My Investing framework

Why, I don't care about growth rates, but about Illiquidity.

As an eager learner about life and investing, my investment framework has changed over the last couple of years. Every day, I learn more about the complex, but simple world of value-investing. Complex because there are 1000 different strategies, preached by 1000 different people, simple because ultimately it all comes down to buy an asset for less than it is worth. Since it is impossible to research every company, I thought, I write down my current investing framework. It is the result of studying other successful investors, my own experience and, obviously, preferences. I think there are many strategies to generate alpha, but the most important thing is to find a strategy that suits your personality, so it is fun for you, and you can stick to it fairly long. For me that means illiquid, obscure microcaps, the lesser they are known, the better. I have no interest in analyzing a large cap company, even if there may be a good opportunity. I like to restrict myself to illiquid companies.
I believe alpha and peace of mind lays in restricting the universe of potential investments. So here is my current framework, when I am researching companies, I look for these attributes.

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1. Illiquidity

The biggest advantage a retail investor has is the ability to buy-and-sell illiquid companies. For me, liquidity is a better filter than MarketCap (even though a smaller market cap usually implies less liquidity).
If we are filtering for illiquid companies, we often achieve this by looking for:

• Low free float

• Low share count

• Over the counter stocks

LS Invest has a market cap of roughly €300m currently but almost 90% is hold by insiders, so the free float is only about €30m. Even though, the company is not that small, it is probably more illiquid than a lot of companies with a smaller market cap, but higher free float.
Companies with low share count tend to be more illiquid too.
The same goes for companies that trade at over the counter exchanges because some funds are not allowed to own them. So, if I screen for a company, I look for low free float (as an absolute number) and a low share count (ideally below 20m) and prefer stocks that trade on an over the counter stock exchange.

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2. Cheapness

I assume everybody that reads this substack likes to invest in cheap companies. However, there are different ways to determine what is cheap.
It depends, what the situation is, LS Invest for example is cheap on an asset-base, while Leatt is cheap on an earnings base, while Parks! is cheap on a norm. Free-Cash-Flow basis. The most important thing is, that it is cheap on a normalized basis.
Growth is very hard to maintain, and even harder to project (correctly).
High ROIC companies tend to attract a lot of competition and therefore become medium- to low ROIC companies, eventually.
The question is which ROIC will not revert to the mean soon. I think this is very hard to predict. For that reason, I think it is easier to predict, that a cheap company should be worth more, when normalized earnings come through. This way, you get the multiple expansion + earnings growth.

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3. Downside protection

Rule number one is, to never lose money. A cheap multiple provides you with a downside protection. But if you miscalculated the normalized earnings of the business, you can still lose money. That’s why hard assets in terms of cash or any kind of real-estate on the balance sheet provides with a double downside protection, besides the valuation. Debt would do the opposite.
Centrotec is probably the best example of that in my portfolio. The company trades at a market cap of €684m, but sold its main division this year for €635m in cash + 41m stocks of Ariston.
Currently, Ariston trades at 9,42€ per share, so cash + shares in Aristron = €1.029m/ 13,1 S/O = 78,5€ per share.
Current share price: 52€. (Yes, you’ve read that right.)

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4. Catalyst

If we have done the right valuation work, eventually the market will agree with you. However, there are a lot of companies, that just stay cheap forever. Thus, I like to look for any catalyst that could happen in the near future, so other investor would recognize the undervaluation of this company as well.

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5. Aligned Incentives

“Show me the incentives, and I’ll show you the outcome” this famous quote by Charles Munger always stuck with me. Even the best company is useless if none of the generated money comes through to minority shareholders. The best way to make sure, that operating results transfer into the share price, is by looking at the incentives of the management. I look for insider ownership, a simple share structure (one class) and little to no dilution.

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6. Business model

While I believe that at the right price, basically any business could be interesting, I prefer business models that are easy to understand and are stable. While it always depends on the holding period (the shorter, the less important), I think direct to consumer companies are easier to understand because you can easily buy their products or use their service. The most important for me is that the competition in the industry is not increasing, I would prefer a business with little competition in a shrinking industry over a business operating in a growing industry with increasing competition.

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7. Countries

Surely there might be a lot of undervalued companies in Poland, Italy or Japan.
But for now, I’d like to restrict myself to companies in Germany, the USA and Canada. I believe that in those countries are enough opportunities.
In fact, there would be enough opportunities, if I would focus myself only on delisted German stocks (which wouldn’t be a bad idea).

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These are the main criteria, that I focus on while researching stocks.
I am sure that will evolve in the future. So make sure, to read my updated version in the future. What are the most important criteria in your investment framework?
Comment below!

Disclaimer: Do not interpret anything above as financial advice. I do hold a position in the discussed companies and therefore may be biased. The article was written for entertainment & educational purposes only.