This article is excerpted from Tom Yeung’s Profit & Protection newsletter dated July 28, 2022. of Tom’s picks, subscribe to his mailing list here.
Growing up, my family’s burger grills looked like this.
Ground beef? Check.
Salt, pepper and spices? Sure.
Then add peppers, onions, saltine crackers and an egg for good measure? Hmm… That too.
It was only after the arrival of the Internet that I learned that we weren’t supposed to to turn our burger patties into meatloaf balls. Many of the world’s top chefs create award-winning concoctions with just three ingredients: ground beef, salt and pepper.
The amateurish practice of overdoing it extends to investing as well. There is always a temptation to have 30…50…100 positions open to avoid the feeling of missing out. And rather than shine, these gargantuan wallets ultimately look like a bland hodgepodge of uninspiring ingredients.
Get rich without really trying
The secret to winning portfolios, of course, is to concentrate bets on a handful of high-conviction positions. A study by Dresdner Kleinwort found that investors only needed ten random stocks to achieve over 80% potential diversification. Thirty actions brings you closer to 100%.
As a general rule, I suggest investors focus their bets on 15-20 positions, rather than juggling hundreds of small bets.
Sometimes these high conviction investments are specific stocks. High Benefit & Protection take Metal desk (DM) makes the cut because the high-growth 3D printing company is trading so close to its liquidation value.
Other times it may mean investing large sums of money in diversified index funds like the Vanguard S&P 500 ETF (VOO). These are inexpensive ways to bet on the health of an entire asset class.
Either way, the trick to keeping only high-conviction stocks is knowing when to say “yes…”
…But also when to say “no”
As in “let’s go not add peppers to our burger recipe today.
10 stocks to sell before you die
This brings me to Eric Fry of InvestorPlace, one of the masters of eliminating losers from his portfolio.
Over the years he has recommended short positions in companies like National Financial (down -87%), Providen (-91%) and Ariba (-99%). Unlike many stock pickers, he’s just as comfortable telling investors to sell as he is saying “buy.”
Now he has created a new report of 25 very popular companies you should be sure to sell immediately.
“Please make sure you do NOT own these businesses now and buy them in the future, even if they are cheap.”
To access the list of these actions, click here to sign up for Fry’s investment report.
Meanwhile, Benefit & Protection readers also have a secret weapon:
The Profit & Protection Stock Selection System.
This is because the quantitative system works both ways. Run the system backwards and you quickly get companies that are likely to underperform over the next twelve months.
Companies on the wrong side of history
Many well-run businesses can find themselves on the wrong side of history.
Blockbuster… Sears… Kodak… Polaroid…
These former blue chip companies would eventually find themselves fighting unwinnable battles. No managerial talent can save a company that is not in the right sector.
Fortunately, these endangered stocks are easy to identify by their low Benefit & Protection “growth” notes:
- Tootsie Roll Industries (TR) | Growth grade: C. Some of these slowing companies fail to innovate and introduce new products. These companies ultimately look a lot like Tootsie Roll Industries, with steady revenue and declining revenue.
- Interactive Platoon (PTON). Growth grade: C. Other companies have the misfortune to come across one-off client modes. Much like Fitbit and GoPro, Peloton’s success in stationary cycles turned out to be more a matter of luck than skill.
- Cato Corp (CATO). Growth score: C. Then there are those who operate in cutthroat industries like fashion retail. Cato Corp’s weak growth looks a lot like a repeat of Ascena Retail Group, J. Crew and countless other bankruptcies.
- Peabody Energy Corporation (BTUs). Growth grade: C. Finally, companies like coal producer Peabody Energy may eventually run out of lives. Although the company was my top pick in late 2020 when it was trading at $2, companies in declining industries cannot avoid bankruptcy forever.
Fraud, allegations and questionable conduct
Then there are companies with questionable track records. Many of them will get “C” grades for quality, and you’ll often find short sellers writing short novels about the business.
- Cassava Science (SAVA). Grade of quality: C. I have long worried about Cassava Sciences, a company with questionable science behind its drug for Alzheimer’s disease. This week, those concerns were confirmed when the US Department of Justice opened a criminal investigation into the company. While no wrongdoing has yet been proven, these investigations are usually red flags for biotech investors.
- Therapeutic of Sorrento (SRN). Grade of quality: C. Meanwhile, companies can also run risky business models. In 2020, I warned investors that Sorrento management was “playing the lottery with other people’s money” by buying up high-risk therapies with no proven performance. The shares have since lost 75% of their value as the blockbusters failed to materialize.
- Limited SOS (S.O.S.). Grade of quality: C. The huge popularity of meme stocks like SOS Limited, Broadband Asia (AABB) and lucky coffee (LKNCY) can often conceal significant corporate governance issues. Some companies like Riot Blockchain (RIOT) ended up surviving by rebuilding its entire management team. But more often than not, these companies end up like Enron, Sino Forest and other eyebrow-raising choices that fall to zero.
Finally, management can often take inordinate risks with a company’s balance sheet. These overstretched companies quickly become sitting ducks when bonds come due.
These companies are easily identified by low Altman-Z or credit scores.
- Difference (GPS). Sometimes financial disasters last for years, as clothing companies from Gap to Aeropostale have seen. These companies can rack up billions in operating lease debt from real estate rents, putting them at risk of bankruptcy if sales suddenly drop.
- We work (WE). Other times, these disasters happen when businesses grow too quickly. WeWork managed to rack up $20 billion in lease debt by the time it went public in 2021. The company is now burning through $2 billion a year, a rate that would deplete its cash flow by Christmas.
- Lordstown Motors (STROLL). Finally, rising interest rates are testing zero-revenue startups like Lordstown Motors that rely on fundraising. These energy-intensive companies find it harder to raise capital, forcing them to scale back their R&D. A feedback loop makes it harder to attract more investment and so on.
Just Sell… Don’t Short
Hedge fund manager Julian Robertson once told investors, “Our mandate is to find and invest in the 200 best companies in the world, and to find the 200 worst companies in the world and sell them short. If the top 200 aren’t doing better than the bottom 200, you should probably be at another company.
The concept of long-short investing is a fundamental idea of hedge fund strategies. By avoiding net market exposure, traders can show off their innate skills without taking on systemic market risks.
In practice, however, this strategy rarely works for ordinary investors. Short positions require constant monitoring to avoid a portfolio explosion. Even Mr Robertson’s Tiger Fund would lose billions in a dollar-yen trade that exploded in 1998.
To take advantage of the benefits of short selling, investors can simply avoid certain actions. If you are lucky enough to pick 15-20 artists above the average, the final portfolio can only beat the market. It’s a much safer way to play in the market, and certainly one that helps people sleep sounder at night.