I know, it has been a while but trust me, I didn’t stop doing value investing, I just cannot speak about it that open anymore and generally, I have less time for the stuff which I’m allowed to do. Additionally, some things have changed in the last year so that I now put more emphasis on time with my family.
Some housekeeping notes:
In the future, I will only speak about companies which are not listed in the Noridcs or DACH region. Additionally, I will start publishing all articles under www.nilsherzing.com (The side is currently in the making, so excuse me if it is far from perfect).
Founding another start-up:
Furthermore, two friends of mine (Oliver Rolle – already a successful IT startup founder and responsible for the development of the IT platform & Tim Klauke – future CEO, industry expert and the guy with whom I developed the initial idea on a nice evening before a long kite-surfing weekend) and I are currently starting another company which is not related to investing at all (we are developing a software platform for the management and total cost of ownership analysis of special purpose vehicles). Currently, we are considering to start a VLog to document our journey and, as two of us have already founded a company, share some advice. But the main purpose would be that we document our decision-making and are accountable for it. So if you like the idea of a VLog or have some general comments write me via email or leave a comment.
but now back to the original topic of this blog:
The Investment philosophy of Nils Herzing
(This is an “executive summary” of my investment philosophy which I wrote more than a year ago.)
This Investment Philosophy frames the general thinking about investing and describes my investment style. It is not a fixed set of rules, it is more an evolving collection of thinking patterns.
The aim of my investing is to generate long-term outperformance (over a time period of more than 5 years). Thus I don’t aim for a low volatility or other fancy things; the sole goal is to maximize the performance in real monetary terms.
I don’t believe in efficient markets, as I think that markets are “Voting Machines” in the short-term but “Weighing Machines” in the long term. I believe that the highest irrationality in stock prices, especially in the short run, exists in small- and mid-capitalized enterprises which have a low free float. Furthermore, I believe that an undervaluation in the long run can occur in large-caps, as most investors only think within a timeframe of 3 years. By taking a long-term investment approach which exceeds 3 years and thinking in time frames of 5, 10, or even 20 years, you are able to outperform the market even in large-caps.
I don’t believe in over-diversification, or in holding more than 20 stocks as it doesn’t add value and destroys performance. On the opposite, I believe that it is possible to get an investment edge via the two following ways:
- Informational edge – More information than every normal market participant has. This means doing field research, visiting companies and speaking with customers and competitors.
- Behavioral edge or “longer time horizon” – by taking a time horizon of more than 3 years, investors can see the value of long-term growth and are able to go against short-term pressure / noise / “pain”.
To participate from short-term irrationalities, it is necessary to have an investment process which is focused on the long-term value creation of a company, thus the value of growth is essential for my investing approach. To pursue this type of investment strategy, it is necessary to find long-term capital and co-investors who think like owners.
The only possibility to increase my returns towards a level of above 15%, to which I try to design and evolve my process to & which I would like to achieve in the long-run, is in my opinion:
- Have a less diversified portfolio of only 8 to 12 companies.
- Avoid a permanent loss of capital, which can be achieved by using quality filters such as good management, strong balance sheets, a quantitative fraud excel check list to also avoid biases and the use of “Owner Earnings” – true cash earnings.
- Use a higher discount rate and thus have fewer potential investment candidates – Mark Leonard, whom I truly admire and have already met, has written about the effect of hurdle rates at constellation
- Shorten the time frame of value realization,g., until the undervaluation is uncovered and the market price reaches the fair valuation of a business. This can be achieved by:
- Inflection points
- Growth in market cap and addition to indexes
- Activist investing
- Take a long-term view of more than 5 years and invest in real compounders, which have an outstanding management / capital allocator, really early in their life.
- Invest in the following situations:
- Invest in real compounders, such as a Coca-Cola, Constellation Software, Vitec Software etc. which have an outstanding management / capital allocator where the business generates high returns on capital while the management is able to deploy capital into further growth, really early in their life. (This is directly linked to point f)
- Invest distressed assets and then improve those assets or create efficiencies by creating economies of scale. This investment style is more suitable for a PE / Activist Investor.
- Invest deeply-distressed, out of favor, cyclical assets and then resell upon the top of the next cycle. One example would be the mining industry which is difficult, boom/bust business. All businesses are somewhat cyclical, but commodity producers are hugely cyclical with long multi-year cycles due to the nature of mining-it takes years and high expense to reopen a mine and it takes several years to do so.
Thus, an investor has not only to think about the undervaluation of a business but also about the fact, how this undervaluation can be reversed. The thing which can reverse such an undervaluation is normally called “catalyst”. A catalyst can arise from two things:
- Activist investing – e.g. a strong investor tries to reverse the undervaluation by putting pressure on the management and making the undervaluation public.
- An ongoing and inherent change in the business which tarnishes the real valuation. This can be something like a turn-around situation, certain break-even situations of high fixed cost business or a business unit which covers the true potential of another business unit and will be closed soon e.g. “Inflection point”.
In my opinion, I can increase my investment return if I focus my investing on small companies which have a strong underlying growth, which is generating value in the long-term and / or by searching for okay companies which are currently in a bad position and have catalysts attached. A really important habit for the success of my investment approach is, that I think 5 years and more ahead and ask myself the question: “How will this business look like in 5, 10 or more years?” Furthermore, I have to avoid the permanent loss of capital by all means by using checklists and the before mentioned thinking habit.
I believe that a buy-and-hold forever philosophy is not always the most value creating way, as it limits my possibilities. A buy-and-hold forever philosophy which is currently practiced by Warren Buffett comes, in my opinion, from the necessity to the size requirements of his investment portfolio. If we just look at the best years of Buffett, the 10 years of his investment partnership, he has not used a buy-and-hold forever strategy. He was simply buying highly undervalued small caps and sold them after a short time period when their value was unlocked, which was sometimes done by himself. Thus, if I would limit myself to a todays Buffett like investment style, despite the fact of my tiny size, I would give up an inherent advantage of being small.
Last but not least, I would like to achieve this goal by investing in an ethical and sustainable manner. I believe so, as I think that sustainability and ethical thinking is equal to a rational view on the long-term time axis. Thus, ethical thinking reinforces my long-term thing and at the end investing.
I wish all of you a happy new year and if you like to read the long-version of my investment philosophy (around 25 pages) shood me a mail or comment 😉