Portfolio Ranking Exercise #2
Ranking my 21 portfolio companies based on 13 different fundamental and non-fundamental criteria
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In August, I shared a well-received post ranking my portfolio companies. Since then, my portfolio has seen some changes and most of my low-rated companies are now sold. Let’s take a look at my current portfolio and rank it.
As long-term focused investors, we learn more about our portfolio companies as time goes on. I firmly believe that you need to own companies to really understand them, at least I need to. However, we must avoid the pitfalls of falling in love with our companies and falling for fallacies:
Price anchoring: I will sell it once it gets back to my purchase price
Sunk cost fallacy: I put so much money in already, now I can’t just walk away
Ignoring fundamental changes/deterioration since we first invested
I want to create a process combining my experience and some numbers to combat these issues and make reevaluating my portfolio quality easier. I intend to evaluate all portfolio holdings at least on an annual basis. The idea is to put incremental capital towards my best ideas, not just the ones down the most. Making a ranking helps to make this easier. This could also help in focusing the portfolio. Ideally, I want to be within 15-20 companies, and while I’m close to 21, there might be options to concentrate further.
Ranking Criteria
I want to use a mix of fundamental and non-fundamental criteria to rank my companies. These criteria are meant to rank the quality of the business and NOT the valuation. I intentionally want to disconnect these two metrics. Having the highest quality score does not mean it is the best investment opportunity. Here are the current criteria I chose:
Management Alignment
Growth opportunities/secular tailwinds
Margin development
Balance sheet
Moat/Competition
Past growth rates
Expected sales growth
ROIC
Reinvestment rate
Capital return of excess cash
Cyclicality/Visibility
Recurring revenue
Working Capital
I used to include management quality here, but I haven’t found a way to put a number on this accurately. Furthermore, I include the projected IRR ranges as well as fundamental IRR ranges (that’s, the IRR excluding multiple changes).
Last time, I gave every category 5 points, but now I have reduced it to 3 points for the following categories: growth opportunities/secular trends, balance sheet, and working capital management.
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