The 8-Tool Investor : Unlocking Your Potential With These Core Skills

Applying the Multi-Skilled Athlete Mindset to Your Investment Journey

Most of you who are familiar with baseball have heard of a “5 tool player” someone who is good or above average in the 5 main aspects of baseball. Someone who can hit for power, average, has speed, fielding as well as throwing ability. Weather you are talking about a professional sport, your job, or investing, I believe there are a number of over arching skills that are crucial to your success in that particular field. The number of skills needed may change from field to field, and not everyone will agree on which particular skills are the most important, like we do with baseball, but the “5 tool player” is an important concept to carry throughout life.

I’ve identified 8 core skills related to investment that I believe make you an “8 tool investor”. As with baseball or any profession, you do not have to be proficient in all areas, and there are specialists, but I believe increasing your knowledge and skillset in all areas in anything is paramount to getting the most out of yourself.

1. Circle of Competence

When first beginning to search for an opportunity an investor needs to have a clear understanding of their “circle of competence”. Your circle of competence, can be thought of as the area you possess a deep understanding, or have specific knowledge, skills, or expertise that can help you make sound decisions. For instance someone who has worked or works in sales may have a deeper understanding of a products lifecycle and stickiness than someone who has not seen the demand first hand. Or this could be someone in a manufacturing industry. They would be able to identify pieces of equipment, or software that are crucial to business operations far better than someone on the outside.

Looking at the investors who have the best understanding of their own circle of competence, Buffett is surly to top the list. Warren Buffett famously has a “too hard” pile on his desk for companies he just cant figure out. While I don’t physically have a pile of papers on my desk representing companies I find challenging to invest in, I have taken lessons from this. I have looked at many international opportunities, and I often find them hard to value, as I am not as familiar with the country’s customs, politics, or consumer behaviors. Buffett has also said “I don't try to jump over 7-foot hurdles. I look for 1-foot hurdles I can step over”. In other words, don’t try and study quantum computing for your investments, look at business’s in plain sight you understand.

2. Business Moats and Competitive Advantages

Understanding exactly what makes a business special, or superior to other companies is crucial to the investor. There can be a number of different moats, or competitive advantages a business may possess. As you progress through your investing journey you may start to prefer some moats to others, lets take a look at some of the most common moats.

1. Switching costs

   Either a high up front cost, or products embedded into a company ecosystem, make it very hard for customers to switch to a competitor. Think AWS (Amazon Web Services, this helps power many website, and has large amount of data built on top of it. Anyone who wanted to switch to a different cloud provider would have to spend months and likely years worth of development resources to do this. A company without this moat could be a video streaming company, think about how you cancel you membership with little friction, and go onto the next streaming service when you finish your favorite show.

2. Brand Power Their are some logos or brands that are so powerful almost everyone will recognize them, and in turn pay more for them. Luxury fashion houses like Channel, Dior, or Louis Vuitton, a technology company like Apple, or a racing team like Ferrari. Brand power can prove to be one of the longest lasting moats, if managed properly. As shown with Louis Vuitton, however consumer behavior can change rapidly, and any missteps from management could permanently damage your company’s reputation.

3. Efficient Scale

   Company’s that can scale their business easily, efficiently, or even reach a more efficient state once at scale have a huge advantage. Costco Warehouse’s subscription model is a great example of this. Costco builds a warehouse, and stocks it with low price merchandise. In order to shop at Costco you need to have a membership. These membership have to be renewed annually, and have no additional cost to Costco, creating a reliable growing source of profits as they increase the number of members.

4. Cost Advantages

   The truly great business’s can have multiple advantages and that’s what we will look at here. As I previously mentioned Costco prides themselves on being a low-cost provider or goods. As a rule of thumb Costco will never have higher than 14% margins on name brand items, and no more than 15% on Kirkland signature items (their in house brand). These margins are for big ticket items however, Costco’s margin on most products is well under 5%. The cost advantages seen at Costco make their customers incredibly loyal, they always feel they are getting the best deal despite the membership fee.

These are some of my favorite examples of moats, but their are many more, network effects, intellectual property, regulatory advantages, just to name a few. Understanding these different moats and how they pertain to a company is crucial to finding not only high quality company’s but also durable long lasting ones.

3. Runway For growth

A companies Runway For Growth can be thought of as how much longer a company can grow its operations, either to market saturation, or the company needs to raise capitol. Sometimes this can also be using cash from operations to fund growth in adjacent verticals. 20 years ago almost no-one would have predicted Amazon to be a global leader in web services, ads, and video, along with e-commerce, but they are. A company who’s core product or service has a long runway for growth is essential. It not only assures the company can grow for a number of years in the future, but it also gives them optionality to expand even further.

4. Management Teams

Understanding who a what your management team is doing is key. When looking at different characteristics of good management teams you will typically find a CEO who has been with the company a long time, or is even the founder, and they often hold a large position in the company’s stock. When the CEO or other members of upper management hold a large % of the company’s stock it aligns the interests of the shareholders and management. For example management is much less likely to do frivolous market acquisitions, or spend on unnecessary luxuries as it will also negatively affect them. A founder led company can also be very powerful, as the founder can usually adapt quicker, rally his workers, has a stronger knowledge of product, and is also more likely to expand into adjacent verticals.

5. Valuation

After carefully analyzing a business, and you’re confident you want a piece of the pie. Their comes the question of, how much is this worth? After all you wouldn’t pay $50 for a steak from the grocery store, $10 sure, but why pay $50 for a steak when chicken is $8. When it comes to valuation their is no finite answer, its an art, not a science. What I have found is competitive advantages, runway for growth, and management teams all play into the price you should be willing to pay for a company. If there are two companies in the same industry, but one has a superior management team, runway for growth, and competitive advantages, you should be willing to pay a higher P/E multiple for that company. I truly get excited about valuation when their is a clearly superior company that is trading at a lower multiple than its inferior peer, or it is clearly being overlooked by Mr. Market.

6. Buying

An important skill for any investor, and just like its counter parts we will discuss next, it’s often overlooked. When purchasing a stock it’s important to not get caught up in recent price action, don’t buy stocks just because they have gone up. Stay true to your research on moats, management teams, runway for growth, and don’t step outside your circle of competence.

7. Holding

Probably the most forgotten and overlooked part of investing, but arguably the most important. The longer your around business’s the more you realize there are very few truly great ones, when you get your hands on one that you can understand you don’t want to let it go.

8. Selling

As I just said we really want to avoid selling great business’s but selling is still a very important skill and their are times to use it. Beyond life events life home purchases, or emergency situations I think we can apply Phil Fishers think that there is only 3 main reasons to sell a stock.

1. A Mistake Was Made in the Original Purchase

If, upon further investigation or as circumstances change, you realize that the company you invested in is not as strong as you initially believed, it's wise to correct that mistake and sell the stock. Sometimes I personally find my perspective changing slightly after I have purchased a stock and held the position for a few week this can be from a misstep in my original research.

2. Deteriorating Business Fundamentals

If the company's business fundamentals deteriorate and it no longer meets the criteria that made it an attractive investment, selling may be necessary. This might be a weakening moat or competitive advantage, the runway for growth is no longer present, or key member of the management team leaving.

3. A More Attractive Investment Opportunity Arises

This is the least important of the three, and should only be used in extreme cases. Fisher warned to only sell a stock, if the stock you are replacing it with is off equal, or higher quality. If the company you have purchased has seen a stock price gain so explosive that no matter the growth, or execution from management, you think there are far better opportunities in equal or higher quality names, it may be a good idea to sell.

Combining all 8 of these tools together is what can truly make a great investor. When you start looking at different professions yourself, you will start to see how the concept of the “5 tool player” is applicable. If you analyze the very top of each profession you’ll notice no one is lacking in any “tool” they are above average in every area, but they are truly exceptional in 1-2 areas as well.