The second quarter of 2024 was a good one for Middle Coast Investing. Our short-term performance was mixed, but I think we made good decisions that will bear fruit in the years ahead. We had a very active quarter. We bought a few new stocks, added several more to our watchlist, and closed two positions. This sort of market environment – where a select few stocks are responsible for a good deal of index-level performance – is tricky for a portfolio like ours. But our aim is not to “win” every quarter, it’s to find stocks we think are likely to go up over the next couple years.

I’d like to use this quarter’s letter to discuss our process for finding and managing our stocks. This aims to be helpful both for new and prospective Middle Coast Investing clients, and the people whose money I’ve managed for years.

Our Strength: Flexible Discipline

My college wrestling coach taught me the concept of a “kata”. Borrowed from Japanese martial arts, the word describes a flow of moves. It is a sequence that one practices so they can execute it in a performance or match. He taught me it because I would get frustrated that when I did A, B wouldn’t happen as expected. It’s not enough to develop and execute a plan in a dynamic setting, whether that’s a wrestling match against someone who’s quicker and faster than you, or a volatile, ever-changing stock market. We have to be ready to adapt and maintain our principles at the same time.

Source: Paris Olympics

Flexible discipline is what we bring to Middle Coast Investing. I hesitate to call it an “edge” or advantage: advantages are hard to prove. But stepping onto a mat or into active investing means believing you can win or achieve your goals. To believe means to understand how it can happen.

We break each component into several pieces:

Discipline

1. Price matters. It’s become quite popular in the post-2008 bull market to invest in ‘quality companies’ and to worry less about the price of those companies’ stocks. While I appreciate this lesson, I still need a reason to believe investors will value shares in a company for more than they’re selling for now. I still need a good price. We like to buy quality, but prefer waiting for reasonable prices as well.
2. Don’t chase hype for the sake of hype. Nvidia (NVDA) and artificial intelligence (AI) related stocks are performing well now, just about all of our biggest Q2 winners included. We might do better this quarter or next by buying more into this wave. But while it’s important to understand what’s going on, it’s dangerous to chase trends. Usually, stocks in a wave will crash to the shore, and I am a bad surfer.
3. A stock’s price today does not predict its future.
   Arlo Technologies (ARLO) is my best example of a company in our portfolio whose performance has been steady since we bought it three years ago, but whose stock has swung wildly – $7-$8/share when we first bought; $3-4 in late 2022; highs above $14 this year.  
   It’s not always fun to live through, but as long as we remember to focus on the business, we can ride that sort of story out. Price matters, but it is not the only thing either; if it was, it would not make sense to be an active investor.
4. Turn over a lot of rocks. Peter Lynch coined this phrase in the context of investing. I’m no Lynch, but from my decade working for investing websites, I’ve reviewed thousands of investing ideas, and have seen what has and hasn’t worked¹. I now have a few go-to sources for additional ideas and also spend my days online looking for new ideas. My developed intuition enables me to recognize which stocks are a good fit for us, i.e. which ideas we’ll be able to hang onto through bad times and ride properly as they grow.

Flexible

1. Avoiding stubbornness. Accept when we’re wrong, accept that mistakes will happen, and don’t double down on bad situations.
2. Being open minded about which companies to consider. While we have an investing style, and I avoid some sectors, it’s important to not get too locked into one type of stock or another. Tunnel vision means missing better opportunities. For example, some huge companies are worth investing in, as are some ‘expensive’ stocks, as long as I can see how they are cheaper now than I think they should be in the future².
3. Avoid false precision. If I’m trying to buy a stock for $10/share, and it seems to be stuck at $10.50, it’s ok to loosen our discipline and pay a little more. Whether the idea works or not doesn’t depend on those $.50/share³.

Investing requires balancing flexibility with discipline, and navigating contradictions. It requires having katas ready for certain market moves and counters, and requires knowing when to throw those out. I’m still building out my katas, but those are the fundamental boundaries.

Defining Value Stocks

Everyone wants to buy low and sell high, but there are two essential philosophies for how to find stocks going from low to high⁴:

Momentum – an object in motion will remain in motion, whether it’s a physical object or a stock. Buy when it’s going up, sell it when it stops.

Value – A stock is connected to the fundamental value of a business. As the business does better or worse over time, the stock’s price should match it. Oftentimes the stock’s price does not match, creating opportunities to buy.

I subscribe to value. In practice, that means I try to understand how much a business might be worth in 2-3 years. I then buy stocks that do not reflect that potential value. I gravitate towards ‘cheaper’, lower earnings-multiple stocks because they are more likely to have that disconnect between price and value. But as seen in our Q2 picks, I am willing to pay higher multiples.

Similarly, it makes more sense to me to invest in smaller companies. Intuitively, the biggest companies in the world can’t grow faster than the market forever. They are also less likely to be misunderstood because everyone follows them.  This is not always true in practice: we own some big stocks, and bought a couple new ones this quarter. My starting point, though, is off the beaten track or contrarian. That is not a bet that ‘small cap stocks are due to do better’, just the lens I use for finding undervalued stocks.

I mentioned quality earlier: I like to own quality businesses. I just like to buy them when their stock reflects a good value as well.

Our portfolio construction

Middle Coast Investing manages separate accounts, meaning each client entrusts us with their money at a given point of time, and we make investments from there. We don’t feel an obligation to have them buy, say, Progressive (PGR) shares just because it’s one of our biggest holdings. We do that only if Progressive shares are worth buying⁵.

How many stocks? Too many dilutes results and attention. Too few and getting one wrong can have outsized pain. There’s a saying that your 5^th idea is better than your 50^th, but I’m not great at distinguishing between those. My style of analysis and research does not justify huge starting positions. I believe each stock I buy should be worth more, but some will rise now and some will rise later and some will never rise, or will drop.

We have most of our money in 15 or so stocks – 69.4% as of the end of Q2 if you include our portfolio with Apple and Amazon, 61.8% if you exclude it – and then build another 10-20 smaller positions. We own 32 stocks in our U.S. portfolios and seven in our European portfolio. The smaller positions might be starter positions, or special cases, or ideas I like that I just haven’t had a chance to build up yet. This means our big picks will matter more, and we also have some balance to avoid blowing up. Survival is a key part of success over the years.

Tailoring to Middle Coast Investing clients

What does that mean for clients? I think it makes more sense for larger accounts to have more stocks, with the smallest accounts having 8-12 stocks.

But working as an advisor has affected my thinking a little. First, I’ve felt that I hold too much cash in personal accounts – 25-30% – from natural conservatism, and I think it’s better to invest more of that cash. As I’m charging fees, I’m also more conscious of balancing ‘the job is to invest’ with ‘remain patient.’ And as an advisor, it’s easier for me to make trades for multiple accounts at once, and to see all accounts together. The logic of concentrating smaller accounts in fewer positions is thus weaker, since it’s all the same to clients and to me. I’m loosening the distinction between smaller and larger accounts as a result.

I also take a client’s investing needs and beliefs in mind. Some stocks are riskier or safer, and might be more appropriate for one or another client. I don’t tend to invest in oil companies or weapons companies, but some of our stocks still may not match the values of certain clients, so I take that into account. As much as we can, it’s important to feel comfortable with how we make money.

Benchmarking

Ultimately, we’re trying to grow your and our money over years. To justify you paying me, my goal is to also beat the obvious alternatives by more than what I charge in fees. Middle Coast Investing offers peace of mind and financial advice and support, but our main aim is for you to do better with us than you would otherwise.

I compare us to two indices. The S&P 500 is the most common ‘passive’ market option, and so that’s our primary target. As our holdings tend to be smaller⁶, I also track the Russell 2000, an index for smaller companies. The Russell is easy to beat – it’s full of a lot of junk – but it tends to ‘explain’ how we’re doing more than the S&P 500 does⁷.

We manage one large portfolio that came to us with outsized positions in Amazon and Apple (76.3% of its holdings as of the end of Q2). We are slowly selling those positions for diversification while managing to a target capital gains number. That portfolio’s performance (I’ll call it the AA portfolio) can diverge greatly from our other portfolios. Starting this quarter, I’ll report our results for all portfolios, and then separately for all portfolios excluding the AA portfolio (we will call this “Core U.S. portfolios”). We’ll do that until the Amazon and Apple positions are a smaller part of our overall portfolio.

A last important point: we report our results quarterly. That is the industry custom and a useful check-in point. However, we are not going to beat the market every quarter or every year.

While saying that can be used as an excuse – “don’t worry about the results for another few years!” – I think it’s important to remember that we care what happens at least 2-3 years from now. We track short-term results because it’s useful, but our discipline is geared towards what’s happening further down the line.

Our Q2 Performance

	Q2 2024	H1 2024	2023	2022	2021	2020
U.S. portfolios	4.0%	9.5%	47.0%	-13.4%	16.8%	12.0%
Core U.S. portfolios	2.4%	7.3%	47.0%	-13.4%	16.8%	12.0%
S&P 500	3.9%	14.5%	24.2%	-19.4%	26.9%	16.3%
Russell 2000	-3.6%	1.0%	15.1%	-21.6%	13.7%	18.4%
S&P 600	-3.6%	-1.6%	13.9%	-17.4%	25.3%	9.6%
Nasdaq	8.3%	18.1%	43.4%	-33.1%	21.4%	43.6%
European Portfolios	6.9%	11.5%	13.4%	-15.3%	4.5%	18.3%
Euro Stoxx 50	-3.7%	8.2%	20%	-11.7%	21.0%	3.5%
DAX	-1.5%	8.9%	19.2%	-12.3%	15.8%	-6.3%

Disclaimers and notes:

• These results are after-fees results and include reinvested dividends or the cash received⁸.
• We started managing the AA portfolio at the beginning of 2024. Prior U.S. portfolio results are identical with/without it.
• All calculations are done by me and subject to error.

Portfolio stats

• Our portfolio level price to earnings for trailing 12 months (TTM) was 20.8. Our price to free cash flow TTM ratio was 17.7. This compares to 21.35 P/E and 17.3 P/FCF at end of Q1.
• Cash and equivalents (the ETFs MINT, JPST, SGOV, and BIL, and short-term U.S. T-bills) was 13.4% of our quarter end portfolio, with an estimated average yield of 3.9%. This compares to 14.7% of our portfolio and 3.9% yield at the end of Q1.
• We bought 55% more equity positions than we sold in Q2.

Our top 12 positions as of June 30, 2024:

• Amazon (AMZN) – 14.9% of our portfolio
• Apple (AAPL) – 13.9%
• Axcelis (ACLS) – 5.9%
• Progressive (PGR) – 4.6%
• Atkore (ATKR) – 4.5%
• Discover Financial (DFS) – 3.5%
• F&G Annuities & Life (FG) – 2.9%
• Broadcom (AVGO) – 2.8%
• Grupo Aeroportuario del Centro Norte (OMAB) – 2.7%
• First Citizens National Bank (FCNCA) – 2.7%
• Aercap (AER) – 2.6%
• Booking Holdings (BKNG) – 2.5%⁹

Q2 Winners/Losers

Winners	% Gain	Losers	% Loss
Apple	2.8%	Atkore	-1.9%
Axcelis	1.4%	Grupo Aeroportuario del Centro Norte	-0.4%
Amazon	1.1%	Lululemon (LULU)	-0.2%
Broadcom	0.6%	F&G	-0.2%
Taiwan Semiconductor	0.4%	Eventbrite	-0.2%
Booking Holdings	0.2%	Machten (MACT)	-0.1%

New Stocks

Lululemon

I mentioned last quarter and higher above that I like buying quality stocks on sale. Lululemon, the 2^nd worst performer in the S&P 500 this year¹⁰, qualifies. I published a full thesis on the stock before its most recent earnings, but the basics: the yoga pants and clothing company has had an amazing post pandemic run that is approaching its end. Its growth in the U.S. is slow/non-existent at the moment, but it is growing very fast in China and Europe. I think that international growth is likely to endure, and that its U.S. slowness is likely to be temporary. Lululemon shares are not ‘cheap’, but they are on sale for an average price, and I think the company will grow faster than average over the next five years. I would be wrong if Lululemon is a fad gone bust, or faces a huge post-pandemic hangover as people get used to leaving the house more. We’ll see.

Astronics (ATRO)

One thing I try to do is apply what I know from one stock to another. Aercap has been a long-time holding, and one of the reasons it is attractive to hold onto at a fair price is the huge backlog in planes that need to be built and sold to airlines. Boeing’s problems, the pandemic, supply chain issues, and so on have slowed delivery of planes and jets (Airbus is also struggling to get up to its production goals). That delay is good for Aercap’s business as the world’s biggest owner of planes, an in-demand commodity, but at some point, the manufacturers will have to figure it out.

Steady demand for planes, stretching out for years, will be good for Astronics. Astronics supplies the seat-back video and power systems you will see on planes while traveling, and leads the market. It also has a small part of its business with the military, both in aerospace supplies and test systems. The company’s balance sheet is shakier than I like, but it should have something like 10% revenue growth per year for quite a while, and is at the point where it should start to make real profit from that. It is not cheap at the moment, but I think it is cheap based on how much money it will make over the next 4 years, and where that will leave it going forward.

I should say I got this idea from an old colleague and friend, Vince Martin at Overlooked Alpha. That newsletter is an example of a go-to source I subscribe to for ideas.

J.M. Smucker (SJM)

J.M. Smucker, like Lululemon, is an S&P 500 component and one of the worst 70 or so stocks in the S&P 500 this year. The maker of Jif, Smuckers jams, Uncrustables, Folgers Coffee, and Dunkin Coffee pods has had a bad 10 months since announcing its purchase of Hostess Brands (Twinkies, Hostess Cupcakes, etc.). Hostess was expensive and exposes J.M. Smucker to the risk that the new weight-loss drugs suppress diehard consumers’ appetite for sweets.

I think J.M. Smucker shares have suffered enough, and are at a point where a buy should work. The company is producing ample free cash flow to cover its likely to grow ~4% dividend while also paying down debt, which will improve both its profitability and its stock value. J.M. Smucker’s products and brands are leaders, including Hostess. I don’t think this will be a huge winner, but I do think there’s relatively safe upside here. I should note that another of my idea sources, Thomas Lott, mentioned SJM on Cash Flow Compounders; I had already been looking at the company for a while, but it’s always good to see a smart investor following it.

GoGo Inc (GOGO)

Gogo sells in-flight wi-fi services, which makes it sound like a similar story to Astronics, but that is just coincidental. Instead, Gogo focuses on the business aviation market, so it’s less tied to the aerospace backlog. Its current business and balance sheet are much healthier than Astronics.

And yet, the story feels riskier to me, because it hinges on Gogo successfully launching its 5G and low earth satellite (named Galileo) products. Gogo has especially had trouble launching 5G, with habitual delays on the roll out. If it manages to successfully roll these out this year and early next, its free cash flow should go up a lot. If it doesn’t, it is vulnerable to competition from Spacelink. It feels a little too close to a binary situation for me to make it a big position, but we may add more to the position over time.

Volkswagen Inc (VOW3) and West Wing (WEW) – We invested our remaining cash in our European portfolio in these two stocks. Volkswagen is a popular value stock given how much of its value is covered by its holding of Porsche. Westwing is an online furniture maker/seller in Europe that did very well in the pandemic and then struggled to digest its growth. I write this on a West Wing desk in an apartment with ten or so Westwing furniture pieces. Any revenue growth and it should be back to solid profitability. That said, these two positions are tiny.

Special situations

I day-traded Ashford Inc. (AINC) when it announced it would pay small shareholders $5/share, making us a little bit of extra cash across a few accounts.

I did the same with Matterport (MTTR) on the day it announced CoStar Group (CSGP) would buy it.

I then went back to buying Matterport as a merger arbitrage play. It seems to me unlikely that the federal government would intervene in such a small, niche merger, and the upside is approaching 30%. The risk is about 50% loss, which is why I only have this trade in one client’s account plus a personal account. The Federal Trade Commission made a 2nd request for information from Matterport and CoStar Group, precluding a quick win, but the companies expect to close the deal in Q4 2024.

Stocks we added this quarter

We added shares in Axcelis, Eventbrite, Vimeo, and Worthington Steel. We started new positions for certain Middle Coast Investing clients in Atkore and Grupo Aeroportuario del Central Norte.

Stocks we sold this quarter

We closed our Dropbox and Pepsi positions, and sold shares in Arlo, Grupo Aeroportuario del Pacifico, Apple, and Broadcom.

Interested in more from Middle Coast Investing? Or in talking to us? Get in touch.

Disclosure: I am long or short all positions as mentioned in this letter. I may change positions at any time. I have no immediate plans to make major changes. This is not investment advice. Investing is risky. Any investing decisions are your own responsibility and should be taken after speaking with an advisor or at your own risk. This is not a solicitation to buy or sell anything. Past performance is of course no promise of future results.

Disclaimer: I calculate performance and all portfolio figures manually, so it may be prone to error. The accounts I manage may deposit or withdraw money over the course of a quarter. I account for that in my calculations by adding/subtracting that money to/from the starting amount at the beginning of the period. This means withdrawals intensify performance and deposits dampen it. For half-year, 9-month, and full-year performance, I multiply quarterly performance by one another to control for deposits/withdrawals.

Please read our full performance disclosures.

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1. One of the best things about the stock market is that, usually, the ‘truth’ will prevail if you wait long enough. ↩︎
2. I explained my style to my brother and he said, “sounds like the music you like – the stuff no one knows.”
   Or as I chide myself every time I say I don’t invest in a certain type of stock: “you mean, stocks that go up?” ↩︎
3. Of course, when I do pay extra, the stock seems to always drop to $9.50 or whatever. I consider that sort of mistiming an offering to the market gods. ↩︎
4. I believe I first saw Bloomberg’s Matt Levine put it this way. ↩︎
5. There’s a whole discussion about the distinction between ‘not worth buying’ and ‘worth selling’. We talked about selling last quarter.    ↩︎
6. 52% of our positions are in S&P 500 stocks; exclude our AAPL/AMZN portfolio, this drops to 35.9%. I include Taiwan Semiconductor in this number, as it’s very similar to S&P 500 stocks in size and characteristics.  ↩︎
7. We include the Nasdaq in our numbers as well, as the Nasdaq is the sexiest, most volatile index. I don’t find it super relevant as a benchmark. I include the S&P 600 as a second small-cap index. For our European portfolio, we use the DAX and the Euro Stoxx 50 as benchmarks. ↩︎
8. Schwab does not allow dividend reinvesting for foreign stocks. ↩︎
9. Excluding the “AA portfolio”, the list is ACLS (7.9%), PGR (7.1%), DFS (5.5%), FG (4.5%), AVGO (4.3%), OMAB (4.2%), AER (4%), BKNG (3.8%), ATKR (3.4%), Steelcase (SCS) (3.4%), AAPL (3.1%), Taiwan Semiconductor (TSM) (3%) ↩︎
10. Behind Walgreens. ↩︎