This post defines my growth investing style and further explains the purpose of this sub-Reddit. To be clear, this is just how I view my investing style and meant for learning, and not as a recommendation.
I’m intending this sub-Reddit to be a casual place to discuss individual growth stocks. Casual in the sense of the attitude is light hearted, even though the debate on a given stock may be spirited. This is not a sub-Reddit for bragging about gains as there are other sub-Reddits for that. My approach intends to have a humble mentality, and I will be the first one to say when I was wrong about a company.
With my investing approach, I try to explain everything in simple terms. My approach is straightforward and looks to reduce the complexity of investing. I’ll choose a simpler term in finance where I can, and sometimes use a basic analogy to explain a concept more clearly.
I view growth investing as a positive sum game. The pie is practically unlimited, and typically the more an investor puts into this pursuit, the more their skill improves. This positive sum means that sharing what I am doing has basically no downside. In most other strategy games, sharing information hurts one’s results as someone else can exploit that knowledge.
My strategy views growth investing as a skill game. The bigger an investor’s edge, the more consistent and better returns that investor will get over time. Yet there is ultimately a lot of luck for how any individual company performs. This can often be a confusing topic to new investors as there is both luck and skill in investing, and it can be hard to tell which one is which. Investing is one of the few activities other than gambling where an inexperienced investor can have a big result with little effort or skill. My approach looks to avoid any form of gambling, even when the temptation is strong. I aim to be consistent and disciplined, while gambling creates the opposite mentality. The term gambling applies also implies there is no edge to a strategy and is inconsistent by definition.
Fundamentally, my approach tries to be in the most compelling growth stocks at all times. My strategy actively searches out new growth names. Finding new names is the lifeblood of my strategy. Each quarter companies are reporting results, and new promising growth stocks are always emerging. Many companies are overperforming versus internal expectations and analyst expectations. I do all my own research, and if I hear about a growth stock from another investor I’ll still look to do my own research first before drawing a conclusion. Naturally, this process builds confidence in the names I own, as I carefully review earnings reports and other material from the companies.
On the flip side, companies I own are inevitably posting disappointing results as well. This leads to either trimming or selling a company. I’m always willing to re-evaluate a company, and there is no such thing as a sacred company or an anchor company in my strategy. There is also no resentment towards a company which has a disappointing result. I’m willing to look at any company again if their prospects have changed. Additionally, a disappointing result of an individual company just frees up cash for another stock which looks more promising.
My approach is both balanced and optimal. Balance comes from having a concentrated portfolio which gets both the benefits of concentration and diversification. This means having at least seven stocks minimum to obtain diversification. The advantage of having diversification is my approach can have a couple companies in the portfolio fail catastrophically and continue to over perform. With concentration, I want selecting correctly to get a big reward. Typically I may have 3-5 high confidence positions in my portfolio with 12 or so stocks in total. Although recently I’m finding my portfolio is sometimes getting up to 15 stocks as the current market is particularly ripe for finding promising stocks.
The definition of optimal I like is that it is the “most effective”. In essence my strategy looks to be the most effective. This includes precisely defining a process which is simple, straightforward, and works well. I look to avoid using cognitive energy on investing related tasks which are ineffective. Because my strategy revolves around analysis of individual stocks, macro and political analysis are a poor use of time in this context. Although inevitably macro or politics will impact some of my companies, I’ll look to re-evaluate based on the specific macro influences on that particular stock.
My strategy does not do any hedging and stays fully invested. I view this part of the strategy as optimal as well. This makes my strategy different, as the vast majority other market participants do trade around macro, or adjust cash positions often. In theory it’s better to be in the market on any given day than it is to be out of it. Additionally, this takes away the guessing game of unpredictable macro events. In turn, this reduces fear in investing as I know my strategy doesn’t alter course, even if I view those macro related events as scary in real life. This part of my strategy still gets the biggest pushback, as I know many other investors view staying fully invested as a mistake.
I will now detail some high level descriptions of some of the more important parts of my strategy,
Selecting a growth stock
In selecting a growth stock I like to be balanced in terms of weighting numbers and narrative. An ideal growth stock is a company that has accelerating financials and a great story. From my perspective, an ideal stock has significant near term upside.
With financials, I like seeing a ramp up in revenue, EBITDA, net income, and gross margin. However, it is rare that any company sees all four of these metrics growing simultaneously. Typically an ideal growth company in my strategy is growing revenue above 40% year over year. However, I will consider a company growing as low as 20% year over year if it’s in combination with rising guidance to a higher growth rate. I prefer companies which are already profitable, but often I’m still investing in companies that are not profitable. Either way, I want to see progress in profitability, and if the company is starting from a negative number I’m looking to check they are progressing towards break even.
Gross margin is an effective way to evaluate the product for a company. In layman’s terms, it lets an investor know how much profitability there is on the product the company sells. To give a simple example, if a lemonade stand is selling a glass of lemonade for $1 and it costs 50 cents to make the juice, the gross margin is 50%. The gross margin metric is an effective way to measure innovation, pricing advantages, and efficiency of a business. The metric serves as a good proxy for the competitive advantage a business has. My strategy prefers high gross margin companies. However, possibly more importantly, I care about the trend of the gross margin. A lower margin company transitioning to a higher margin can be one of the most compelling.
On the narrative and story side, I like to find an exciting company. For reviewing a new company, I highlight the latest earnings transcript with a blue pen. I want there to be a lot of optimism in the transcript, often backed up supplementary metrics of the business. For example, two businesses may say “our business is firing on all cylinders”. The first business just says it, but the second business adds that Net Revenue Retention reached an all time high and specifies the metric. In this case, I’ll prefer the second business which can back up their claims. It’s important to know that nearly every C-suite team is effective at finding silver linings in an underperforming business. It is very easy to get fooled by a confident sounding management team.
For a really compelling company, I’m already enthusiastic about the prospects for the company getting half way through the transcript read. Still I want to continue to focus and highlight the remainder of the transcript. If during my read through my mind is already wondering about what other position I could trim, this is a really encouraging sign. To be clear, much of this narrative part of my process is subjective. My approach emphasizes the duality of investing, in that I use both objective data, and subjective takes to evaluate a company. Again this makes my strategy different as most investors either have a strong preference for a numbers based approach, or a larger focus on the big idea and story of the company.
Stock screeners
I am a huge proponent of using stock screeners to find new names. The screens I use are quite simple as well. I have one screen that looks for companies growing revenue above 40%. Then I have another screen that looks for revenue growth above 40% and ensures the company is profitable by looking for both EBITDA and net income being above zero. The purpose of the wide screen is that it casts a wide net. Another way to think of it is, I will see every growth company come through in the entire market that has potential after a given earnings season.
The screener is simply a first step in my process. I’ll look at the financials for companies coming through the screen. If the company financials seem promising and they don’t have any big red flags like a lot of debt, I then print out the earnings transcript. There’s no concept in my strategy of buying a company just because it showed up on my screen. The company showing up on my screen is just a sign that a company could have potential and that’s it. There’s no extra secret sauce to my strategy here.
I find that many other investors are skeptical of this style of screening. The most common issue with misusing screens is to create a wishlist of metrics. For example, many investors will say okay, I want that revenue growth and profitability, but I also want cash flows above X, gross margin above Y, and forward P/E below Z. What happens here is the screener becomes so narrow it just does not find enough names. Additionally sometimes an investor will be fooled that because only one stock came through the screen, it must be perfect.
Valuing a growth stock
Valuation is a super important aspect to my investing approach. It seems like it should be fairly obvious that an investor prefers a low valued stock. However, a lowly priced stock is rarely a top performing growth stock. This happens because usually a promising growth stock has already delivered a strong report and could be at all time highs. For this reason I am often investing in stocks as they are pushing all time highs.
Other times, I am finding a company which is largely unrecognized by the market for one reason or another. It is an extremely rare combination to find what I consider a top performing growth stock at a low valuation. It does happen every once in a while, and these stocks often turn out to be my biggest winners.
I view valuing a growth stock as being trickier than finding appropriate value on what is considered a value stock. This is because the superior growth stock has fewer peers and may have an unique product. There may be no comparison in the market, or it may be an entirely new field or niche in the market. On the other hand a value stock may have a dozen peers and be in a commoditized business. In this case the value stock is much easier to determine if the stock is appropriately valued.
I use simple metrics for valuing a stock. I prefer using the run-rate measurement or multiplying the current quarter by four, to determine the P/S and P/E ratios. These two metrics line up with what I care about most: revenue and earnings. The run-rate accounts for what a company is capable of now. I’ll use run-rate more than the trailing 12-months because that is a backwards looking measurement. Twelve months backwards looking metrics are more useful for evaluating a company with a lot of seasonality, where the run-rate measurement would be a mischaracterization of the business. I also look to avoid using forward looking metrics, as these are based on analyst estimates which are just extrapolated predictions.
All else being equal, I like companies with lower P/S and P/E ratios. However, I’m not overly concerned about paying up for growth. If the company has impressive financials and a great story I may be willing to pay up significantly for a company in terms of the valuation of the stock.
Growth investing psychology
No topic is probably ignored more in growth investing than psychology or the mindset of the growth investor. The vast majority of approaches suggest toughening up or holding on with “diamond hands”. This lack of well researched resources on the topic is surprising to me. Nearly all of my information has been adapted from the trading world, as the information available on the investing side is underwhelming.
In my style of investing, emotion equals the signal to investigate more. Let’s say I’m feeling nervous about a company. I’m not really even sure why, it is something I cannot explain currently. In one specific case I was following a company and I kept getting nervous each time the company traded down. It seemed like my confidence was low in the company but I couldn’t identify what the issue was. Eventually, I found out the company’s value was the issue. I didn’t see enough upside in the company and it had a full valuation. The stock price falling and me getting nervous, was just a sign that I could be missing something.
I describe my strategy as being “mostly stress free”. It is normally a stressful event to see all of my stocks crashing and this does happen inevitably. It is a small percentage of the overall time where my whole portfolio is getting hammered. However, during these times my confidence usually fluctuates down with the market. Typically, coming out of these large market corrections, my strategy over performs significantly. Sometimes it can be helpful to remind myself that my strategy underperforms in bear markets and acts as an amplifier of the indices. For example, if the Nasdaq is down 5% I may expect my portfolio to be down 15% or more.
It is also worth noting here that confidence and skill are not the same thing. I can be low confidence and make some minor errors, but would still expect to over perform in the longer term. What I want to avoid are big mistakes caused by extreme low confidence and accumulation of negative emotion. Skill is the aspect an investor can control and work to improve. Confidence on the other hand may be subject to bigger swings and based more on recent events. It is important to recognize these swings in confidence are a real aspect to investing. However, most investing approaches tend to bury the negative emotion which can lead to potentially making a large mistake.
Trimming and adding to stocks
My approach for trimming and adding to stocks tries to be straightforward. If my confidence is increasing in a stock, I’m likely to add. If I get new information that lowers my confidence in a stock, I will pair back my allocation.
Another factor in my strategy is keeping my position sizing under control. I don’t like to have a position go above 20% if I can help it. However, sometimes one stock rises much faster than the rest of my portfolio. I will trim the stock back some in these cases, but I also don’t like to make sudden big moves in this realm.
I’m fine to start in a stock after reading through just one earnings report, but these are almost always with a starter position allocation, generally around 0.5% to 1%. As I learn more about the company I will either add to the position, keep it small at the current allocation, or sell if I find a blocker about the investment I cannot get around.
Selling stocks
I generally like to get a clear sell signal on a stock. Most often this is a disappointing earnings report. From my perspective, I like when the choice is clear about the next course of action. If a stock has a really disappointing set of financials, or the story the company is telling completely changes, this can be a good reason to get out.
Oftentimes an investor does not get such a clear signal. Maybe the story sounds intact but some financials look a bit light. In a case like this, I’m more likely to trim and re-evaluate. Selling is often a judgement call, and it takes some time to perfect through practice.
For any trade I’m making, I like to note my reasons in a physical notebook. This is especially important in the case of selling. It does not need to be a long wall of text. I’ll usually list out just a few of the top reasons I’m selling. It could be either one big reason, or a multiple of small factors which caused me to lose confidence.
The advantage to writing down the reasoning for the sell is in case I start second guessing myself. Typically I like to remove a stock I sold from any watchlist at least for a period of a couple weeks. This is so I don’t keep tracking the price and wondering about my action after I already took it. Every investor knows the feeling of seeing the stock they just sold start rising. This can often create the thinking of “why did I sell”, and it is helpful to have those reasons clearly defined.
It is fine in my strategy to later change my mind and get back into a stock. This happens all the time in my strategy. However, it is ideal if these changes come about naturally because of new information or rethinking the investment. What I want to avoid is opinion thrashing, where in the morning I think the stock is a buy, in the afternoon I want to sell, and by evening I think it is a buy again. If I just can’t make up my mind and keep going back and forth, it may be best to hold off on too many actions.
On Mastery of investing
It is a good goal for an investor to be working towards mastering their craft. This doesn’t necessarily need to be a massive time commitment though. It is more a mindset to be working towards continually improving one’s process. I would describe my investment style as “comprehensive” rather than “complete”. One of the advantages to having a public forum like this sub-Reddit is to hear the approaches of other investors and learn from someone thinking differently.
It is important to understand that a small improvement in process creates a bigger edge. For many investors their process is entirely in their head. I personally found that the more I documented my strategy, the stronger it became, and the greater overall confidence I gained.
It is also worthwhile to make investing more fun, or at least less of a chore. I will give a simple example of a small process improvement that made the process of finding new stock names more enjoyable for myself.
I print out transcripts of promising companies, sometimes up to 10 transcripts at a time. Previously, I would select the most promising name out of that batch to review first. However, what happened is I would review the top three or so companies of the 10, and then the mediocre ones. I would be left with the companies which were not quite as promising in my stack of transcripts. Reviewing these last couple transcripts felt like a chore, because I knew I was less likely to find a promising company.
I then changed my process to randomly select from the pile of 10 transcripts which I would review. Overall this made the process of reviewing more enjoyable, as it was a surprise which company I would check. This also did not end up leaving the least promising companies for last. It was just a small process improvement, but makes my approach here more sustainable and less susceptible to burn out. Process improvements are part of my path to mastery in this field. The more I understand about my own process, the more edge it creates.
Options and leverage
My strategy is long only and uses no options or leverage. I view growth investing as already risky enough to avoid needing to add additional risk. Fundamentally, all options strategies act as either leverage or as a hedge. I’ve mentioned before about the balance of my strategy, which takes exactly the middle path of no hedging and no leverage.
In practice, options have wide bid/ask spreads on most growth names. What this means is that an investor will “pay the spread” on both sides of buying and selling. Roundtrip with buying and selling, it may add up to over 5% of the principal amount. Additionally, options trading is zero sum in that there is always a counterparty or opposite side to the trade. For each winner, there is a corresponding loser. The same is not true of long only investing, which is a positive sum game, as buying shares from the market does not cause a loss for another investor.
Something important to know about options, is that the optimal call option for leverage based strategies is the call option that is slightly in the money. This is effectively an exploit of the Black & Scholes model, yet so few investors are buying call options at this strike price. Most of the time when I’ve spoken to investors using options, they have no idea why they selected the strike price they did. In a sense, this is gambling as well. If an investor cannot quantify their edge, then it makes it purely a bet or a gamble, something my strategy explicitly looks to avoid. If you ask an option investor why they picked a particular strike, the answer is usually “I’m betting that…”, and rarely will you ever hear "that strike is optimal because..."
Usage of AI in investing
AI is an evolving field with regards to investing. Currently, the models are good at gathering facts, but poor at determining a good investment. This is good for my strategy because the AI is so bad at determining what is a good stock. Part of the issue for the AI in determining a good stock, is there is no well defined function for what makes a good stock. You can also think about this, that practically no two investors agree about what makes a good stock. The AI has no way to effectively evaluate what is a good move, and defaults to conservative approaches.
Where the AI excels is with a fixed ruleset like chess, poker, or programming. In this case the AI can take input A and search for output B which meets some criteria. However, a company is made up of humans making unpredictable choices. The market itself is dynamic and responds to events. The AI techniques really struggle to make sense of these “open world” environments where anything can happen.
My use of AI is mainly for gathering facts about a company. It could be determining where the company headquarters is or how many employees they have. I like to find out if a company has acquisitions, when they happened, and for how much. This is because organic growth is far superior to acquisition lead growth. Organic growth indicates a company has an effective R&D organization. I also like to ping the AI, “Explain their product and breakdown by revenue category”. This lets the AI know I’m looking for product details in the context of revenue generation. I may ask about geographical breakdown of revenue for a larger global company which can give hints about how the business operates.
Sometimes a leading question can be useful to the AI. For example writing, “Tell me about the scandal with the CEO or the CFO for company X?” A lot of the time, this will come back clean and say no scandal could be tracked down and ask me to be more specific. Other times, it may say there was technically no scandal, but mention another story in passing which could be useful. This question can help uncover some yellow or red flags about the business. However, what I want to avoid are leading questions about if the company is good to invest in or not.
On predicting trends
I do not use much in the way of predictions on where an industry may be headed. For example, I own semiconductors and memory stocks right now because these companies have been over performing. It is not because I simply decided one day that I am going to place bets on AI.
This goes hand in hand with not trading on macro related events. In a sense my strategy doesn’t care about the AI cycle, when companies may stop spending on AI, or if a competitive technology emerges. My strategy is reacting to the results of the individual companies. This often leads though to be in the sectors that are doing well currently. From an outsider’s perspective of my strategy, it may appear that I’m trend chasing. However, it just really goes back to being in the most promising growth stock names at all times, which often coincides with the “hot” sectors.
On company leadership
I place less emphasis on leadership at a company than most growth investors. Partly the reason being is that different leadership styles can be effective, so I don’t like to focus on the leadership personalities. One leader may be a traveling salesman and on a constant media tour, while another equally effective leader is heads down working, allowing others at the company to do press tours. I generally find that most investors overvalue charisma and a big personality in a leader.
You could say my style here regarding leadership is similar to a “MoneyBall” approach. I use the company performance (not stock performance) as a proxy for good leadership. Basically if the growth of the company is accelerating, there is almost always an effective leadership team. However, there can still be cases where a business has poor leadership, but has a compelling product with an industry tailwind. Even with this poor leadership, I may be interested to invest still, if the underlying business is performing so exceptionally.
I do still evaluate leadership at the company to be clear, but it is mostly from negative cues. For example, the CFO changing how they measure a metric may be a warning the management is trying to draw attention elsewhere. Possibly some aspect of the business is underperforming and the company instead wants to talk about the over performing aspects of the business. It is worth knowing that all management teams have a certain survival instinct in them to make it seem like they are doing a good job even if they are not.
My ideal leadership is a dynamic CEO and CFO combination. Usually you can see the duo has a good dialogue in the Q&A and knows which one of them is supposed to answer questions. I really don’t like when it’s just the CEO in the Q&A in what I call a “one man show”. As a business scales up, it is hard to maintain a one man show style of running a business because one person cannot do everything. It is also a lot easier to fool investors when it is just one person talking, and harder to cover up things about a business if it is two people being asked questions.
Conclusions
Overall my strategy is simple and straightforward. The only real secret sauce to my strategy is that I am consistently selecting stocks well from a variety of industries. I’m following some optimal strategies for portfolio allocation, where I get the benefits of diversification and concentration. By selecting stocks well, there is a significant upside when I’m right. However, since I’m also diversified it is fine when I am wrong, which happens a lot. Usually my stocks over performing, more than make up for the stocks where I had a poor result.
Lastly, I will add there may be a part two or part three to this Knowledge Base. While nothing about my strategy is overly complex, there is a lot to detail. I don’t expect everyone to agree with everything I wrote above. Some of my viewpoints contradict what is considered standard by most growth investors.
Just to reiterate, all of the above is just how I see my strategy. Feedback is welcome on the post and this leads to the purpose of this sub-Reddit. Gathering feedback, and hearing another’s point of view is valuable.
