Today’s post is the heart of my 33-year journey: HOW I plan to turn $1 into $100 through long-term investing. It’s the framework I’ll rely on—and refine—for the next three decades. (If you haven’t yet, read the first post to understand the goal and why it matters.)
ALL ABOUT ODDS
As we all know, the only thing certain about investing is uncertainty. Therefore, there is no sure way of achieving 15% annualized for 33 year years. At the same time, many of us don’t know that investing long term is also about probabilities. Therefore, despite the uncertainties, I can take calculated decisions to increase the odds of reaching the desired 15% return.
To increase the odds of achieving great returns, I should analyze the real life risks (not the alpha, beta kind) , understand the moat of the business, verify management’s commitment & integrity proved by history, and confirm margin of safety. These things are complicated, and take years of practice, and learning to get it reasonably right.
Clearly, I am no expert. Therefore, I plan to start by protecting the downside first, by reducing the odds of failure (Thanks Charlie for bringing inversion in my life). I plan to avoid businesses I don’t understand, companies with limited history, high debt, management with limited proven history, and businesses in sectors with very low return of capital along with high capex requirement.
While this type of filtering might cause me to miss on a few great opportunities, it will greatly reduce odds of failure. It will help me survive through my challenge. Essentially, it will help me buy time to develop my circle of competence.
The Ideal Math & Margin of error (inspired by Nick Sleep’s and Zak’s strategy)
My intent is to find businesses that add real economic value, who grow their intrinsic value by at least 10% a year, and are available at 50% discount.
A business with intrinsic value of $1 growing at 10% annually for 5 years, will reach to the value of $1.62 at the end of 5th year. And if bought at 50% discount, i.e. at the price of 50 cents to the dollar, the investment will yield annualized return of ~26%. While these are extremely hard to find, but not impossible.
However, it is impossible to have a 100% accuracy in investments. Therefore it is important to account for margin of error. In an equally weighted portfolio, if I can achieve at least 50% success rate, i.e. 5 in 10 investments stay flat, and other 5 provide the desired returns of ~26%, the portfolio will yield 13%.
ADDING REALISM
While the above math, even with the margin of error looks good on paper, in reality, there are several factors that will affect this math positively, or negatively – portfolio weights, miscalculation in intrinsic value calculation, overperformance or underperformance of individual stock compared to expectation, etc.
However, even with 50% accuracy, I can increase the odds of better returns by having higher weights to my high conviction ideas, and also hold longer, if the moat of the business gets stronger.
TL/DR – 100x playbook
At individual investment level:
– Avoid companies with high debt, no moat, bad management and poor economics.
– Seek businesses that grow their intrinsic value > 10% annually.
– Buy with 50% margin of safety.
At portfolio level:
– Allocate more to high conviction ideas
– Hold for longer if businesses strengthen.
These two things, if done wisely, and at a lower absolute failure rate of less than 50%, there is high probability of achieving 15% annualized returns.
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