117 - What risks are you willing to underwrite?

Mental Models discussed in this podcast: Operational Leverage Risk Management Please review and rate the podcast If you enjoyed this podcast and found it helpful, please consider leaving me a rating and review. Your feedback helps me to improve the podcast and grow the show's audience.  Follow me on Twitter and YouTube Twitter Handle: @TreyHenninger YouTube Channel: DIY Investing Support the Podcast on Patreon This is a podcast supported by listeners like you. If you'd like to support this podcast and help me to continue creating great investing content, please consider becoming a Patron at DIYInvesting.org/Patron. Show Outline The full show notes for this episode are available at https://www.diyinvesting.org/Episode117 Business Risks Stock specific Acceptable: Price - I'm willing to compromise on my price target of less than 10x earnings in recent days. Now I'm willing to accept up to 15x earnings per share for high-quality businesses Growth Rate Estimates - I'm willing to accept being wrong on my estimate of growth. I'm usually targeting businesses that grow revenue/earnings at double-digit rates. If my pricing is right, I can be wrong on my growth rate assumption and still do fine. Operational Leverage - I'm willing to bet on and be wrong about operating leverage Unacceptable: Balance Sheet Liquidity - I want a liquid cash-filling balance sheet Self Funded - I don't want to buy a company that has to be funded by debt Bankruptcy Risk - No bankruptcy risk of any kind, which means I am unwilling to accept highly leveraged companies. Commodity Risk - I'm not willing to accept exposure to commodity prices.  Portfolio Risks Related to your overall strategy or investment portfolio Non-stock or business-specific Acceptable: Illiquid stocks - I'm willing to accept lower liquidity in my stocks than other investors. I'm willing to spend months building my positions instead of just days or hours.  Concentration Risk - I'm willing to hold fewer stocks than other investors. (3-5 companies) Tracking Error Risk - I'm willing for my results to be dramatically different from the results of an index like the S&P 500 or the Russell 2000.  Unacceptable: Unwilling to underperform inflation for long periods of time. (5-10+ years) Unwilling to underperform a 10% baseline absolute return over time Brings in decisions like how to address cash drag I have realized while preparing for this show that I don't really know what my "unacceptable risks" should e on a portfolio-wide basis. So let me know what I'm missing. You can send me an email or DM me on Twitter.  Summary: As an investor, the risks you take can be categorized as either business risks or portfolio risks. In order to earn a return, you must take some risks from each type. In other words, how are you willing to fail?