Personal Hedge Fund, Q2 2016 Update
The Base Code: Performance & Valuation Model
I. History
At the end of 2015, I decided I was going to get serious again about investing. While the first quarter of 2016 was about dipping my toes back into the water and beginning the underpinnings of my daily research, the second quarter was about getting serious, building financial models, and predicting future macro-economic trends for the coming decades.
But before I get into the investments I made in Q2 2016, it’s worthwhile understanding the foundations that they’re built upon. If you’d like, you can view part 1 of my journey towards a Personal Hedge Fund, including the origin story, and my personal history of returns above the market.
II. Foundational Matrix of Tech Investment
Even though Warren Buffett famously never invested in tech (aside from his most recent investment in Apple), it’s something I’m exlusively investing in. Because, as Andreessen Horowitz says, “software is eating the world” and because I’ve spent my life trying to understands human behavior and the mechanics of technological innovation.
Over Q2 of 2016, I’ve begun to develop an investment philosophy dedicated to how technology, and software, are going to bleed into human’s everyday lives. You can begin to get a sense of that just by looking at Humanizing Tech’s navigational structure. As it stands today, the main topics I research, think about, and write about on the reg include: AI, Investing, Health, Video, Energy, and Shoutouts (people who create these things). More to come in that area shortly.
As I’ve started to stratify these concepts, I’ve begun to break them down into different layers of a human + tech stack. Currently, I view them as having 7 layers, and attempt to invest in the market leader for each of those layers, as follows:
- Computation & Data Processing: CPUs, GPUs (NVIDIA)
- Connectivity: wireless and cellular data (T-Mobile / Deutsche Telekom)
- Energy & Transportation: self-driving solar cars and interplanetary travel (Tesla, because SpaceX is and will remain private for some time)
- Computing Devices & Health: smart phones, computers, watches (Apple)
- Information: knowledge search (Google)
- Connection: social media (Facebook)
- Commerce & Logistics: purchasing, shipping (Amazon)
The above serve as a framework for thinking about humanity’s needs that are currently being solved through technology, but I also think about this in terms of macroeconomic trends over vast time horizons, which I’ve labeled tech “dial tones”.
III. Investment Performance: Nearly 2x the Market
In Q3, I had seen the coming of AI as the next big wave and so I invested heavily in NVIDIA GPUs, which is used for training AI models by the biggest tech firms in the world. It’s paying off. I also invested in Tesla and MobileEye, which helps with autonomous cars and T-Mobile because they’ve removed every objection you could have to switching carriers. It’s paying off. And of course Apple because they’re so incredibly undervalued. It’s paying off.
As of Monday July 11th, my current all-time performance (a few trades at the end of December 2015, plus most trades in Q1 and Q2 of 2016) is +9% and my performance year-to-date (YTD) is +11%. But no matter how you look at it, I’ve performed almost 2x better than the S&P500.
- My 2016 Performance: +11%
- S&P500 (Market) Performance: +6%
- That’s an Alpha of 5% (11% -6% = 5%)
I performed nearly 2x the market in 2016 (5% Alpha)
The performance in the graphic above is only showing maybe a full quarter of my Buy-On-Sale-And-Hold (BOSAH) philosophy. Showing the performance now is nothing more than an intellectual exercise to stay rigorous in my analytical and reporting capabilities, but my holding philosophy is at least 1 year (to get the much lower capital gains taxation) but practically more like 10 to 30 years. So, my performance at this point is negligible. It simply doesn’t mean anything because I don’t expect the results of these investments to pay off for years into the future. So, what we’re seeing right now is simply short-term volatility at play. Not what I would attribute to real returns, even though some of my bets are starting to pay off (take NVIDIA’s GPU bet for AI, self-driving cars, and VR, for instance).
I also use another free service to track my performance as related to both the market, plus other investors, both at large and in the technology sector.
Finally, here’s a snapshot of my current valuations across a number of tech companies that I’m either invested in or tracking:
You want to invest in companies with high real assets (T-Mobile), high economic profits (Apple, Nike), and where you think the company is going to grow more than the market is giving it credit for (Apple, T-Mobile, NVIDIA).
IV. Open Source Valuation Model
I’ve linked to a Google Sheet below that is completely open source. That includes both my investment performance and also my valuation tool as it stands today.
It’s not tied to a Microsoft Excel file on a Windows machine (where most financial models exist) because you can’t get the same data sets on a Mac using Excel. In fact, you can’t get much of anything using Excel on a Mac when it comes to company financials or stock performance. So it was quite a bear to put this together. I was forced to use Google Sheets as it’s the only way to get across both Windows and Mac operating systems, and paid software like Microsoft Excel.
Google Sheets is free to use and scales really well. I’m connecting to Morningstar financial data based on scraping their website using a CSV download API and parsing it into a Google Sheet tab. I’m also using Yahoo Finance data to round out some other market price and Beta volatility metrics to get all the data, format it, and then be able to work with it on other tabs in the Google Sheets file. There’s also an instance with Alibaba, were it’s pulling foreign currency data, so have controlled for that so everything is in USD. I handle all of my investments through Robinhood’s free app that does not include $10 commissions and use their monthly PDF reports to track performance.
As you can see, I’ve chosen tools that are absolutely free across the board. You’ll understand why this is in the coming quarter. Hint. Hint.
Here’s the file:
Valuation Model Explained
I’m using Discounted Cash Flow to do my valuation, and comparing one stock to another using a “% of Price” methodology.
For example, I say that a real asset is defined as the dollar values of Cash and Inventory and Net Property Plant and Equipment (among a few other line items). I then take that total dollar value and divide by the current $ Market Cap to get a % valuation (e.g., 70% of the value of the stock can be described by real tangible assets, and therefore the other 30% is described by what we predict will happen in the future, hopefully growth).
Known Issues
A few things to note:
- I have locked this down at the moment from being able to edit or copy because it’s still a bit fragile and took countless hours to get this working properly. If you want a real copy, please comment below or email me and I can get you one of your own you can play with that isn’t tied to this core model.
- For example, on the back-up data tabs, everything is run through an API call so mucking about with it could break it.
- Also, when you enter a ticker into one of the blue cells, not all the financial data pulls through accurately because it’s pulling full financial statements (income statement, balance sheet, cash flow) and each company’s is different.
- So, to add a new company to the analysis, you have to copy two tabs (e.g., “DIS” tab and “DIS Val” tab), the update the tickers on both tabs, then re-link up the Val tab cells to the other tab. Because the Cash line item may be on line 133 in one company’s financial statement, but on line 134 on another. Not every public disclosure is exactly the same.
- If you find other issues as you review, or a calculation bug, please comment or email me and I’ll correct it.
V. Next Steps
The model that I’ve created above needs to be extended. Obviously the ideal state would be to do the analysis to set an accurate price target for the stock and buy more of it when it drops below that target. But analysts often get that wrong because there are so many variables at play and often it’s the terminal / future growth value of a company that typically moves the stock price around. I’m not sure any human is smart enough to build a be-all, end-all model for a company and a market.
That said, I’m getting closer to a strategy for how to get around this. Right now, it’s why I’m looking at things in % terms instead of straight dollar values.
I also don’t want to get too diversified. An old Buffett adage is to put all your eggs in one basket, but to watch that basket like a hawk. He’s right. Spreading your investments around too much dilutes your returns. And if you do that, you might as well just invest in the S&P 500 and stop taking an active approach to investing.
I also have this desire to make this entire investing process as simple and easy for millennials as possible. Where investing is a game without the risk, that actually rewards you with something tangle. Not just points or a high score in Tetris, but real world dollars. A game that’s fun and pays you.
I’ve been toying with different product approaches and monetization models, but for the moment I’m just trying to get my own manual process perfected before I turn it into a platform. Ultimately it’s because I believe that if you’re fortunate enough to gain knowledge, then you also have a responsibility to share it.
VI. A Note on Brexit & How To Make Money In a Moment
I want to take a moment to chat about Brexit and what that really means for you if you’re looking to get started investing or saving for retirement (as my parents have always said, “it will be here before you know it”). Right after the vote happened, the stock market cratered and all the gains I had made over the past 6 months were wiped out in a moment. Zero. Zilch. I still had all the original money I put in. I just hadn’t grown it or made any interest on it. And that’s the point of all this. You are completely liquid because you can sell at any point in time. But even professional investors forget the first rule of business, “buy low and sell high”, so they sell at the worst possible times.
What actually happened to the stock market because of Brexit? It was a fire sale. Everything was up to 10% off their normal prices. So, do this thought experiment for me.
Imagine you got an email from Apple saying that all iPhones, iPads, Apple Watches and MacBooks were on sale, 10% off for a few hours this morning. What do you think would happen? Their online stores and physical stores would be overrun with traffic. People would be buying as much as they could get their hands on, even if it meant reselling these products on eBay because they knew they’d make a return almost immediately. The price would go right back up to normal levels after that 2-hour window was over.
But for some reason, when you say Apple’s stock price is 10% off, people panic and run for the hills. Nobody rushes to buy Apple. They rush to sell it. It sounds like lunacy doesn’t it? So, when Brexit happens or the next bubble bursts, should you be scared? Of course not, you should be buying as much as you can get your hands on because you know that you can resell it a bit later for a profit.
And with Brexit, the market bounced back in a week. I went from having all my returns completely wiped out, maybe $600 profit to $0, but now it’s back up to $700 profit. If you would have bought more shares in anything, Apple, Tesla, Amazon, doesn’t matter who, and then waited a week until the market corrected itself, you would have made a really quick couple hundred bucks.
Buy low, and sell high may be the rule, but it’s not one that people fundamentally understand. So I’m going to change it. Right now. Because user experience matters more than logic:
Buy on sale, and hold (BOSAH).
It’s that last half that’s tricky. When do you sell? Sometimes you need cash, for an emergency hospital visit or to buy a house? But what is an emergency and what isn’t (that new TV is on sale!) I think I’ll keep working on that part. But the first part is dead-on-balls accurate.
Find a good company, with good management, that make a good product better than others. And then always buy on sale. Hopefully this open-source tool can help you “catch em all”, just like Pokemon Go.
— Sean
