The following my be off-topic. If so, feel free to delete it. Using this framework has led me to invest in many of the same stocks Saul and others discuss at length on this board, and it offers another mental model for evaluating them.
Four years ago, I read the book “Antifragile” by Nassim Taleb and it changed everything about how I invest. I stopped creating stories in my head about how things would work out in the future, and began ruthlessly cutting out anything I didn’t think I could measure in real time. This applied to investing and real-life.
About the same time, I started voting in David Gardner’s Explorer missions. I came up with a framework, which I’ll cover below, that tries to pick stocks based on their Antifragility. It completely ignores valuation, total addressable market, and – for the most part – business momentum.
It is far from perfect, but with four years of data via these Explorer Missions, I wanted to present my findings.
Out of all Supernauts who vote on these missions, using the Antifragile Framework has landed my picks as the top performer.
* My average pick has returned 68% – outperforming the alternative by an average of 19.7 percentage points. And it has correctly chosen the outperformer 59% of the time.
To put that in perspective, the top five performers are all investors who I consider myself very lucky to be in the company of:
TMFCheesehead (19.7 points outperformance, 59% accuracy)
TMFgoLong (14.6 points, 57%)
TMF1000 (13.0 points, 49%)
TMFGalagan (11.7 points, 57%)
TMFInnovator (11.0 points, 57%)
I include that just to show proof there may be something behind this approach. I intend the rest to be a brief primer on what – exactly – the framework is.
The basic premise is that the future is far more unknowable than we believe or are comfortable with. If we can accept that, it changes our approach to the world. Instead of trying to maximize things, we can try to position ourselves to benefit from the unknown
Who do we do that? By limiting our downside (being harmed by negative unexpected events) and keeping ourselves exposed to uncapped upside (being rewarded by positive unexpected events).
The framework attempts to do this by evaluating three very simple aspects of a company. In order of importance, they are:
1) The barbell technique A company should be devote 80%-ish of its resources to a line of business that’s protected by a wide moat, but devote the other 20% to optionality.
Three things I evaluate are:
- The mission statement: Is it clear, optionable, and inspirational?
- The moat: High switching-costs, network effects, and low-cost production that’s demonstrated over time are the most powerful. Patents and brand value I consider to be less powerful, but still relavent.
- Optionality: Does the company’s history/mission make me think it will have multiple lines of business I don’t even know about right now, in the future? Points for companies that can demonstrate this, more points for those that do it effectively between industries (think: Amazon).
2) Financial Fortitude Companies that have lots of cash and little debt actually get stronger from recessions. While weaker players are pushed out of the market, these companies gobble up market share for the long run.
Two things I evaluate are:
- Financial statements: Particularly, cash, debt, and free cash flow – and consider what effects a recession might have.
- Customer concentration: Companies that rely on a few customer for the bulk of revenue have a huge danger of that customer changing their mind. If that happened, it would represent a negative, unforeseeable event that would crush a stock.
3) Skin in the game When the people running a company have a vested interest in creating long-term value, there’s a much higher probability of them focusing on value creation via stock price – as opposed to value extraction via high-priced compensation packages.
Three things I evaluate are:
Role of founder: These individuals often see the company as an existential extension of themselves. I consider it a positive if they are still involved.
Insider ownership: I want to know that insiders will only succeed when I – as a shareholder – succeed. Our financial interests are aligned.
Employee engagement: At the end of the day, rank and file employees are the ones doing the critical work. I use Glassdoor.com to monitor if they are happy where they are, and what the most salient cultural issues might be.
And that’s it. Notice what’s not there:
Discounted cash flow models
Predictions about what will happen in the future (though I do include “possibilities” via optionality)
Thoughts on valuation (though I will consider this if brand is the only real moat a company has)
Any type of story about what a company will become.
It’s simply focused on the things I believe I can measure right now.
Then framework has gotten input from people all over TMF – including many on these boards. It’s also not perfect: when it comes to biopharma and Chinese stocks, it has a pretty terrible track record. When what I consider to be low-moat companies are performing well (think CMG and UA in their hayday), it can also be very wrong (though both of those examples ended up vindicating the framework).
I wish I had a comprehensive list of every stock I’ve ever rated and its returns over the next 3-5 years, but that’s just too much work for me. Instead, in the future, when I do evaluate a stock, I want to be able to return to this posting for those that might have questions about what the Antifragile Framework really is.