Drystone Communications



October 15, 2012

Do not let the risk that’s in your face distract from more serious risks lurking behind you, nor let the in-your-face risk trick you into taking drastic steps that can actually leave your portfolio more exposed. The noisy, in-your-face risk? Stock market volatility. The quieter but more pointed risk? The potential for multi-year losses, or at best near-zero total returns, on bonds. The drastic step? Abandoning diversification.

Drystone does not define diversification as mindlessly filling lots of asset allocation buckets and slavishly holding each of those buckets in all market environments, a mechanistic approach which can consign portfolios to mediocre returns or worse. Nor, though, does Drystone define diversification so loosely as to be meaningless. Proper diversification means being nimble and opportunistic, always reassessing investments already owned and always searching for new investments with favorable risk-adjusted return prospects, but doing so within the asset mix ranges outlined in a carefully crafted Statement of Investment Objectives and without letting greed or fear push a portfolio to extremes.


July 16, 2012

Projecting future financial success or trouble is of course harder and more subjective, but a big set of clues can be gleaned from the competitive forces at work in the particular industry where a company operates. One popular way to describe an industry’s competitive structure is the Porter Model, named for the Harvard professor/consultant who first described his framework in 1979. To Porter’s original five competitive forces, later researchers added a sixth force. These six are:

1. Intensity of competition between existing companies in an industry....I try to avoid destructive oligopolies of commoditized giants bashing each other on price in an endless bid for market share.

2. Threat of new entrants/ease of exit.

3. Substitute products or services.

4. Bargaining power of customers.

5. Bargaining power of suppliers.

6. Government....speaking of government as part of the landscape, a note on “crony capitalism”: Aside from being philosophically repugnant, crony capitalism is not a path to sustainable shareholder returns. Many companies lobby and rent-seek and succeed in getting subsidies or exemptions or sticking it to competitors for a while, but it’s clear which “stakeholder” ultimately drives that tour bus. Also, when management is busy playing sycophant, they risk losing whatever intrinsic competitive edge or respect for shareholders their company may have originally possessed.


April 18, 2012

I am confident in the ability of Drystone portfolios to meet clients’ objectives: all of you have demanding but achievable objectives, and there is a sufficient universe of investment opportunities with the intrinsic merits and reasonable valuations necessary for building durable portfolios. In fact, the best part of portfolio management will always be ferreting out such opportunities and fitting them together into a cogent, productive whole. Success accrues to those with a process to ferret and fit over and over again and get it right more often than wrong.

A quick reminder of the multiple reasons Drystone uses Diversified Investments like ETF’s when building portfolios: 1. Diversified Investments can help a portfolio benefit from broad asset classes where I expect compelling aggregate performance but do not expect individual security selection to generate substantial additional value; 2. Diversifieds can complement the return potentials and balance the risks present in Drystone’s Concentrated individual investments; 3. Diversifieds can serve as placeholders to keep a portfolio’s overall asset mix at appropriate percentages until I’ve decided on new Concentrated Investments – this is likely the case, if you see a Diversifieds sale and Concentrateds purchase occur simultaneously.


January 18, 2012

No investor should use sweeping generalizations of possible market/economic behavior as the starting point or prime motivation for any purchase or sale. Start instead around a core of known quantities and work out in concentric circles of slightly increasing uncertainty, until you reach the limit of useful, reliable analysis. If you have to stretch too far out in those circles to justify an investment, then it’s more prudent to avoid it.

The most powerful known quantity is the current price of an investment: a sufficiently cheap entry price for a stock, or generous yield for a bond, can offset a lot of the uncertainty inherent in projections of sustained growth or financial soundness, while overpaying can lead to disaster if actual growth or soundness falls short of projections. Drystone’s #1 metric for assessing a stock’s current value is a company’s free cash flow ÷ enterprise value (FCF ÷ EV), with FCF equal to the cash generated by business operations minus capital expenditures and EV equal to the market value of the company’s stock plus long-term liabilities minus cash on hand.


Drystone LLC investment portfolio manager