

Discover more from Liviam Capital - Finding Reinvestment Moats
I spend a lot of time thinking about portfolio construction. Specifically, I focus on three things:
How many companies should I own?
Which companies are worth owning and why?
How much cash should I have?
Before you answer each one of these questions, I can’t stress how important figuring out your own personal long-term hurdle rate is. It will absolutely inform your strategy for investing. For example, if you’re looking for a 5% annual return, you might as well invest in an index fund. There is really no purpose to picking stocks yourself.
My personal hurdle rate is 20%+ annualized over a very long time. Whether or not I can achieve it is debatable, but it certainly is the goal. I work backward from there, and every decision I make is to help me achieve that 20% annualized rate.
How many companies should I own?
It goes without saying that the more companies you hold, the more difficult it is to attain a high return, if only because by definition your total return is the average return of all stocks in your portfolio. Having said that, the more diversified you are, the less risk of permanent loss of capital. In terms of risk mitigation, 30 stocks is the cutoff; there is no risk reduction benefit for any additional stock in your portfolio. Really it’s about striking a balance between maximizing returns and minimizing risk.
On the other hand, reducing the number of holdings in your portfolio has some intangible and indirect benefits that people can’t really quantify and therefore don’t focus on. Concentration is a forcing agent that makes you choose to invest in only the highest quality businesses, perhaps subconsciously. Your bar for investment will become much higher and you will find yourself saying “no” much more often than “yes”.
On Twitter particularly, everyone has an opinion on every stock. There’s people posting astronomical 6-month returns and it’s easy to feel overwhelmed with new ideas and unsure about your own process. Yet calming your mind and saying “no” to a million different ideas is a critical component of successful investing temperament. You don’t need to have an opinion of every business. You need the time to focus on very few ideas, and in turn, this will enable you to have the confidence to own just a few businesses for a long time.
Which companies are worth owning and why?
Knowing your own temperament and your investing goals is key. Because I want to concentrate my holdings and hold for a very long time, I look for quality businesses with lots of reinvestment opportunities. I say no to basically everything else, including deep value, special situations, turnarounds, etc. I also say no to any industry or business that is “swimming against the tide” or in a competitive industry with commodity type products.
So for example, I view Coca-Cola as swimming against the tide with regards to sugar consumption in the world. Same for consumer packaged goods companies. I view airlines, car manufacturers, and retail as competitively-pressured and commodities, so I won’t even go there mentally. I also stay away from stuff I’m not smart enough to understand like banks. I also generally stay away from businesses that are struggling to grow or growing along with GDP. In general I do not care if any of these types of businesses are undervalued, buying back shares, or have a high dividend yield. I just say “no” immediately.
As a result, my pool of potential investments is quite limited at the onset. I like it this way, because it allows me to focus all my time on very few businesses.
In terms of the key attributes of businesses I like: I’m looking mostly for high returns on capital and a long runway, protected by a wide or growing moat and run by able management. Then it comes down to valuation work, and I like to keep this simple. Doing DCF’s and attempting to predict valuations to the nth decimal does not really add any value for me. I just try to predict as reasonably as I can the annual revenue growth over 5 years and then take the net margin using the net income margin at maturity, and then slap a fair multiple on it. I look at it conservatively using a few different inputs and make a determination whether or not it will help me achieve that 20% goal.
Finding businesses at the intersection of quality and reasonable valuation is a simple concept but it’s not easy to find, which is why I own very few businesses. There are some businesses I know and love, yet don’t own because the current valuation does not realistically support a 20% annual return from that moment. There’s no shame in saying “no” or “not yet”. Again, I don’t want to dilute my returns for the sake of adding a new holding and/or risk prevention.
Sometimes a stock I own will run up to where I don’t see a 20% forward return at current prices. I generally do not trim my holdings for any reason apart from the quality of the business deteriorating. There are several reasons for that: (1) capital gains taxes (2) the equity is still showing an acceptable forward return and cash does not and (3) I would have to redeploy the money somewhere else and I might not have a better option.
How much cash should I have?
I generally do not keep much cash, if any. The reason is that cash drag is a real thing and even if my holdings are a bit expensive they are usually still showing decent forward returns at any given point in time, and as we all know, cash doesn’t have a positive return. At times, I have been able to hold cash for a month or two, but that’s about as long as I have been able to go.
Whenever I have cash I just add to my best idea which is usually a holding I already have.
It’s also impossible to predict the market’s short-term movement so trying to find a bottom is useless and a waste of time. Again, I try to focus all my energy and time on knowing the businesses I know and a few others too.
Summary
Know what your hurdle rate is and work backwards
Diversifying decreases risk but concentration has a few important benefits
I say “no” to almost everything
Focus on just a few quality businesses with lots of reinvestment opportunities
I don’t trim and I don’t carry cash
How I Approach Portfolio Construction
I was quite surprised by the fact that you dont like to hold cash. I thought I was doing it wrong all along but Im glad to see other people like yourself adding to the best positions.
Thanks again
Great Article! I myself have learnt from owning a multitude of stocks to a few now about which at least I can say I know a little better. And focus is paramount if one aims to beat the market - I had written a bit about it earlier here: https://compoundingwisdom.substack.com/p/the-paradox-of-investing . Hope you like it!