As mentioned in my Investment Philosophy, I strongly believe that the only way to outperform the market consistently is to be contrarian, taking up either credit risk, illiquidity risk, concentration risk, leverage risk and/or impatience risk (the risk of being impatient and doing too much trading as a result), and that the more types of aforementioned risk you can take with your investment strategy, the higher possibility and potential of outperforming market returns.
Compared to only illiquidity risk and concentration risk of NCAV stocks, when investing in Great Companies, I have the option to also take up leverage risk and impatience risk as well.
When offered a big fat pitch (eg. bear market), most retail and institutional investors are forced to sell thus making me take up illiquidity risk as I would be buying stocks that would be very hard to sell immediately, and also I would be tying up cash into stocks thus increasing my own illiquidity risk. At that critical moment of time, I can also safely leverage up to a maximum and go into only a concentrated few of the greatest companies in the world. The fact that the companies I would invest in are the best of the best reduces the probability of them blowing up while offering spectacular returns if held for a long time.
As a result, my priority in investing would always be in great companies since it allows me to take up a much bigger plethora of aforementioned risks compared to just Active Indexing and NCAV stocks.
What’s to note is that there are two types of Great Company stocks in my eyes, one being Dividend Aristocrats and the other being Tax Efficient (no dividends but high ROIC). Ideally the most effective way to growth wealth would be to invest in Tax Efficient Great Company stocks (John Huber of Base Hit Investing explains this very well), but the focus on which type of Great Company stocks to buy would be heavily dependent on what stage of accumulating wealth I am.
When I am starting out accumulating wealth from a standstill, liquidity is of essence, since I’m still very dependent on a job salary to take care of myself, so I would need standby money just in case I get laid off. So even though Dividend Aristocrats aren’t as Tax Efficient (the companies’ income is taxed before shareholder’s dividend income is taxed as well), the incoming stream of dividends eases the need to sell and the stability of Dividend Aristocrats’ dividends allows for better budget forecasting and better gauge on whether borrowing to invest is viable at any moment.
Once I don’t rely on my job salary to take care of myself much or at all, Tax Efficient Great Company stocks make a lot of sense. Great returns can be generated with investment capital locked in without having to sell. This will help reduce the problem of having to figure how to put the excess of money into work if I were to constantly selling my stocks. This also reduce cost to an extreme minimum as less frequent trades means I’m paying less or even no capital gains taxes and transaction costs.
I’d mainly evaluate great company stocks with the same four filters Charlie Munger uses, which is
- Understand the Business
- Sustainable Competitive Advantages
- Able and Trustworthy management
- Bargain Price and Margin of Safety
The only times I would sell would be if the adjusted P/E’s earning yield is equal to or lower than 1/2 earnings yield of AAA grade bonds, I would sell the holdings completely as I could easily get better results parking my money in essentially risk free investments.
I would also leverage / hedge my portfolio based on the average of undervaluation / overvaluation indicated by Shiller P/E ratio and Total Market Cap / GDP.
Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)