S2E7: How to invest in single stocks (and why you probably shouldn’t) | Sasha Yanshin
Most people shouldn’t invest in single stocks - they’d be better off investing in index funds - but that doesn’t stop a lot of people trying. That’s the view of Sasha Yanshin, YouTuber, Damo’s friend and nemesis - and it’s Damo’s view too. He keeps up to 10% of his allocation for investing in specific stocks because he enjoys it.
In this episode Sasha gives a little flavour of the work involved and some best practices in case you want to chance your arm. But please be mindful of the risks and consider capping your exposure if it is something you want to try.
Stock picking principles from Sasha Yanshin
Sasha says if you can’t identify the risks of an investment you’re not investing, you’re gambling.
Sasha thinks if you want to invest you should try not to become a fan of the company. It’s not about being in a club, it’s about getting a return on your money which demands critical thinking - and being critical.
The vast majority of people shouldn’t be investing in single stocks, they would be better off investing through index funds. Check out our “Can anyone get rich?” and “How to actually start investing” episodes if you want to learn more about index fund investing.
Whilst Sasha says most people shouldn’t invest in single stocks, he also acknowledges that trying to beat the market is basically human nature - a lot of people will still try in the face of the odds.
To figure out if a stock is worth investing in, you basically need to figure out two things:
The price you’d be happy to buy in at now, i.e. your valuation of the company today.
The price you think it realistically could reach in the future, i.e. when you’re going to sell - your target price. It could happen in months, years or decades.
You might like a company but not like its price and vice versa. Of course you’re looking for something that’s undervalued.
When you’re investing in a company, you are buying part of a business - a share of it.
It can be useful to consider how you’d approach buying a whole business, e.g. a corner shop. You’d want to go through the accounts and understand how they have changed over time, what are the trends in the area, how is demand changing for the products they sell, is there stuff the shop doesn’t sell but would deliver growth, is their regeneration in the area etc. You need to understand if it’s a good business that is likely to grow and how its value today compares to the price today - and your target price in the future.
If you want to invest in a company, it’s best practice to build a valuation model mapping this stuff out. Sasha does a bottom-up analysis. He assesses every part of a business, every revenue stream, what the drivers of revenue are, prices of course, the propensity for prices to change over time, demand, how that will change in the future - all the costs in the business - everything. He models it all out.
The point is that investing in single stocks is a lot of work.
And if people do have the time, most people don’t have the skills (like making good models on Excel).
Before you even build a model you need to figure out which companies to model.
To do that Sasha reads all the quarterly and annual filings (or results) for a company (and keeps reading them if he invests). There is a short and long version of these results - he reads the long one.
His goal with a model is to minimise overall errors, he’s not trying to get it perfect which is impossible.
The problem with top down models (which is more like taking high-level numbers like revenue and adding changes over time) is that when you make errors they are likely to have a massive impact. If you add a 30% growth rate to a company’s revenue for 10 years that will deliver a very different outcome to adding 35%. If you get just one or two things wrong then it can make your model worthless.
Obviously you don’t know what’s going to happen in the future. Sasha is trying to give his best, most reasonable estimate for each input.
So he values a company today and asks what would be a fair price. If it’s significantly less than the price then he will buy at what feels like a discount.
His definition of target price is when he’s happy to sell, based on his latest valuation - not what price he thinks the stock will reach because you don’t know if/when that will happen.
He runs different scenarios, which basically means taking his model and overlaying it with different risks, e.g. a factory productivity jump from robots. Some things will be correlated, if X happens Y will happen and vice versa. He’ll run simulations and end up with a range for his target price.
I’m not even going to attempt to explain how a Monte Carlo simulation works (cheers Damo) but the goal is to accurately estimate the probabilities of uncertain events.
When a stock reaches his target price (and thinks there’s not much upside left) he’ll sell.
But knowing when to sell is the toughest part.
Remember a valuation will change over time. As new information becomes available, the model should be updated.
His initial valuation can be wildly different from his final valuation because things change. In the last two years, for instance, a lot of his valuations have come down.
Sasha says every quarter it’s important to read all the releases for the stocks you’re invested in. Plus you need to stay on top of the news, read about the industry, what competitors are doing, competitor filings etc. Then you need to update the model but that’s just the stocks you own - finding new ones and building new models comes on top.
He suggests you listen to earnings calls, which is when a company goes through their results and answer some questions.
He thinks this takes about 20 hours per company per quarter - so 200 hours if you have a portfolio of 10 companies - and that’s the minimum, he says.
Sasha says a lot of people think what’s happened in the past matters. He says that’s wrong. It’s a company’s situation today - and your best view of what that means for the future - that matters.
The valuation should be based on numbers, not sentiment.
A lot of people, at least on social media, say they want to hold their positions forever. It can be a bit cult-like.
Sasha says don’t be a fan, be an investor - and at least understand the difference. Fundamentally, you have to sell to make a profit. He’s happy to sell a bit lower than his target price in some circumstances e.g. if there’s a better investment opportunity elsewhere.
You should beware biases, like confirmation bias, because we like to be right.
He doesn’t change strategy. He executes the same strategy over and over - which can be boring. It takes discipline, but that’s probably the best way to get a return.
He actually spends more time reading about companies he doesn’t invest in.
‘Buy low, sell high’ is easy to talk about, but much less easy to do - partly because of emotion, and crowds.
The market isn’t perfect. You can invest in a good company that performs well but the market doesn’t like it.
He says there’s an element of luck but it’s like poker, how do you play when luck goes with you or against you?
Fund managers are incentivised directly by assets under management (how much money people give them to invest which they take a % on), not by their investments doing well. Them making money doesn’t rely on their performance. Of course if they do badly you would expect investors to pull their money but the system isn’t perfect. And part of that is because a lot of people don’t know what bad looks like. When the market is rising, bad fund managers can still make money which keeps their investors happy even if they could’ve made a lot more by buying the market (investing in an index fund).
Beware creators talking about stocks. They make money from you watching what they say, not if what they say is right. They are incentivised to be popular rather than right.
When an industry is disrupted, e.g. travel during Covid, you need to figure out if it’s a short term disruption or more fundamental
You’re more likely to do better if you diversify rather than invest in one stock. In part this is because of time. You don’t know when a company will shoot up. If you give yourself a wider spread you’ve got more chance of one company jumping in a given year. If that happens you can take the profits and reinvest them - which means investing more over time without increasing your initial outlay - and you can’t do that if you’re all in on one stock.
Whilst buying low is the goal, beware investing in a company that’s dropping when you think it could go to zero - or at least be aware of the risks.
Being a good investor is like becoming a concert pianist. Are you happy/able to put in that level of work?
Damo has a limit of up to 10% of his portfolio for investing in individual stocks because he enjoys it but also understand that it’s unlikely to be the best way to invest (v index funds) which is why he caps it at 10%.
