A Great Investor Connects The Dots, Let’s Discuss How

One of the hardest things for an investor to do is to consistently outperform the S&P 500. Most fail, which is why the general recommendation is to invest mostly in index funds.

However, as humans, we always have hope! And it is that hope of outperforming the broader market that keeps the active money management business alive. Like the lottery, we know the odds are against us, but some of us play the game anyway.

I’m one of those delusional people who regularly has 20% or so of his capital invested in individual securities. I got lucky finding a 50 bagger back in 2000. Unfortunately, I’ve been hunting for my Moby Dick ever since.

A recent high-performing stock example reminded me why we should always try to connect the dots when investing. A great investor tends to see things before the average investor does. As a result, a great investor tends to also be much wealthier.

Connect The Dots To Outperform

What is the one thing so many of us have gained since the pandemic began? Perhaps it’s the ability to multi-task with screaming kids in the house? Or maybe it’s realizing what we want to do with our one and only life?

Nope.

The one thing many of us have gained since the beginning of 2020 is weight. Here is the ideal weight chart if you’re curious.

According to one poll from the American Psychological Association, about 42% of people gained more weight than they intended during the pandemic.

Of those surveyed, the average weight gain was a significant 29 pounds. Meanwhile, 10% of those surveyed said they gained more than 50 pounds!

When we’re at home more often during a stressful world event, of course it’s natural to eat more and exercise less.

Given the mortality rates from COVID-19 are higher for overweight people, I tried my best to lose weight. Instead, I gained at least a couple of pounds. Irrational, but also rational.

The Now Obvious Investment

It was quite apparent that by July 2020, weight gain was becoming an accelerating trend. Therefore, a great investor would have connected the dots and concluded that buying an apparel company made sense.

Of course, you couldn’t just buy any apparel company. You had to buy an apparel company with a great brand, a growing online retail presence, a strong balance sheet, and mass-market appeal.

Let me introduce to you Levi Strauss & Co (LEVI). The company was founded in San Francisco on May 1, 1853. LEVI first went public in 1971 but had been private until its second IPO on March 19, 2019.

The Haas family helped fund my business school (UC Berkeley) and are big donors all around the SF Bay Area.

LEVI is up a whopping 129% in the past 12 months, compared to “only” 38% for the S&P 500 during the same period. The company recently reported strong 2Q2021 results with sales up 148% year-over-year.

As we know, 2Q2020 was a tough time as many of its stores closed due to the pandemic. Therefore, the comparison period was easier. However, the company essentially said that due to expanded waistlines, demand for its jeans and clothing was very strong.

Well damn! If I had connected the dots, I could have more than doubled my money. So sad.

The Risk: Who Needs Clothes Anymore?

A great investor also has to be careful not to be delusional as well. It’s easy to say we all should have bought LEVI in the summer of 2020 when our pants were getting tighter.

However, back in the summer of 2020, who needed new clothes anymore?

Millions of people suddenly were allowed to work from home indefinitely. As a result, there was no need to buy business casual clothing from Dockers (owned by Levi’s). Sweatpants and t-shirts are much more comfortable than jeans and button downs.

The upgrade cycle to larger clothing sizes wouldn’t have been enough to get overall sales growing again. Instead, a savvy investor would have had to find more catalysts before buying.

How To Become A Great Investor And Connect The Dots

To properly connect the dots, a great investor needs to go through a top-down process. He has then got to methodically go through what datapoint could mean what for which investment.

1) Back in 2020, an investor would have first had to make a prediction about the overall market’s direction. Check baby, check baby, 1, 2, 3!

2) Then an investor would have had to determine whether the government’s support was enough. Check!

3) Then an investor would have had to analyze the overall apparel market and what millions of people staying home all day meant. Fail!

4) Finally, the investor would have had to do a deep dive into LEVI before coming up with an investment decision. Fail!

In other words, a great investor would have had to connect the dots within the dots. Further, even if the great investor had successfully bought Levi stock last summer, he would have had to resist selling until now.

In just one quarter, Levi’s stock rose by 50%. The temptation to take profits would have been strong.

Connecting The Wrong Dots

Do you know what I decided to invest in instead of Levi Strauss & Co last year? Lululemon (LULU). I had held the stock for several years by mid-2020 and decided to add to my position.

My simple thesis was that comfort clothes were in and dress clothes were out. We own some overpriced Lululemon clothing in our family so were customers as well.

LULU performed well in 3Q 2020, then came crashing back down. Over the past 12 months, LULU is only up 21.52% versus 38% for the S&P 500 and 129% for LEVI. What an underperformer!

I connected the wrong dots. Investors didn’t want to pay up for LULU clothing during a pandemic nor did they want to pay a 60% higher P/E multiple than Levi’s stock.

In retrospect, I now realize I was in my own bubble because our finances weren’t rocked in 2020.

I didn’t lose a job because I didn’t have a job. Financial Samurai operated as usual because it’s on the internet. Finally, our passive retirement income streams stayed steady.

Due to these factors, I wasn’t price sensitive to $120 yoga pants. But enough clients were to slow down sales. A great investor is aware of his or her biases when investing.

Connecting The Dots With Real Estate

As you may know, I’m bullish on the housing market and I’m a buyer of rental properties. I want to experience the double benefit of rising rents and rising property values for decades. This way, my kids won’t get pissed off at me when they’re older.

It’s the year 2046. The kids and I are sitting around the breakfast table talking about the good old days. Over waffles, I start getting poked by my son who is asking me why I didn’t buy real estate back when prices were “so cheap.”

“Dad! If you had bought more property in the early 2020s, you wouldn’t have to keep grinding away on Financial Samurai today! You’d be thinner, have more hair, and not snore so much. You could also finally enjoy full retirement with mom. Heck, we wouldn’t have to still live at home with you guys either!“

With the average one-bedroom apartment costing $6,500 in San Francisco 25 years from now, we had decided it was best for our kids to live with us until they found their respective life partners. Frugal for the win!

First dot to connect: My kids don’t have the ability to invest beyond their custodial Roth IRAs and investment accounts today. When they are adults, they will likely wish they could rewind time and buy real estate 25 years ago. Therefore, to prevent them from thinking I was a dummy, I will buy more real estate in the 2020s.

The Second Dot To Connect With Real Estate

The 10-year bond yield is back down to ~1.36% from a high of 1.75% on March 31, 2021.

This tells us that inflation expectations are declining and mortgage rates are coming back down. The housing market should cool this summer, as it normally does every year. 

However, I forecast a post-Labor Day bump in real estate demand after two months of cooling off. It seems like everybody is traveling right now and YOLOing.

Lower mortgage rates act as a tailwind for real estate prices. Therefore, I’m actively looking for real estate investment opportunities from now until September 6.

After another surge in real estate demand post Labor Day, there’s going to be another two-month slowdown during the holidays and winter. At this time, I will aggressively look for more opportunities again.

I’m thinking there’s a 30% chance the 10-year bond yield continues to head lower, a 50% chance the 10-year bond yield hovers around 1.3% – 1.6%, and only a 20% chance the 10-year bond yield gets back to its high of 1.75% by the end of the year.

Therefore, with an 80% chance mortgage rates will either stay the same or go lower again, I remain bullish on real estate. 

If you haven’t refinanced your mortgage yet, you should definitely check online and call your bank. I use Credible to see what the latest rates are. The lending platform provides no-obligation quotes in minutes. I currently have a 7/1 ARM at only 2.125%.

As you can see from the chart below, mortgage rates are heading back down. A 15-year fixed rate mortgage looks especially enticing if the fees aren’t high.

The Third Dot To Connect With Real Estate

One of the best strategies I’ve used to make an investment decision is to compare what’s going on with a public security before making a private investment in a similar space. Specifically, I’m looking for strong-performing public securities that may act as leading indicators for private investments.

One example I discussed in a previous newsletter was Airbnb’s IPO on December 10, 2020. The stock IPOed at $68/share and closed up 113% to $144.71/share. At $144.71/share, Airbnb was valued at more than $100 billion.

However, Airbnb raised funds from Silver Lake and Sixth Street Partners in April 2020 at only a value of only $18 billion. In other words, Airbnb management panicked big time during the spring of 2020.

The demand for Airbnb stock in late 2020 was a clear signal to buy private hospitality commercial real estate. So I did. Real estate prices never move as quickly as stock prices. Today, we are seeing a clear resurgence in travel demand.

What’s The Next Public Equity Example?

As someone who is bullish on rental properties, I own and track the performance of American Homes 4 Rent (ticker AMH).

AMH describes itself as, “an internally managed Maryland real estate investment trust, or REIT, focused on acquiring, developing, renovating, leasing, and operating attractive, single-family homes as rental properties. As of September 30, 2020, we owned 53,229 single-family properties in selected submarkets in 22 states.”

AMH stock is up 42% year to date and 49% over the past 12 months. In other words, AMH stock has only just started taking off over the past six months. The market is starting to come around to the bull market rental property thesis.

What The Dots Tell Us To Do In Real Estate

1) Continue To Hold Our Rentals

The recent performance of AMH is telling owners of single-family homes or rental properties to, at the very least, continue to hold. Rents and property values are rising.

There is no way I’m going to sell my rental properties now that we are rocketing out of the pandemic. People are flocking back to big cities as the herd usually arrives once all is clear.

On the other hand, if the latest variant again leads us to another lockdown, the demand for single-family homes will get another boost.

2) Invest In A Private REIT That Bought Earlier

For those with motivated capital, you should identify private REITs that aggressively purchased single-family rental properties in 2020 or 1H2021.

Although I still believe AMH will do well, it’s relatively harder for me to put new capital to work after a 46% YTD ramp. I’d rather go back in time like Marty McFly.

For example, on April 4, 2021, The Wall Street Journal made a fuss that institutional investors were buying up single-family homes.

A bidding war broke out this winter at a new subdivision north of Houston. But the prize this time was the entire subdivision, not just a single suburban house, illustrating the rise of big investors as a potent new force in the U.S. housing market.

D.R. Horton Inc. built 124 houses in Conroe, Texas, rented them out and then put the whole community, Amber Pines at Fosters Ridge, on the block. A Who’s Who of investors and home-rental firms flocked to the December sale.

The winning $32 million bid came from an online property-investing platform, Fundrise LLC, which manages more than $1 billion on behalf of about 150,000 individuals.

Back in April 2021, you might have scoffed at Fundrise for buying the Amber Pines community for an average price of $258,064 per home.

However, with the median-priced home in America between $380,000 – $399,000 today (depends on who you ask), Fundrise’s $32 million purchase is looking better by the day. DR Horton, the homebuilder that sold to Fundrise, should have held on!

There’s a great saying in real estate, “the profit is made on the purchase, not on the sale.” With a lower denominator (purchase price), your percentage gains get stronger and stronger. The Amber Pines community should provide a solid recurring yield for Fundrise investors.

3) Find A Sponsor Who Purchased Earlier

Another investment strategy is to participate in a private real estate syndication deal where the sponsor purchased the property in 2020 or early 2021. The sponsor is then looking to syndicate some of its acquisition to other investors.

I was on a webinar last week where a sponsor did just this. It bought 100% of a Hilton hotel in the Dallas MSA in late 2020. It is now syndicating 10% of its position to investors on the real estate platform.

Participating in the deal is like jumping back in time and buying the property at December 2020 prices. Not bad given we’ve seen a strong recovery since then.

When someone on the webinar logically asked why a sponsor wouldn’t just keep 100% of the position, the sponsor responded, “this has always been part of our business model.” For 70+ years, the sponsor has been investing and syndicating deals in the hotel space.

To find a sponsor that takes down 100% of a property first with 100% of its own money is already rare. This means it has total skin in the game. I won’t fault such a sponsor for syndicating some of its ownership for diversification.

Can’t Always Get Every Investment Right

Even a great investor will connect the dots wrong at some point and lose money. That’s just the nature of investing. You got to take the licks and keep on going.

However, the hope is that over time, we are able to learn from our mistakes. The more experience we have, the more we tend to recognize investment opportunities.

One of the biggest problems I have as an investor today is the lack of time. Being a parent to young children is a full-time job. Therefore, I know I will never be a great investor, which is why the majority of my public capital is in index funds.

But for those of you who have time, I strongly suggest practicing connecting the investment dots on a daily or weekly basis. There are obvious investment signs everywhere. You just need to spend the time to find them.

Related posts:

Focus On Trends: Why I’m Investing In The Heartland Of America

To Get Rich, You Must Practice Predicting The Future

Stocks Or Real Estate? Which Is A Better Investment

Readers, what are some overlooked investment opportunities right now? What investment opportunities seem obvious to you, but perhaps not to others? What could I be missing in my bullish rental property thesis?