Sleep Well Investments Framework

Finding time-tested businesses trading at a reasonable price - helping investors sleep well.

"Ultimately, nothing should be more important to investors than the ability to sleep soundly at night,"  Seth Klarman.

Unfortunately, I haven’t!

I have fallen into the trap of buying companies growing at all costs and broken businesses at cheap valuations! While that looked great when the market was optimistic, it was a disaster in uncertain times. With the benefit of hindsight, these baskets of stocks dropped the hardest.

This numbing experience led me to change my investment process radically.

From this day on -

1. I will only look into time-tested businesses that can defend their moats and reinvest at a high return on invested capital over time. In other words, I will only focus on high-quality companies.

2. I will only buy these businesses when they perform on my Thesis Tracker and when the price is right.

They must score above 13/20 points on the Sleep Well Investment checklist (below) to earn a position in my Sleep Well Portfolio. Below is my scoring system.

Sleep Well Investments Score (25 Jan 2024)

You might not have heard of some of these names, but they are surprisingly impressive in their niche markets, with some having total market command. Importantly, they showed they can reinvest at a high return on invested capital over a long period.

The catch is they are rarely offered at a reasonable price. So, the trick is to find a relatively unknown and under-appreciated (mostly boring) or own them over decades, where the initial high multiple we pay for them matters less than the value they have created. BCG research shows that sales, profit, and free cash flow drive 95% of stock performance, while valuation drives just 5% over 10 years.

Below, you can find the links to some of sleep-well picks so far:

• CrowdStrike - Cloud security leader +27% CAGR since IPO

• The VAT Group - Vacuum valve leader +32% CAGR

• Shimano - Bike component leader +12% CAGR

• Floor and Decor - Future leader in hard-surface flooring +30% CAGR

• MIPS - Helmet safety leader +45% CAGR

• Thor Industries - RV leader +14% CAGR

• NVR - Top US East Coast Hombuilder +30% CAGR

• Circle Business Leader [Part 1, Part 2] +24% CAGR

• Veeva Systems - Leader in Life Science [Part 1, Part 2] +43% CAGR

• Leader in global logistics software [Part 1, Part 2] +31% CAGR

• Network security leader [Part 1, Part 2] +13% CAGR

• Dino Polska - Polish success food retailer +38% CAGR

• Kinsale - Leader in E&S insurance submarket +50% CAGR

• Sea Limited - Tech Titan in Southeast Asia +30% CAGR

Directory to FREE and Premium Research

🗝 The Key To Sleep Well

Sleep Well Investment Checklist explained

At the core, the checklist is adapted from

• Anti-fragility concept borrowed from Nassim Taleb,

• Irreplaceability from Anthony Deden,

• Mundane businesses from Matthew McLennan,

And various studies from other reputable investors. They provided me with abundant questions but focused on the right aspects when judging if a business can endure the test of time.

At a high level, I have grouped the criteria into three categories in order of importance:

• Survival - Business quality [13 points]

• Endurance - Competitive position and risks [4 points]

• Fair value - Valuation [3 points]

The first group investigates how a business has survived the test of time and the likelihood it will still be around for decades. The second category assesses whether the business can endure the pressure of competition and external shocks by measuring its moat development. Finally, I use multiple valuation methods to estimate the business's intrinsic value and establish a price range to acquire a piece of the business that provides a high level of margin of safety.

Notice that business quality (17/20 total points) is more important than valuation (3/20 total points). The margin of safety for me comes mostly from the resiliency of the business than the cheapness of it. This is not a knock-on to value investing. The method still allows me to penalize overvaluations, but I am more comfortable choosing business quality over a bargain price.

Sleep Well Investments aims to analyze only top-quality businesses (monopolies, oligopolies, market leaders) and avoid bad ones. Henceforth, points are deducted for unconvincing missions, commoditized/fad products, high competition, low barriers to entry, business risks, and overvaluation.

The following table breaks down what I analyze under the three categories: 

A business is rated resilient and investable if it achieves 13 points. For one reason or another, it lacks future visibility but is made up for convincing valuation even in the worst-case scenario. Next, with a score above 15, I rate a business anti-fragile. Here, I believe the business will thrive under external stress and deserve a higher portfolio allocation, but the trade-off is that valuation won’t be cheap. Finally, a business reaches the highest level- sleep well. They are anti-fragile businesses, and their valuation is also compelling. In this case, I would happily allocate 5% of my capital to acquire a piece of this business.

13 = resilient business - 1-3% of the portfolio at cost-basis

15 = antifragile business - 3%

16+ = sleep well business - 5%

Investment Thesis tracker

Sleep Well Investments stay ‘sleep well’ if they continue overcoming the competition and unknowns over time.

That’s why I also track their market share movements vs. key rivals.

Check out the thesis tracker section for follow-up updates if anything interests you.

As shown in the table above, green indicates gaining market share, red indicates losing, and yellow indicates stability. Gaining or losing market share speaks volumes about the quality of the moats and barriers to entry.

Consider this:

A business expanding its market share relative to key rivals is likely a result of widened competitive moats and stronger pricing power. In theory, that should allow the business to sell products at a higher price, buy supplies at a lower price, and enter new markets and products more effectively. Operationally, that likely leads to better cash conversion and higher free cash flow per share growth. From an investment perspective, the return on invested capital (ROIC) is likely higher than its peers.

Market share movements encapsulate all the underlying aspects above. Simple and elegantly effective (as my fellow investor -Ryan Reeves, author of Business Breakdowns summed it up succinctly). Thank you, Ryan 🙏.

Tracking market share also encourages investors to think long-term and provides an excellent opportunity to verify the business quality (sleep well scorecard).

So, join my quest to find and track sleep-well investments!