Q&A with Portfolio Manager John Rotonti Jr.

January 2025

The Islamorada Investment Management (IIM) Industrial and Infrastructure Portfolio is scheduled to launch in January 2025.

This Q&A includes the questions I’d want answered if I were in your shoes and considering investing with me. Think of it as the IIM Industrial and Infrastructure Portfolio Owner’s Manual. Below I tell you how I think you should measure me and when I think you should consider firing me. I will be taking this document seriously and you should too. When something changes, I’ll update this document, alert you of the change, and explain why I’m making the change. Thank you for your time and consideration. I appreciate you all very much!

After reading this, if you have additional questions, please contact me at [email protected]. I look forward to answering more of your questions.

For those of us that choose not to read 7,000 words, can you please just give us a quick overview of the IIM Industrial and Infrastructure portfolio you’ll be launching?

Sure. The IIM Industrial and Infrastructure strategy is a domestic, long-term focused, low-turnover, roughly 30 stock portfolio that aims to invest in high-quality industrial, infrastructure, and housing-related businesses at attractive valuations. Importantly, the businesses should be run by leaders that think and act like owners, and that are economically aligned with outside shareholders. The vast majority of holdings will have already achieved scale, have healthy balance sheets (sometimes with net cash), have high and/or rising returns on invested capital (ROIC), stable or growing free cash flows (FCF), and high terminal values with what we think are long runways of per-share earnings growth. The rate of growth is less important than the duration of per-share growth (as long as the valuations are reasonable). We believe these businesses will have high barriers to entry, wide and sustainable moats, and several will operate in oligopolies or duopolies with high and stable market share, pricing power, and limited competition. Others will have leading market shares in highly fragmented industries providing opportunities for long runways of growth through both market share gains (organic growth) and consolidation/M&A (inorganic growth). The businesses will offer strong value propositions and solve big, important problems. We’re looking to invest in companies that do hard things and do those hard things well. We’ve got to believe these businesses are resilient and adaptable with survivorship genes and an almost maniacal focus on maximizing long-term business value per share.

Tell us about Islamorada Investment Management.

IIM is a fee only, independent registered investment advisor (RIA) founded in 2008 by Cale Smith in Islamorada, FL. (Note that registration of an Investment Advisor does not imply a certain level of skill or training.) We take our responsibility as “fiduciaries” very seriously.

We’ve got some exciting announcements…

We’re changing our name in early 2025 to “Bastion Fiduciary.” When Cale founded the company in 2008 nearly all of his clients were from Islamorada in the FL Keys. And our other portfolio manager Lauretta Reeves was also based out of Islamorada for a while. But now we have clients across several states and our workforce is distributed across 7 states. Our homebase is still FL but our name change will reflect our broader investor base and distributed team.

A Bastion is a defensive position on a military structure (or fortress), sometimes even surrounded by a moat. The “defensive” nature of a bastion symbolizes our plan to protect (defend) your capital first and foremost. Our secondary objective is to grow (compound) your capital over time. We also plan to defend you from some of the noise and short-termism from Wall Street. The Bastion image also represents the types of businesses we aim to invest in…those with strong economic castles and protective (durable) moats. Finally, Bastion shows respect to Cale and three other members of our team that served our country as officers in the military.

We are acquiring another fee-only, independent RIA with a focus on financial planning. We’ll now be able to offer our clients even more planning services and most importantly this will enable the three portfolio managers to focus more of our time and attention on researching businesses, valuing stocks, and managing our portfolios. I should mention, the company that we are acquiring was founded by and is run by Cale’s lifelong best friend. They were in the Coast Guard Academy together, lived together on 3 different occasions, and share the same insane work ethic and the same client-first, fiduciary ethos and culture.

Tell us about IIM’s founder, Cale Smith.

I’ve been studying investors for almost 25 years, and I even created a podcast to further my study of investors, and I think of Cale as a great investor, and even better businessman, and an even better human. I feel like I won the lottery when I met Cale and then when he offered me a job doing what I love.

Cale treats his team very well and cares for his clients deeply. Many of them are like family to him.

Cale also cares deeply about his community. Let me give you a quick example. I was recently in Islamorada for our annual client meeting. Cale was on the Chamber of Commerce in the past but he is still very active. And while we were there, Islamorada shipped in 30 tons of ice for its annual Holiday fest when they try to make this beach town look like a winter wonderland and where the kids can have snowball fights and stuff. Anyway, the parade was on a Friday. And Islamorada is small (I think 6000 people) and everything is basically on either side of a main road (Cale told me all directions in Islamorada are given based on (1) mile markers and (2) bay side or sea side). So, on Thursday he spent 3 hours painting parking lines around town to help find ways to park all the traffic for the parade. And on Friday night he spent 2 or 3 hours parking people’s cars. This is something he did while he had his whole team in town and was preparing for a 60-person event on Saturday night.

Also, Cale is methodical and careful about who he hires and what businesses he acquires because the most important thing to him is maintaining the company culture. So, when Cale was thinking of hiring me, it wasn’t like a typical interview process. It was more like a courtship over 6 or 7 months. So, Cale is just very thorough, thoughtful, and methodical in everything he does.

Why should clients invest their hard-earned money in your IIM Industrial and Infrastructure Portfolio?

I think I’m a good investor and a good person and I love what I do. My parents are broke, partly because they received some bad financial advice, and ever since I discovered investing, I’ve wanted to make it a career so that I could help people like my parents.

I’ve spent over 20 years studying businesses, industries, markets, and other investors. I think I have a very good idea of what works and what doesn’t in investing, and I know what skills I’m good at and which I’m not. I think, when it comes to investing, I have a lot of self-awareness and humility, and I continue to learn and improve.

I work to develop this skillset, trade, art form (however you want to categorize it) incessantly and intensely. I’m laser focused and intense!

My life is organized in a way so that investing is pretty much all I do. I’m not married, and I don’t have kids. I don’t even currently have a dog. I don’t play fantasy football or golf…ever. I rarely watch sport. I watch the Olympics and the World Cup and maybe an occasional boxing match, so that gives you an idea of how often I watch sports. I don’t have anything at all against these hobbies, but they are just not my hobbies. My hobby is my career. My career is my hobby, and that’s investing. I love everything about investing and I’m intentional and laser focused on getting a little better at investing every single day (just like great businesses compound their intrinsic value every single day). I read relentlessly, and I’m a good (and fast), active reader. I think I can connect the dots well and I’m an independent thinker that develops my own point of view and conviction. I think I can dive deep into a company or an industry, while at the same time sit up at 30,000 feet and think about how the opportunity fits into the bigger picture and how it may fit into the portfolio. I avoid FOMO like the plague, I do the hard work and I build independent conviction.

Importantly, I think there’s a difference between being a good analyst and being a good investor. I think I’m a strong business analyst as well as a contrarian, independent thinker with emotional discipline and good judgement. Emotions and judgement are key differentiators!

My other differentiators are my patience, time horizon, and zero FOMO.

Outside of investing, my only other regular hobbies are going to the gym and getting outside to ruck or ride my bike. I love to travel, but even then, I’m spending some time reading and thinking about investing. The only time I’m probably fully tuned out from investing is when dining out (which I love to do) or spending time with my family (including my 8 nieces and nephews), whom I adore.

I have my investing philosophy tattooed on my arm! How’s that for conviction and judgement;)?

What is the IIM Industrial and Infrastructure Portfolio?

It’s a domestic, roughly 30 stock portfolio that invests in high-quality industrial, infrastructure, and housing related businesses at what I think are fair or preferably discounted valuations.

The portfolio will launch in the second or third week of January 2025.

By domestic, we mean companies that report in U.S. dollars and whose primary exchange is in the U.S. The portfolio will not invest in ADRs.

We will be patient and very long-term focused, and I think that will manifest itself in a very low turnover, low trading, low activity portfolio. Most of the trading will occur around big dislocations like a broad market drawdown, an industry/sector-specific bear market, or when one particular stock moves a lot either to the downside or upside (this usually happens during earnings season).

Last thing I’ll say is that the portfolio will not be fully invested at all times. I suspect an average cash position to be 10%-15% (there is a lot more on cash management below).

What is your stock picking philosophy and strategy?

I don’t like to be type-casted, but if I was forced to describe my stock picking style, I think it would be Quality Growth at a Reasonable Price (Q-GARP) or preferably Quality Value Investor. The one thing I won’t do is knowingly sacrifice quality, and by quality, I mean a quality business and quality management team that has an owner-operator mentality and is economically aligned with outside shareholders.

And I’d like to invest in these businesses only when I think their common stocks are trading at fair or preferably discounted and even preferably severely discounted valuations so that the portfolio has the potential to benefit from BOTH per-share intrinsic value growth and multiple expansion.

I’m comfortable paying what I think is fair value and more comfortable buying what is hated (and yes there are opportunities to buy greatness when it is hated but they are rare, and you have to be ready when those opportunities present).

Quantitatively, the vast majority of holdings will have already achieved scale, have healthy balance sheets (sometimes with net cash), have high and/or rising returns on invested capital (ROIC), stable or growing free cash flows (FCF), and high terminal values with a long runway of per-share earnings growth. Based on my analysis, these businesses will have high barriers to entry, wide and sustainable moats, and several will operate in oligopolies or duopolies with high and stable market share, pricing power, and limited competition. Others will have leading market shares in highly fragmented industries providing opportunities for long runways of growth through both market share gains (organic growth) and consolidation/M&A (inorganic growth).

Qualitatively, the businesses will offer strong value propositions and solve big, important problems. I’ve got to believe these businesses are resilient and adaptable and protected by what I think are sustainable competitive advantages (emphasis on sustainable), and should have advantaged, owner-operator corporate cultures.

Maybe most importantly, I want to invest in companies that do hard things and do those hard things well. We will largely be investing in companies that take a long time to scale up and that are participating in projects that take immense capital and years or decades to complete and then once completed will have asset lives in the decades. I believe that things that take a ton of capital and decades to achieve have some of the highest barriers to entry and the widest, most defensible moats. This is the opposite of conventional wisdom where the market rewards profitless SaaS with insane valuations because they can “scale up quickly.” My analysis leads me to believe that companies that grow too fast and scale up too quickly also scale down quickly and they lack barriers to entry (which means they are assaulted by a constant barrage of competition) or sustainable competitive advantages.

Investors should think of this as a low-activity, very long-term oriented portfolio of 30 or so stocks of competitively-advantaged businesses with what I think are long runways of per-share growth. As long as the valuations are appropriate, the rate of growth is less important to me than the duration of profitable growth. The portfolio will invest across a growth spectrum, but all companies will have what I think is a long-duration, profitable growth runway.

Each year I will ask many of the same questions about portfolio holdings: – Did the company’s moat(s) get wider or narrower? – Did management think and act like owners? – Do the company’s products and/or services remain relevant and is the company still offering a compelling value proposition? – Do I think the company’s per-share value will be higher in five years and at roughly what rate do I think per-share value can grow? – Is the valuation still reasonable?

What is your portfolio management philosophy?

By far the most important part of the portfolio management strategy will be to only pack it with high-quality, profitable, growing businesses! When we find these (unique) businesses, hopefully we can buy their stocks cheaply and put them in the portfolio (if we can’t buy cheaply-enough then they will remain on our watch list/wish list).

Once these high-quality profitable growers are in the portfolio, my hope is that they go to work for us, compounding on our behalf! But compounding takes time (decades really) so we will let our winners run (meaning that if the stocks outrun growth of intrinsic value we will give them some leeway and time for their business value to catch up to the stock price). If the valuations get too stretched (more on this below) we’ll trim or (rarely) sell out. But, I suspect that over time, most of our sales will come from losers, but even then I’ll be reluctant to sell.

It will be a roughly 30 stock portfolio (let’s say 20 to 40 stocks because I insist on thinking in wide ranges to offer the portfolio flexibility).

I’m going to initiate positions in one of three sizing baskets. A core position will be initiated with a 3% weighting. Core positions meet all of the quality criteria and are trading at a discount to what I think is fair value. 5% or higher positions meet all of the quality criteria but are severely discounted and hated. This is the ideal situation. If I’m not buying and thriving in drawdowns, then I’m not doing my job well. These opportunities are rare, but will hopefully be big drivers of our returns over time. And then a 1% position meets the quality criteria but are trading closer to fair value and offer limited or even no margins of safety based on my estimates of fair value, often conservatively calculated.

To be clear, “fair value” does not mean I think the stock can’t go higher because I’m investing in businesses that I think have growing intrinsic values. It’s just that I think returns will be driven by EPS growth (and maybe some dividend yield) rather than P/E multiple expansion. Or thinking about it in terms of a DCF, fair value is the price I can pay and earn my required rate of return. So, as an example, if I’m using a 10% cost of capital, then fair value means I think intrinsic value can compound at around 10% (and hopefully the stock price follows intrinsic value up over time).

The plan and hope is that these 1% positions grow into core 3% positions either because the stocks increase or because I find opportunities to size into them over time.

I will sometimes use baskets where I’ll buy 3 or 4 stocks in an industry, each with a 1% position. I think of these baskets as almost one core 3% position. The reason for baskets is either because I think the industry is going through a bear market and all stocks in the group are undervalued and I think there are multiple ways to win OR the stocks are all discounted and the businesses are quite similar with maybe only subtle differences.

What 1% positions are not are profitless, mismanaged, or insanely valued speculative gambles placed on hot stocks in hot industries. To be clear, 1% positions will meet the quality criteria and be fairly valued based on my assessment. This will be a no FOMO portfolio…hard stop. If you think I’m FOMOing, you should fire me!

Importantly, this will be a very low turnover portfolio. I have a very strong bias toward inactivity because the hurdle to get a new position into the portfolio will be very high (think Warren Buffett’s 20 punch-card framework) and the bias will be to hold onto our stocks for a long-enough time to let compounding take effect. I don’t like parting with great businesses that I understand well that may have a decades-long runway of per-share growth just because the valuation is on the high-side of fair. Great businesses have a way of surprising to the upside and growing into their somewhat stretched valuations. In other words, I will let our winners run and give them some leniency on valuation. If the valuations balloon outside a zone of reasonableness, I will trim. If the valuation bubbles bigger and bigger, I will sell out.

The cash raised from the sale will likely not be deployed quickly because of our strict selection criteria!

And as I will repeat extensively throughout this document, the portfolio will likely have an average cash position of 10% and maybe even 15% (depending on what the market is offering me). But, and please take note of this, it is my job to put that cash to work when I am presented with “slap me in the face” opportunities. If I am not buying aggressively during market sell-offs, then I’m not doing my job nearly well enough!

Can you please talk about your cash management strategy more, and also how much cash do you plan to launch with?

Cash build will be a residual of the opportunities that the markets presents us. Cash build is a residual of my selective philosophy and process: only buying the best businesses at attractive valuations. These opportunities don’t come around frequently so rather than settle for lower business/managerial quality (which I refuse to knowingly do) or to reach on valuation (which I rarely do), then cash is the outcome of the selection process.

It’s quite nice that cash yields 4.5% today, but that is not the reason I will be holding cash. I’ll be holding cash because I think quality stocks are expensive and opportunities scarce.

The cash also provides a cushion during a downturn, and then just as important, it allows me to invest aggressively during downturns without having to sell our stocks (with temporarily depressed stock prices) that we think have years and maybe decades of compounding ahead of them.

Not having to source funds from stocks we love at temporarily discounted prices is key to not interrupting the magical power of compounding over time! I’m not sure the value of this can be easily quantified, but I believe strongly that it can have an outsized impact on our long-term returns. Having a war chest during a panic is the gift that literally keeps on giving!

If I am not investing aggressively during drawdowns then I am not doing my job well, and you deserve a job well done! If I fail to size up our favorite holdings or add stocks from my watch list during drawdowns, then you should fire me (and I’m serious).

I’ll be launching with roughly 35% cash as I size into my 1% positions over time. Hopefully the market gives me the opportunity to size up those positions rather quickly (like maybe over a few months). So, when the portfolio launches on day one it won’t be entirely built out. All 35 stocks will be there, but I’ll be building those positions over time and that’s the reason for the large starting cash position.

But a normal cash position will be 10%-15%, which is still high and noteworthy for anyone considering investing with me.

When we get a “slap-me-in-the-face” opportunity, like a broad market sell-off, I’ll take that cash down to 5% or lower. My job is to be in a position to take advantage of generational buying opportunities on your behalf.

I think it’s important to highlight that because the portfolio will not be fully invested, my investors should absolutely expect me to be able to deploy the cash effectively during drawdowns. I’ll be praying for drawdowns quite honestly (you read that correctly). And since I won’t be fully invested most of the time, I owe it to my investors to get fully invested when prices are dirt cheap, and that’s my plan and that’s what I intend to do. Hopefully by now I’ve been clear that this is one of the ways that you should measure me.

Why limit your strategy to only industrial, infrastructure and housing related stocks?

Although I’ve been a generalist for over 20 years, these are the industries and sectors that I know best and have always gravitated to, and have the highest conviction in long-term. After I eliminate all of the lower-quality companies or businesses that I don’t understand well enough to invest your money into, this is what I’m left with (with a few exceptions here and there). I think that this trashing (elimination) process is key to long-term returns.

Of the things that keep me up at night, having a limited investing universe is not one of them! Let’s examine some (not all) of the possibilities for the IIM Industrial and Infrastructure Portfolio…

Consider the growth of AI data centers which are a critical infrastructure layer of the digital economy and a critical foundational pillar in the re-industrialization of America. As infrastructure investors we can invest in hyperscale data center owners, data center REITS, the engineering and construction firms that build the data centers, the rental companies providing the equipment and machinery to do the actual construction of the data centers, and then into all the industrial technology going into the data centers from semiconductors to server racks and clusters to networking gear like switches and routers to electrical sensors and connectors to copper and fiberoptic cabling/wiring to HVAC and liquid cooling to the utilities, gas fired turbines, and generators used to electrify and power the data centers to the natural resources and renewable energy sources used to power the utility and power companies, to the natural resource royalty companies leasing land and other resources to the data center owners, and on and on.

Or consider a single-family or multi-family home. This includes everything from the homebuilders to the third-party installation companies, to the building products/materials companies (providing everything from roofing to insulation to siding to flooring to cabinets to decking to paint to plumbing fixtures and on and on) to home improvement retailers (particularly those with large and growing logistics networks used to serve professional builders), to companies providing home services including everything from pool maintenance to pest control to plumbing (the 3Ps), and more.

Obviously large holding companies and alternative asset managers investing in infrastructure through equity and private credit is another category of stocks that cleanly fit into the strategy. (Note: alternative asset managers are some of the largest data center owners in the world).

You don’t have to think too far outside the box to see that banks providing home (or industrial/construction) loans or companies providing home insurance or short-term rental companies allowing homeowners to turn their homes into income-generating assets could also easily fit into the strategy as well.

And we haven’t even mentioned traditional manufacturing, industrial distribution, robotics (including in healthcare, collaborative robots, and humanoid robots), life sciences tools/medical devices, or industrial technology and automation companies of different varieties.

We mentioned data center REITS above, but there are other real estate opportunities including cell towers, industrial warehouses, medical facilities, and more.

Because I’m having fun, I’ll close this section with this thought: One also doesn’t have to think too far outside the box to realize that Visa is a payment processor and fintech but also an infrastructure technology company as it owns 10 million route miles of telecommunications network (for reference the earth’s circumference is about 25,000 miles). The two images typically used to describe Visa are “electronic/digital rails” and a “toll road on global commerce”, both of which are “infrastructure” metaphors.

It’s clear that there are some strong secular tailwinds in industrials and infrastructure coming from fiscal stimulus, AI and other mega projects, renewable energy transition, the electrification of everything, and the broader re-industrialization of America. But what about housing? Are there any tailwinds there?

Housing is this incredibly important industry because it’s roughly 35%-40% of the CPI and 15%-16% of U.S. GDP. Because of this, housing has a multiplier effect on the U.S. economy. If you want to understand the U.S. economy and where we are the current economic cycle, then I think you must understand housing.

Housing is also crucial because the 30-year fixed rate mortgage is unique to the United States, and for most people their home is not only where they create some of their best memories, but it’s also their largest financial asset.

Because our home is where we spend most of our time, where we lay our head, and raise our families, and because it’s just this important part of our net worth, homeowners are constantly investing in their homes. When times are tighter, they spend to maintain and repair their homes and when times are better they spend on bigger renovations and upgrades.

Additionally, the supply demand dynamics for homebuilders (and adjacent companies mentioned above) is quite attractive because the average age of a home in the U.S. is about 45 years old and homeowners are unable to move (upgrade) because they are locked into their 3%-4% mortgages while current mortgage rates are 7%. This is leading to near record lows for existing homes for sale. At the same time we are roughly 3 million to 7 million homes short (because we underbuilt for more than a decade coming out of the GFC) on the supply side at the exact same time that demand for new homes is strong from Millennials, the largest age cohort in U.S. history that are just now entering their prime homebuying age. In short, I believe strongly that we need to build more homes, particularly entry-level starter homes, and this will be a long-term tailwind not only to the homebuilders but a larger group of related companies as well. This is the type of supply (low), demand (high) dynamic that I’d like to invest behind.

I’m highly confident that despite the cycle in any given year or two that homes will still be in demand (and a crucial part of the U.S. economy) in ten or twenty years. I can’t say the same about extremely high multiple profitless SaaS that has low barriers to entry, low/no moats, faces unrelenting competition from those low barriers to entry (how many HR SaaS apps do we have today???), and could be facing an existential threat from Gen AI agents.

Will the portfolio have a benchmark?

If I fail to outperform the S&P 500 on a net (after fee) basis over a five-year period, you should consider firing me and putting your money into another IIM strategy, or a very low-cost S&P 500 index fund or other very low-cost broad market index fund.

In an ideal world I’d like to set up an investing framework (and communicate to you in ways) that supports much longer-than-normal time horizons, so I’d prefer to be measured over 7-year periods. But I understand that 7 years is a lot to ask from many people so I’m settling on five.

If five years is too long for you, this is not the strategy for you.

How will you manage risk in the portfolio?

At IIM, my primary goal and north star as a portfolio manager is preservation of my client’s capital over a full-market cycle (roughly 5 years) and my second and third goals (of equal weight) are to grow my client capital over time and to communicate with them transparently and often.

There will be multiple layers of risk management in the portfolio: (1) I will manage risk in the portfolio first and foremost by only investing in what I think are high-quality, profitable growth businesses with exceptional management teams that are economically aligned with outside shareholders. I will not knowingly sacrifice quality in the portfolio no matter what.

(2) The second important layer of risk management is my insistence on valuation… that is never paying more than I think is fair value and taking larger positions in those high-quality businesses that I think are most undervalued. This is a no FOMO, no YOLO, no MOMO-chasing portfolio.

(3) Our investments will be spread across roughly 30 stocks with an ample cash cushion most of the time.

(4) I will not speculate on unproven, earlier stage, profitless companies trading at excessively high valuation or even in great businesses trading at excessively high valuations. Remember that our 1% positions (at cost) are not speculative bets, but rather stocks in companies that meet all our qualitative and quantitative investing criteria, but that just trade at fair value and offer less of a margin of safety.

Because of the insistence on business quality and undervaluation, I do not expect the portfolio will suffer many single-stock blowups (but there could surely be some). Blow-up typically come from companies with too much debt or mismanagement or ones that are suffering from industry headwinds and deteriorating fundamentals, shrinking moats, and therefore deteriorating intrinsic values. Blow-ups also come from insane valuations. We will try to avoid these situations like the plague, but I will make some mistakes. Although I will make mistakes, my hope is to create a portfolio where the biggest risk is opportunity cost (that is underperforming the market for periods of time and on occasion surely long periods of time). If you are not prepared to underperform for at least a few years, you should not invest with me!

Will you try to minimize beta (volatility) in the portfolio?

No, I will not. I consider volatility a gift to long-term investors, not a risk. Some of the best performing stocks historically have high betas (see Tesla, Nvidia, Lam Research, Builders FirstSource and Xpel). Volatility allows long-term investors to buy low and sell high and is therefore the price investors pay for attractive returns over time.

To be clear, and it’s important to understand this part of the strategy, I’m perfectly fine if our stocks fall after we buy them, particularly the 1% positions that I’d like to size up over time. In fact, I welcome our stocks falling.

Additionally, many of the companies we will invest in operate in cyclical industries and carry higher betas. That being said, unless something major changes between now and the portfolio launch date in January 2025 the portfolio has an average beta of only 1.2 (and an average two-year forward P/E of only 20x, which is roughly in-line with the market). The average beta of our 16 core positions (3% weighting at inception) is also 1.2. And interestingly, of the 35 stocks in the portfolio today (once again there could be some changes between now and launch) only three of them have both a beta and a NTM+1 P/E above the portfolio average. In other words, I have some higher beta stocks in the portfolio, but they tend to have very low P/Es. I also have some higher P/E stocks, but they have lower betas.

The only part of volatility I will lose sleep over is if we don’t have enough of it! I suspect that our long-term returns will be higher in a higher volatility market. I welcome a higher VIX so we can put our cash to work.

Will the fund invest in any asset classes other than stocks and cash?

This is a long-only, domestic stock fund so I think that’s mostly it.

Keep in mind that it’s possible we build up exposure to real estate through REITs or to private markets through publicly-traded alternative asset managers.

If gold gets crushed, I’d consider putting up to 5% (at original cost) of the portfolio in gold.

When will you sell?

I will sell when I determine that I was wrong (which will definitely happen), when the valuation balloons outside a zone of reasonableness/sanity, or when management disappoints in a really value-destructive way. I will also trim (and possibly sell) to source funds for a new idea I like more if I’m running with less cash than I had hoped for (but that will be a high hurdle).

How will you communicate with us?

IIM portfolio managers will communicate with you regularly and fully transparently on our internal message boards, in our newsletters, on our podcast, and in occasional letters to investors. You can also email or call us directly.

What is your investing superpower?

I’m not sure I have any superpowers, investing or otherwise, but if I did here is what they are…

I think my investing superpowers are extreme focus and dedication. My life is organized in a way that intentionally prioritizes investing (see above). I don’t have a wife or kids currently and my favorite hobby is investing.

My other superpowers are patience, an ability to keep my eyes on the far-away horizon, independent thinking, and a strong repulsion to FOMO.

I think I have really good investing judgement.

What are you not good at?

I am not good at averaging up and adding to my winners. I’m excellent at letting winners run (and not touching the stocks), but there have been occasions in the past when I should have averaged up meaningfully and consistently and I failed to do so. Of the behavioral biases, anchoring to my low cost basis is probably the one I’m most susceptible to. But I’m working on this.

This portfolio will rarely invest in profitless businesses, and I use what I think are conservative valuation assumptions so I have missed lots of early returns in multi-baggers in the past.

Who should not invest in the IIM Industrial and Infrastructure Portfolio?

To begin, I don’ think anyone should invest any money in the stock market that they may need in the next five years.

Relatedly, you should also not invest with me if you have to stretch to come up with the $100,000 minimum.

If you don’t buy into the philosophy of thinking like a business owner and focusing on the long-term horizon, then this is not the strategy for you.

You should not invest with me if you can’t handle a bumpy ride (we will be investing in cyclical industries).

You should not invest with me if you think five years is too long of a performance measurement period.

You should not invest with me if you are looking for your money to be fully-invested at all times. That’s a position that I fully respect and sympathize with. But that’s just not how I’m going to add the most value over time.

Are there any category of stocks you will avoid?

I will avoid lower-quality profitless companies that are poorly managed, companies that don’t fit the industrials/infrastructure/housing mandate, and stocks with excessively high valuations (no matter how attractive the business, moat, management, and long-term opportunities).

The truth is there is a fairly long list of businesses that I admire strongly, but am not comfortable putting in the portfolio at this time strictly for valuation reasons. I’m a value investor and it’s very hard for me to underwrite their stocks at current prices. Some of you will say I’m not properly valuing their optionality. Honestly, you’re probably right.

Are there any industries you want more exposure to over time?

We are launching with roughly 30 stocks, only one of which would be considered healthcare (life sciences tools). Over time I’d like to add a couple more life sciences tools or medical device companies (including robotics).

The strategy is also currently light on software (outside of the mega-cap hyper-scalers). Over time, at the right price, I’d like to add some profitable infrastructure software or construction/architectural, or supply chain software.

How do you think about valuation for stocks?

I don’t think I do anything special when it comes to valuation. What I think is special is my patience (patient when buying and patient when holding ) and how I avoid precision (and FOMO) like the plague.

There is ample research showing that FCF yield is the best predictor of forward rates of return. So, I use FCF yield primarily but I try to make sure I’m using normalized FCF in the equation and then I add a range of expected growth rates to that to come up with a range of expected annualized rates of return.

Another really straightforward way to think about valuation is the total shareholder return (TSR) formula which says the total return you earn from a stock in any year is the dividend yield + EPS growth + / – the change in the P/E ratio. There’s a lot here. First, I need to once again come up with a range of expected EPS growth rates. And then I need to think a lot about the P/E ratio and whether I think it has room to expand (and why) or in some cases how much I think the P/E multiple will contract (and how fast EPS needs to grow to offset that in order to still earn my required rate of return). When thinking through the multiple, I will calculate justified P/E multiples (what is the warranted P/E based on the company’s earning growth, return on incremental invested capital, and risk profile/cost of capital?) and also look at buyout multiples of similar companies or the multiples of a carefully selected peer/comp group.

Sometimes a sum-of-the-parts (SOTP) valuation can be helpful when separating core business valuation from other business segments that may offer upside optionality.

Sometimes I’ll use reverse DCFs to try to determine what the market is pricing in and whether I think that’s low or high.

Most importantly is I avoid precision. So, when I’m estimating EPS of FCF per share I do so within ranges or error bands and I just group our holdings into baskets. So one basket is companies that I think can grow EPS at a 5-year CAGR of 7%-10%, then another group that I think can grow at a CAGR of 10%-15%, and then a third group that I think can grow 15% – 20%+. Then after one year has passed, I just ask myself if each company in the portfolio can continue to grow at the same estimated range of rates for the next five years and I continue to roll this analysis forward year after year. Occasionally I might have to move a company into a new basket of expected growth rates, and very occasionally that will cause me to take action in the portfolio (either trim or add to the position and possibly sell out).

How do you think the stock market is currently valued in late December 2024?

A range of common metrics used to value the S&P 500 are in the 97% percentile, meaning stocks have historically been less expensive than now 97% of the time (or stocks have only been more expensive 3% of the time). Some of the metrics such as the Buffett Ratio are in the 100% percentile. This suggests returns for the S&P 500 for the next few years could be below the historical average annual return of about 10% (in truth stock rarely return 10% in any given year but that’s a discussion for another day). It’s true that some of this overvaluation is driven by mega-cap tech, which as a group are trading at far above average multiples.

Although I pay attention to all these S&P 500-level metrics and I do think the market is over-valued, my preferred way to gauge stock valuation is to do so on a stock-by-stock basis in my universe of about 100 high-quality stocks that I’d be willing to own at the right price. And today, very few of those are downright bargains.

Relatedly, Goldman Sachs has an Ex-Tech Compounder (ETC) basket and the average NTM P/E of that basket is 28x. So, yes, I think quality stocks are quite rich. On December 17, 2024 Dubravko Lako (Global Head of Equity Macro Strategy at JP Morgan) said, “Where valuation is the richest, by far, is within a specific segment of the market that is called ‘quality.’ Quality stocks are trading at the highest premium, I want to say, ever. Ever.”

But I feel good about the portfolio I’m building, and I look forward to size up positions (remember we are launching with a very large cash position) as soon as the market gives me the opportunity.

What are you currently reading?

What I read is based on the work season.

Right now a lot of firms are putting out their Market Outlooks for 2025 so I’ve read several of these from, for example, Liz Ann Sonders and Kevin Gordon from Charles Schwab, Torsten Slok from Apollo, Richard Bernstein from RBA, Henry McVey from KKR, and others as well.

Also right now all the Wall Street analysts are putting out their industry/sector-specific outlooks for 2025. So, as you’d expect, I’m reading those across the appropriate industries and sectors.

Also right now Goldman Sachs recently had its great annual industrial conference so I’m reading a lot of those transcripts and the analyst overviews.

There are also maybe a handful of companies that have had investor days recently so I’m reviewing those slide decks and reading those transcripts.

In January my reading season will shift to reading earnings transcripts and investor fourth quarter 2024 letters.

How can we follow your work or contact you to learn about possible next steps?

You can sign up for my upcoming newsletter here. And you can reach me via email at [email protected]. Once you email, I’m happy to chat over email or we can set up a time to talk via phone or video. Thank you again!

 

Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.