Focus on the Downside, Sleep Through the Downturn
How I structured a quality portfolio that I won’t panic-sell
Markets drop, screens flash red, and even the strongest investors feel that pit in their stomach. The S&P 500 was down more than 4% for two consecutive days, something that has only happened a handful of times in the last 50 years. There is real confusion and panic. In times like these, headlines scream louder than fundamentals—and that’s when long-term investors must lean into clarity, not panic.
Markets are probably due for another few days of downward pressure. In these situations, it is important to focus on business fundamentals and to reevaluate our portfolio. Ideally, we can consolidate low conviction positions into higher convictions, as there is selling regardless of the qualities of a business.
Over the last year I tried to front run a possible downturn, but really I’m trying (and we all should) to always be prepared for a downturn. Right now, the Trump administration is unpredictable and is creating chaos for global businesses and supply chains. I don’t want to get too much into macro, it’s not my thing, but people speculate that Trump does this to get interest rates down in order to refinance a large portion of the US debt pile.
Companies, organizations and nations around the world are getting cautious:
Is the US still a reliable ally?
Can we safely rely on their products and services?
How can we get more independent?
Many questions with few answers, but even if the tariffs get resolved, I expect that a shift has started away from US dominance and towards localization of supply chains. We don’t know what will happen and if we’ll get a downturn at all, but here is how I have been preparing for one.
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How to prepare for a downturn
In a downturn, we’ll see pain across most industries and companies, but they won’t suffer equally! There are a few things to keep in mind and check for all our holdings:
Is the business of high quality and has a strong competitive advantage?—This way we won’t be cut out so easily when businesses are looking to cut costs. Ideally, we want high visibility and recurring revenues.
Are margins resilient?—How far might margins decline in a downturn?
Is there an existential risk?—Is the balance sheet strong and can the company endure years of hardship? 10/20 of my companies have a net cash position and 19/20 are within my <2x net debt/EBITDA leverage range.
Is management opportunistic?—Never let a good recession go to waste: Deploy capital into M&A and buybacks during hard times.
What I’ve done
I always preach to look at the downside as much as the upside in investing. Invest with a margin of safety, however you want to implement this concept. Risks don’t matter in a bull market, but can ruin you in a bear market. Selling a company I believed in isn’t easy. But that’s exactly what discipline looks like. Here’s what I’ve done and openly documented on this Substack over the last year.
Created a 13-criteria quality score to assess and rank the quality of my businesses.—I detailed my quality score in this post and walked through one of my holdings, Mercado Libre, in this post. Check it out and implement it (or something similar) for your holdings!
Created a 5-year IRR model to value my businesses with a three-case scenario analysis (bear, base and bull case) to have a variety of outcomes—a good investment should have an average IRR of >15% and a bear case upside >5%. I intentionally separate quality and valuation. Both are vital but should be looked at in relative isolation.
Sold out of higher risk and lower quality businesses and trimmed positions trading at stretched multiples.
Diversified my portfolio away from the US. Now US companies only account for 20% of my portfolio. The world is huge and there are great businesses in many places.
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How I reduced risk by selling
I have been very active over the last year. While I’d love to be less active and just hold my existing portfolio, I realize that I’m still early in my career with 5 years of experience. Investing is a game of life-long learning and I’m trying to embrace that. As I age, I hope to reduce turnover, but even the best investors still try out new ideas and quickly discard them again. What’s more important is to hang onto your winners.
Here are the companies I sold over the last year in order to reduce my risk:
Ulta Beauty: It wasn’t a high conviction and had several headwinds like slowing growth, increasing crime/increased need for security investments and retail is a tough business with low barriers to entry. The valuation was also stretched and I was happy to focus on other holdings.
RCI Hospitality: Execution was not as I hoped, with low M&A activity in the club segment (large moat) and investment into distractions without a competitive advantage. Morally, the business also developed into a direction I do not like (gambling). Resilience was also too weak with higher reliance on consumer spending, despite having large alcohol sales.
Ashtead Group: The capital intensity was too high for me, with billions in maintenance CapEx required to run the business. With rising inflation, it looks like maintenance CapEx intensity is rising in the business, adding a new risk to the investment case.
Danaher (reduced): I put some of my Danaher position into Sartorius Stedim, which at the time traded at a significant valuation discount to Danaher, while it usually demand a premium due to its bioprocessing pure play strategy (one of the most lucrative segments in healthcare).
Stemmer Imaging (acquired): I sold because the company got acquired, but I’ll include it anyway, because it can tell us something about buying undervalued companies. The potential of an acquisition can be a good hedge in downturns. Stemmer got taken over at a 60% premium, because it was trading below its fair value.
AO Johansen: The business was fundamentally weaker, with higher cyclicality and inability to protect margins (something critical as a distribution business). While it remains cheap and offers a great sum of the part upside, especially in case the business is sold, there were stronger companies in my portfolio where I wanted to focus on.
UFP Industries: UFPI highly depends on the economic cycle and building demand, while also relying on lumber prices. Furthermore, it is a low margin business with a low competitive advantage.
Pluxee (trimmed): I decided to put half of my Pluxee position into Edenred to reduce to individual company risk and play the employee benefits sector as a basket with both duopolists. I haven’t put more money into the basket, because there are structural risks to the sector that I don’t want to be more exposed to.
Atkore: Like UFPI, they are highly dependent on the economic cycle and building demand. I do not understand commodity pricing well enough to accurately understand these businesses. Furthermore, they are fundamentally worse than the rest of my portfolio, but trading at potentially attractive valuations. Peace of mind is more important however, and a better protected business model.
Alimentation-Couche Tard: ATD announced its intent to do a gigantic merger with Seven & I holdings, which added a new risk to the business. I did not expect them to try such a large merger at their size, compared to bolt-on acquisitions with a much lower risk profile.
Amazon: I wanted to reduce my exposure to large caps and saw fundamental declines in the quality Amazon offered (at least in Germany). Furthermore, valuation was extended at the time. This was one of the tougher decisions, because of the overall very high quality score Amazon has. Full details here.
Lifco (trimmed): Lifco is a great business, but it is a bit cyclical, as a collection of niche industrials and health care products. With weak organic revenue in 2024, valuation was stretched and I decided to take some risk off.
Hermle: The business wasn’t able to protect its margins and is suffering way more in this downturn than in previous downturns like 2009 and 2020. With low visibility and high cyclical exposure, I decided to divest it and focus on more predictable businesses with a higher competitive advantage.
I hope this checklist and the examples of the actions I took are some guidance in these hectic times. While we can always hope for the best, we must consider the worst. Stay disciplined and only risk what you can afford to lose/don’t need to touch for many years.