Dear Subscriber,
I recently watched a brilliant interview featuring iconic investor, Stan Druckenmiller, during which he discussed several interesting topics including his early bet on Nvidia stock, his success shorting bonds, his daily routine and his approach towards asset allocation.
I want to focus today on the last point in this letter.
Part 1: Betting Big
Druckenmiller is a believer in concentration and “betting big” on one’s best ideas. This was also characteristic of the late Charlie Munger, who argued that the more positions one has, the closer one gets to becoming the market and thus achieving market returns. Warren Buffett has also spoken openly about diversified portfolios representing “protection against ignorance”.
This got me thinking about my own portfolio construction. As a conservative investor, I’ve always parked the bulk of my earnings into a low-cost index fund as a safety net in case my individual bets don’t go as planned. The Magic Formula portfolio I run actually constitutes quite a small percentage of my overall capital (~15%).
Unfortunately, in recent years, I’ve experienced the opportunity cost of under-allocating to positions that went on to increase in value several times over. This was the case with Williams-Sonoma Inc. (NYQ: WSM) and DICK'S Sporting Goods Inc. (NYQ: DKS), both of which tripled in value since my initial investments. However, due to their relatively low allocations in my portfolio, the nominal return was underwhelming, despite their extraordinary percentage gains.
Given my relatively small allocation to individual bets, coupled with the broad diversification I gain from my index fund exposure, I’ve decided to whittle down the number of holdings in my Magic Formula portfolio to my 5 best ideas. The rationale behind this decision is that I want to avoid repeating a scenario where a bet that goes up multiple times in value still doesn’t move the “net worth” needle.
Now that’s out the way, check out the below elevator pitches for the five remaining positions in my Magic Formula portfolio.
Part 2: Elevator Pitches
Crocs Inc (NSQ: CROX).
Iconic and distinctive, this shoe brand trades at a low single-digit free cash flow multiple. The core Crocs brand boasts a strong operating history, characterised by solid gross margins, consistent earnings growth and high returns on capital. The company has historically prioritised share buybacks over dividends and has steadily reduced debt since acquiring HeyDude in 2020.
I anticipate three year returns of 25%-35%, driven by moderate earnings growth, continued share buybacks and a multiple re-rating to the industry average.
Buckle Inc (NYQ: BKE)
US-based casual apparel retailer with a long-standing history as a family-run business. Its experienced management team has been steering the company for decades, delivering a strong track record and maintaining a pristine balance sheet. Trading at an attractive 10% FCF yield, the company faces limited room for organic growth but compensates by returning the vast majority of excess cash flow to shareholders through regular and special dividends.
I anticipate returns of 15%-25%, driven primarily by sustained, generous dividend payouts and a modest contribution from earnings growth.
Warrior Met Coal Inc (NYQ: HCC)
Leading US producer of metallurgical coal, a critical component in steel production. With steel demand outpacing supply and no viable green alternatives to met coal in sight, the need for met coal is expected to remain robust. As one of the largest players in the market, Warrior is well-positioned for growth, particularly with its major Blue Creek project set to come online in 2025-2026.
I expect double-digit returns driven by several factors, primarily increased earnings growth when Blue Creek comes online, a multiple re-rating and the potential for capital returns from excess cash flow. This could take the form of special dividends, as seen in the past, or substantial buybacks, following the successful approach of met coal peers like Alpha Metallurgical Resources (NYQ: AMR).
Ituran Location and Control Ltd (NSQ: ITRN)
Israeli telematics company, with 70% of its revenue coming from recurring subscription fees, both domestically and internationally, including significant growth potential in Latin America. Additionally, the company owns a 17% stake in Bringg, a Unicorn recently valued at $1 billion, offering further optionality and upside potential.
Williams-Sonoma Inc (NYQ: WSM)
Shareholder-friendly furniture and home goods retailer with a conservative capital structure and low debt, trading at a reasonable 7% FCF yield. The company has been cash flow positive since 2007 and I expect buybacks to continue alongside dividend growth over the next three years. The current $1 billion buyback authorisation represents ~6% of the market cap. I expect returns to be driven by continued earnings growth and shareholder-friendly capital allocation through dividends and buybacks.
Part 3: Final Thoughts
I am aware that this portfolio is very different from the one I started in 2021. I also appreciate that although all the positions were sourced on the Magic Formula screener, I am not strictly following the strategy anymore as I planned.
I suppose this is part of investing and it is for each of us to figure out our style through years of trial and error. I am still planning to use the screener for idea generation but, given the new focus on large, concentrated bets, I suspect I will be much stricter now before entering new positions.
I am excited to follow these bets over the upcoming years and look forward to sharing updates with you all.
Kind regards,
QC