Wednesday, February 13, 2013

Asset allocation methods from a shark: Kevin O'leary

Today I will be writing about Kevin O'leary's approach to investments. Kevin O’leary is chairman of O’Leary Funds and is my favorite shark on the Shark Tank as he’s brutally honest, a supporter of free market capitalism and he’s just super awesome. Shark Tank is a TV series where entrepreneurs try to get The Sharks (successful business people) to invest in their business, I recommend watching it as its really entertaining.   

I only watched 2 or 3 videos of him talking about his approach to investing, so my knowledge on his investment strategy is necessarily limited, but here are some of the gems I learned from him:

Control your portfolio’s exposure:

Kevin suggests that investors do not allocate more than 5% of their portfolio to a single stock. He also suggests that your portfolio shouldn’t have a more than 20% exposure to any single sector. By allocating your portfolio this way, you significantly reduce your risk of being wiped out in the event that a company or sector you’re overexposed to collapses. If you have invested heavily in Citigroup before the great recession or the newspaper industry at their peak of profitability, you would have lost your shirt.

Exposure to emerging markets can be good:

All else equal (assuming valuations are the same as developed market stocks), the average emerging market stock should generate higher returns than the average stock based in a developed country as they’re in an environment of higher growth.  Over the long-term, a company can only grow earnings about as fast as the GDP growth of the countries in which they operate. Banco Santander Brasil is likely to grow profits at a higher rate over the long-term as compared to some bank that operates only in Italy.

Apart from investing in companies based in emerging markets, investors can get exposure to high growth countries by investing in companies based in developed countries that generate revenue and profits from emerging markets. Starbucks may be based in the U.S. but it has operations all round the world.

Your investments must return cash:

Kevin O’leary suggests investing only in stocks that pay a dividend (apart from gold and maybe some of his venture capital investments, I think all of Kevin O’leary’s investments provide him with a yield). After all, the purpose of owning a business (or a part of a business in the case of stocks) is to be able to regularly take out cash from the business. The investment will certainly be less risky if it regularly returns cash to shareholders. If you invest in high quality companies that consistently raise their dividends, it is not uncommon for you to receive significantly more cash dividends than the cost of your original investments over the long-term. In these types of situation, you may earn a decent return even if the company goes bust at the end (although it always sucks when one of your cash cows die). And even if you don’t come out ahead if the company you invested in goes bankrupt, at least you would get some of your capital back resulting in a smaller loss. Whatever it is, cash dividends reduce risks!

According to an article in Warren Buffett News published on August 2012, Warren Buffett (through his holding company Berkshire Hathaway) earns a 39% dividend yield on the cost of his original investment in Coca-cola shares. Here’s the link to the article:

I personally think that if management can reinvest profits at an above average rate of return, then it should reinvest as much profits as it can. Of course I have to make sure that the company is stable and very likely to remain competitive and maintain profitability over the long-term. However, Kevin O’leary’s principle of requiring an investment returns cash to shareholders is a sound one.

Hold a basket of currencies:

Currency risk is definitely NOT something that keeps Kevin O’leary awake at night. I can’t exactly remember what he says with regards to currency diversification so I can be wrong, but I think that Kevin, through his investments, have exposure to the major currencies such as the Canadian Dollar, the U.S. Dollar, the Euro and the Chinese Yuan. He has a larger exposure to the Canadian dollar as he lives in Canada.

By investing in such a way that we’re exposed to a few major currencies, we reduce the risk of significant losses from the deterioration in the value of any single currency. With all the idiot Keynesian economists running around and the ability of central banks to manipulate the money supply, it makes sense to diversify our investments in such a way that we won’t experience a large decline in our purchasing power in the event of a collapse of a major currency.

Thank you for reading and may you always sustain good returns on your portfolio! Take care.