Friends,
The New Year is a great time to look ahead, but also to consolidate the wisdom we've gained from the past. In that light, I (Stoffel, here) want to reflect on the scars from 2022 that are still with me.
My portfolio dropped 53% during the year and had an even larger drawdown peak-to-trough. That led to a big change in the way I make decisions: I introduced valuation as a key component to my investing process.
Often when I explain why I'm doing this, I show this graph. It details when I first bought Shopify in 2017 (green arrow), how it grew to a huge part of my portfolio by late 2021 (black arrow), and how it fell 83% over the next year (red arrow).
Importantly, I also show that at its peak in 2021, Shopify's stock had ridiculous expectations. If I had done a reverse discounted cash flow (rDCF) analysis on it, I would have seen it needed 54% growth in free cash flow every year for a decade to justify that price.
That's 7,500% growth in free cash flow over 10 years.
"Had I realized that," I tell people, "I would have at least trimmed the position by 50% at that point."
Well, the surging stock market tested my valuation-focused resolution in 2024. During the fourth quarter, I trimmed positions in Axon, Shopify, and Tesla after all three had significant run-ups leading to stretched valuations.
Will that be the right call? Only time will tell.
But going back to my previous example from Shopify, I realize an uncomfortable truth. Had I been focusing on valuation throughout the pandemic, I probably would have started trimming long before the stock peaked in late 2021.
In real life, I would have waited over a year before my decision looked like a good one. The same thing may occur with Axon, Tesla, and Shopify. That's why I just sold some -- not all -- of these three stocks.
It's also a reminder that the only way to keep your sanity in investing is if you take the long view. Invest in wide-moat businesses at reasonable valuations -- and don't be afraid to take some off the table when your analysis says it's prudent.
Wishing you a happy New Year in 2025,
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Brian Feroldi, Brian Stoffel, & Brian Withers
Long Term Mindset
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