The Moats And Monopolies Portfolio Update Q3 2023

A Little About Me

My first career was in retail banking, working in savings and investments. Not a CFA. Not a professional analyst. Nor a portfolio manager. But certainly, someone who dealt daily with people with very high net worth (typically £500k to £5 million), and had to hold a working understanding of how the markets operated and of individual stock ideas. The job ended in 2008 after months of verbal abuse and one death threat. You can probably make your own connection between the dates, my role and the general public at large...

Working now as an educator, there are three things that I try my best to be: humble, kind and honest. I have used Seeking Alpha for many years passively for research, but as I start to contribute more to the Seeking Alpha community as a fairly new analyst, I wish to apply these same values here as I do in my day-to-day life.

This is the first update since I began publicly sharing my portfolio here in the last quarter. I have decided to call it the Moats and Monopolies portfolio to reflect the nature of the companies in which I invest.

Investing Philosophy

Before you read any further, it's worth me sharing my thoughts on investing right out of the gate to ensure that you don't waste your time reading the rest of the article should you be on a different path. I will turn 40 this quarter. With this in mind, my investing horizon is 15-20 years and my goal is to use my portfolio to retire early. I am long only and consider myself a part owner in the companies in which I invest. I do not dabble in shorting, options trading or any kind of momentum or short term trading. I do not believe that I can predict or time the market nor am I a macro economist.

I believe that the best way to actually achieve Alpha is to be concentrated in a small number of high quality assets and then holding them for long periods of time to allow their values to compound. I am 99% invested in the stock market (with the other 1% a speculative amount of Bitcoin) and do not hold any bonds or alternative investments, as I believe that over the long term the stock market offers the best returns. I do not care about volatility; I am a pretty rationale person and acknowledge that this is the cost of admission to generational wealth creation.

I define quality assets as those that have high free cash flow margins or the future ability to create and sustain them. These high margins are maintained by companies that have defensible moats against competition or, even better, monopolistic parts of their business that allows them to continue to compound over time. In addition, these quality companies should be able to invest their earnings at rates of return. I believe it is important to understand the spread between returns on invested capital and weighted average costs of capital (ROIC - WACC) as well as owning companies that can maintain returns on capital employed (ROCE) that are consistently above 20%. Quality assets have manageable debt, and with a couple of exceptions (the railways that I own), they should have debt that can be paid off with no more than 5 years of free cash flows.

I avoid companies that I do not understand and whose cashflows I cannot to a reasonable extent forecast. Companies that are over reliant on market cycles and commodities, such as banks, car makers and miners are avoided. I am happy to pay higher prices for quality assets. I am not happy to speculate on higher prices for companies that have not demonstrated that they have sustainable and profitable business models because other people are hyping them.

I do not really care about dividends at this stage in my investing life. They are a nice little dopamine hit when they hit my account but I am more interested in total return, and dividends are both tax inefficient and potentially wasted opportunities to invest in companies that can invest in themselves.

I avoid Twitter/X, Reddit and other places where people discuss stocks on a day to day basis. Life is for day to day, investing is for quarter to quarter at the most.

Finally, I believe in understanding what I own. The Moats and Monopolies portfolio has just 20 stocks and a handful of ETFs. This means that I can keep up-to-date with what is happening with my companies as well as investing my time into modeling out what I believe to be realistic targets for future cash flows.

Changes

Buys

Enphase - Enphase (ENPH) is a company that I have been a fan of for a while. It develops micro-inverters for solar panels and is starting to branch out into other battery storage and home charging solutions for electric vehicles. It is one of the two dominant players in the US residential market and is growing quickly internationally, particularly in Europe. It has had some issues recently with stock levels and has slowed production accordingly. There have also been some disincentives in some US markets for installations, reducing demand. I see these as short term headwinds and my thesis is that the market has overreacted in its selloff of over 50% over the past year. During that time, revenues, operating profits and cash flows have all continued to grow and the company has a healthy 20%+ free cash flow margin, little debt and high returns on invested capital and capital employed; further, the long term tail winds for renewable energy are plentiful. There is an argument that the company's technology has been somewhat commoditized, but even if that is true, competition cannot commoditise long term relationships built with installers over time and Enphase has worked hard to deliver excellent service to the businesses it serves.

Games Workshop - (OTCPK:GMWKF) is a small British company primarily responsible for creating products under the Warhammer name. It sells its products directly online and in its retail stores and is increasingly open to licensing its intellectual property - in the past few years to video games and within the past few months Amazon Prime for a potential TV series. There is no real competition for this game/art project/collectible/immersible universe. It's had a bit of a run up this year following excitement for the aforementioned Amazon deal (which also excites me), so I have initiated a small position with the hope to increasing it when the price cools down. 25% free cash flow margins with a high dividend return and a wonderful management team who understand their market and are respectful to their fans, I believe this is a great small cap to buy, hold and forget with incremental dividend re-investment to further compound future returns.

Linde - (LIN) is the only dividend aristocrat I (now) own. Another British company, but with a very different remit - along with Air Liquide (OTCPK:AIQUF), it dominates the industrial gas space and a recent acquisition of rival Praxis means that it has a market leading share in the production of many industrial gases. It is the epitome of a boring company, and its margins are slightly lower than the usual I aim for; however, with post merger efficiencies, it should be able to achieve around 18% free cash flow margins. My thesis is quite straight forward: 1) we will always need industrial gases and more importantly 2) I believe that hydrogen fuel will become an increasingly important part of our global decarbonisation attempts and Linde is in a strong position to benefit.

Sells

Starbucks - (SBUX) is a good company. I had owned it for the best part of a decade and been well rewarded over that time; however, as my investing philosophy slowly evolves, it was time to kill a couple of my babies. Starbucks has reached saturation levels in its domestic markets and is reliant on emerging markets for its growth. This could have an impact on future margins as revenues grow over time but profits won't necessarily keep pace. Further, Starbucks' free cash flow margins are lower than I am now looking for and their debt significantly higher. There are also smaller questions surrounding the CEO transition and unionisation attempts from company owned stores in the US. To clarify, I do not think Starbucks is a bad company by any means - in fact, I believe it is a hold for most investors and will hover around a market average return with a dependable and easy to understand business model. If I were retaining more holdings in my portfolio, it would still have a place, but as I really whittle down, I can't find a place for it in my top 20 ideas.

Deere & Company - (DE) is another good company, and like Starbucks, I would continue to hold it if I were more diversified. It has been a solid investment for me over the years, growing its earnings and raising its dividend as it moves towards the inevitable smart and connected evolution of its agricultural products. I like companies that have compounded over many decades, and although past performance is not a guarantee of future returns, it is the most reliable indicator that we have. Deere was sold due to its relatively high capital expenditures, low free cash flow margin and its increasingly large debt due to offering loans and payment plans to its business customers. This is a risk that is hard to evaluate, which makes my ability to forecast its future harder than I would like it.

PayPal - (PYPL) is an interesting one. On paper, at its current valuation, it offers one of the best risk adjusted investment opportunities in the large cap space. Having said that, this is the only investment that I have sold at a loss for many years and to be frank - I'm glad to see the back of it. Could it do an Adobe/Meta/Nvidia like mega recovery? Possibly. Would I care if it does? No. It has a history of poor/bizarre decision making that has alienated some of its users and confused maybe of its investors. I found the new CEO appointment underwhelming and amidst increasing competition in the digital payment/wallet space, it's time for me to sell and reallocate funds into what I perceive as better opportunities.

Netflix - (NFLX). I really loved owning Netflix. I enjoy a lot of its premium content and it is effectively what we treat as television in our household. I have owned the stock for a long time, having signed up within the first few weeks of it being first available as a streaming option in the UK and have never cancelled. Having said that, I have sold shares at different points in its rise and had a relatively small allocation of my portfolio left in it. As I considered what were the very best opportunities within my investible universe, I reflected on how media companies have come and gone over the decades and despite periods of dominance, no media company has stayed at the top for the duration that I wish to hold my positions. Further, I believe that user generated content will continue to increase in both popularity and production values than scripted studio shows. This was a reluctant sell, but I believe that it is ultimately the correct one.

Nintendo - (OTCPK:NTDOY) - Nintendo is another good company that was hard to justify as great - particularly with my focus on a pretty streamlined portfolio. I purchased Nintendo relatively recently as management seemed increasingly interested in extracting value from its IP, with a trove of iconic characters available to be licensed into movies and TV shows as well as new generations of video games for future consoles. I believe that Nintendo has to modernise and as we undergo a period of transition from physical purchases to digital purchases and probably subscription services for gaming, I wonder if Nintendo is ready for the change. Another reluctant sell.

Technology ETFs - I owned 2 technology focused ETFs - one based on an MSCI Semiconductor index, another on an MSCI World technology company index. In focusing down my assets, I simply decided to sell out and invest more into the Nasdaq 100, which I have set up as a savings plan to invest on a monthly basis and hopefully take advantage of drawdowns over the next year or two.

My portfolio

5.23% Visa

5.18% MSCI Inc

5.15% Adobe

5.00% Mastercard

4.78% Microsoft

4.61% S&P Global

4.66% Alphabet

3.99% Moody's

3.84% MercadoLibre

3.85% Amazon

3.76% Canadian Pacific Railway

3.84% LVMH

3.60% Union Pacific

3.46% Apple

3.11% Booking Holdings

2.65% Games Workshop

3.05% Evolution Gaming

2.82% Linde

2.43% Rightmove PLC

2.43% Enphase

14.25% ETFs

1.36% Bitcoin

6.95% Cash

Number of Stocks - 20

Number of Total Holdings (including cash) - 24

Median Market Cap (billions) - €113,999

Mean Average Age of Company - 61 years

Weighted Gross Profit Margin - 72.94%

Weighted Levered FCF Margin - 27.42%

Weighted ROIC - 35.32%

Weighted WACC - 11.34%

Weighted ROCE - 67.66%

PE on Price* - 31.29

FCF Yield on Price* - 3.62%

10 Year Revenue Growth - 15.40%

10 Year FCF Growth - 22.49%

*This is skewed by my Amazon holding.

My top 6 individual holdings by current market value

MSCI - (MSCI). Another great company that has its fingers across the markets with high margin and recurring revenue streams. It provides financial data to analysts, portfolio managers and institutional investors as well as providing many of the biggest indices with which passive ETF providers create investment products. It has free cash flow margins around 35% and high returns on invested capital (25%) and capital employed (38%).

Adobe (ADBE) - I hold Adobe because it is a steady compounder that grows its revenues and cash flows in almost every market condition. It has an increasingly diversified revenue stream and is benefiting from the move towards artificial intelligence by doing something I believe is very clever - rather than simply designing AI that will scrape the internet and will inevitably face copyright infringement law suits in the future, it is creating its own data set from its creative suite. It is an incredibly well managed company and even if its Figma deal falls through, it still has such a comprehensive software suite that it will continue to grow for many years. It's current free cash flow margin is just below 40% with returns on invested capital and capital employed at 20.53% and 33.97% respectively.

Mastercard (MA) - See Visa.

Microsoft - (MSFT) is a tech ETF unto itself. If I were only to hold one stock in the technology sector, it would be Microsoft. If I were only to hold one stock period, it would be Microsoft. It has fingers in many growing pies and a few monopolistic or oligopolistic parts of its business, including Windows, Office, Xbox, Bing (don't laugh) and the jewel in the crown - the cloud infrastructure as a service platform, Azure. It has a free cash flow margin of around 23% at the moment and as it continues to move legacy programs onto recurring cloud subscriptions, I am confident this will continue to tick up over time. It has a 25% return on invested capital and a nearly 40% return on capital employed.

S&P Global - (SPGI) is another of the greatest companies in the world. It has a huge data set related to commodities and stocks all around the world and sells it at very high margins. It is part of a small oligopoly along with Moody's (MCO) and Fitch (privately listed): in order for companies to raise money from the debt markets, it must receive credit ratings from 2 of these 3 companies. S&P also receives money from indices it licenses to ETF providers, such as the ubiquitous S&P 500. Each of these parts of its business are high margin and mostly recurring revenue. Its current free cash flow margin is just below 30%; however, its returns on invested capital and capital employed measurements are currently lowered by its recent acquisition of IHS Markit, but I'm confident they will tick back up higher after these growing pains have settled.

Benchmarking

When I decided to begin my portfolio share, I also wanted to offer full transparency by benchmarking my portfolio's performance against the main benchmark indices - assuming an imaginary $10000 starting amount. In the graph above, you can see Moats and Monopolies portfolio is the dotted line, with the S&P 500 coloured yellow, the MSCI World green and the Nasdaq 100, grey. Rain or shine, I will continue to update this each quarter moving forward.

Thank you for reading and feel free to follow along. I appreciate any constructive and kind feedback as well as any investment ideas you wish to share!