at the right price.

I’m going to name two local examples.

I had a high triple-digit % 3.5-year RoR on my investment in Investment AB Latour (No symbol) including dividends. Because of a NAV premium of almost 80%, I sold 99% of my stake and reinvested it. The company grew around 6% since I sold it. Some investors literally contacted me and told me “Look, it continues to grow!”

Yes, it continues to grow – but the money that I invested, most of it in Swedish consumer defensive, had at that point grown nearly 23%, not including dividends, at a much more appealing yield and overall upside.

Just because an investor sells something that’s expensive and that stock continues to grow, does not mean it was a bad choice. Only time will tell – and it depends on what you buy instead.

Example number two is a real estate company called Nyfosa (No symbol). My return on this investment is at this point over 600% in less than 2.5 years. I know many investors who sold when reaching 100-400% returns. I have not, because valuation and analysis dictate to me that the company’s growth is matching its valuation expansion. The company has increased its portfolio, introduced a good, quarterly dividend, and become a major player in several swedish geographies. Because valuation is high, but not excessive, this is not a sell, despite this degree of return. I would sell Nyfosa if it increased another 20% from today’s share price, but not before.

So, Buy & Hold notwithstanding I firmly believe that every investment you ever make should have an exit target – because you should actively manage your investments, even if it’s possible to simply “BUY” and then never check your portfolio again except for dividends.

While in some of my work I do cater to the Buy & Holders that don’t want to rotate, I firmly believe in the following:

Any excessively-valued superb-quality company can be sold at what is a realistic exit/profitable multiple or valuation and can be replaced with an investment of similar or greater quality, with better valuation, yield, and upside.

If you agree with this, there is no reason not to adopt a more actively-managed portfolio strategy.

Conclusively

The points made here are, in the order of 1-4:

  • Portfolio Diversification
  • Expertise/Knowledge
  • Quality & Valuation
  • Exit Multiples/Valuations & Reinvestment

I consider these key in achieving what you see in my portfolio for the year of 2021. I would strongly suggest to anyone seeking similar levels of outperformance to adopt similar methods.

You don’t have to diversify as much, be as valuation-focused, or even exit your investments. Just be aware and consider these things and their place in your strategy.

Remember, winning an investment argument is easy. It’s easy because it’s binary. Yes/No.

You either beat the overall market with your investment or you don’t.

You either make good money, or you don’t.

I don’t listen to investors that don’t make good money. I won’t even give someone trying to advise me on what to do the time of day without first seeing what he/she has achieved. There is literally no point to it. That’s why I never went into bank-managed mutual funds. I sat there and listened to someone telling me why I should invest in something that underperformed the market, and/or a free index fund.

It’s also why I don’t say as some value investors do, things such as “Crypto is a bad investment” or “Tesla is a bad investment.”

If you say that – are you insane?

Have you seen the returns for these investments over time? You cannot seriously make such a blanket argument and expect me to take you seriously.

However, Tesla and Cryptocurrency are not investments I hold in my portfolio. They’re not for me. Their risk profile and ups and downs are far outside of my overall risk tolerance. The money that I’m writing about here on SA is not some sort of monopoly money or inheritance from a rich aunt. They’re my life savings, and what I’m supposed to live on. I will not enter investments that are unappealing in terms of risk, and for me specifically, these are investments that I view as outsized.

In my investment approach, I derive a lot of inspiration from Kevin O’Leary (excepting his latest focus on Crypto’s and NFT’s), and his no-nonsense approach is one I try to follow – but even his investment strategy isn’t one I do a 1:1 on – the man has more money than I do, so our risk tolerance is very different.

However, I believe in one message he sends, and that is: Don’t do stupid stuff/buy stupid stuff. (cleaned the language up a bit)

Potentials for the rest of 2022

I wouldn’t be doing my job if I didn’t talk specifics in this article – so let’s dig down.

I’ve made several investments in 2021 and 2020 which have yet to reach their potential. These investments are currently flat – once they go up, that outperformance would have been nearly 10-15% higher than it is today. Let’s talk about sectors and name some examples.

1. Healthcare/Pharma

Many of my investments in Healthcare and Pharma have yet to meet their potential. We’re talking almost 10-12% of my current portfolio, which on a YoY basis has rather meager returns, with the exception of AbbVie (ABBV). We’re talking companies such as Fresenius (OTCPK:FSNUY), Bristol-Myers-Squibb (BMY), Merck (MRK), Cardinal Health (CAH), CVS Health (CVS), and others. As you can see from my portfolio exposure, I’ve taken a firm stance in favor of pharma and healthcare in the long term, and once this pays off, I expect further outperformance.

Many of the stocks here are actually still substantially undervalued. I would direct you to my/our articles on the companies, to see if these can be of interest to you.

Healthcare/Pharma is by far, and easiest, the underperforming portfolio segment currently. Am I worried about this? No – the companies will likely deliver performance eventually, with their excellent fundamentals and upside.

I would seek further exposure to the sector and to the companies here.

2. Finance

Finance has taken a beating during the year and hasn’t really performed as other segments. While certain stocks have outperformed, such as Ameriprise Financial (AMP), DNB (OTCPK:DNBHF), Prudential Financial (PRU), Principal Financial (PFG), and others…there are many that have not. Companies such as Unum (UNM), Swedbank (OTCPK:SWDBF), Resurs (OTC:RSRSF). So, Finances is a sector where there’s plenty of buyability as well – will be pushing more money to work here.

There are plenty of massively appealing businesses here – and their appeal will not shrink, going forward.

3. Telecommunications

I don’t quite understand why this sector is as pressured as it is – beyond the usual suspects and analyst comments, of course. But I couldn’t be happier at the undervaluation. I’ll keep pushing money to work in Orange (ORAN), Verizon (VZ), AT&T (T), Telia (OTCPK:TLSNF), Telenor (OTCPK:TELNF), and Tele2 (OTCPK:TLTZF) – and others.

This is a segment rich in quality, safety, yield, and income – and it hasn’t given me significant market-beating RoR this year so far, despite being over 15% of my portfolio.

4. Real Estate

This is a two-sided sector – because part of my biggest RoR this year have come from this sector. However, there remain significantly undervalued stocks in this sector that deserve your attention. To my mind, this is probably one of the most split sectors we currently have – the highest as well as the dirt-cheapest valuations out there.

In such a sector, you need to be careful – and you need what I mentioned above, knowledge and expertise.

In closing

Outperforming the market to this degree of course means I’m content with my portfolio’s overall performance this year. I’m also happy for the people (there are some of you) that have written to me and thanked me for the articles that resulted in some of you garnering similar returns.

What I can say is that I will stick to my strategy and look to repeat this performance going into 2022.

I hope you’ve enjoyed this piece!

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