Keeping it simple is harder than you think

The heart of my investing process

My New Year’s resolution was to write two minute monologues to ensure I have thought through an investment and have a means to track of it. A week on, I’ve kept the resolution. The first company I reviewed this year was Games Workshop, and the monologue is here. I’m also tweaking the concept, invented by Peter Lynch, so it sits at the heart of my investing process.

This is my (current) definition:
A two minute monologue is a short script explaining what the company does, what kind of opportunity it is, what I expect the company to do and what could go wrong, in words an interested teenager could understand.

It should be updated whenever there is significant news and tested against annual reports, conversations with management, employees, customers, suppliers and investors.

When a company doesn’t behave according to script it should be avoided, or if it is already in the portfolio it should be replaced by a company that matches its script.
It seems simple, even obvious. I didn’t choose Games Workshop as my first two minute monologue because I thought it would be easy (it happened to publish its half year results) but I think it will prove to have been easy compared to most of the monologues that lie ahead. Even so, it was hard work.

Games Workshop was a relatively easy monologue for me because I’m familiar with the company. I first wrote about it for Moneywise Magazine as long ago as 2006 (I think!) and have followed it ever since. Although I’ve never played Warhammer, I played role playing games as a teenager, and I find it very easy, a pleasure even, to walk into Games Workshop and ask the staff there about the new plastic and resin miniatures, and how Warhammer is different from, say, Dungeons and Dragons.

But even so, I had to re-read all my notes, and re-read the annual reports going back six years when the notes weren’t clear. If Games Workshop published earlier reports (I have requested them) I’d have gone back ten years. I extracted key data for the whole period, calculated the fundamentals, and charted the company’s turnaround. Then I had to decide, of the pages of research I’d accumulated, what information was critical to the investment case and squeeze that into 350 words (I failed) that my eldest son could understand (I succeeded).

The result is very satisfying. Without a structure that puts the emphasis on risk: what the company needs to do, and what could go wrong, I tend to write a rationale that makes a persuasive case for investing in the company. Really the two scripts should be the same, but I think I used to do  the research, decide to add the company, and then explain why. The objective was to justify the decision rather than challenge it, and sometimes I kidded myself I’d made a good one.

The order of the script is also helpful. It starts by testing my knowledge of the business, what it does, and what I can expect from it: nothing much if it’s an asset situation, cyclicals recover when their industries do, turnarounds must cut costs and unprofitable products, from stalwarts I want more of the same, and for fast growers (assuming I ever add one to the portfolio) much more of the same. Only then, having examined what might go wrong, does the script tackle valuation.

Too often in the past I’ve started by deciding a company is cheap, and looked for reasons to support that decision. It’s another way to kid myself, sometimes into using the wrong valuation method. I started out thinking Armour was a cyclical company and that earnings would recover, but actually it had also entered new markets to which past earnings were less relevant. It would have been safer to have based my valuation on tangible book value once I’d figured that out, but I’d already convinced myself the company was cheap.

So, I’m committed two minute monologues for every company in the Thrifty 30. It’s going to be hard work, and I don’t think many will turn out as well as my first, but it must be done!

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