How to avoid portfolio bombs

The allure of finding a big winner is difficult to resist for most equity investors. After all, we’re doing it to make money! However, there’s just as much (if not more) benefit from avoiding losers as there is from picking winners. Or as Warren Buffett has famously put it: "Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”

Simple maths supports this hypothesis too – a 50% loss requires a 100% gain just to get back to breakeven.

This is especially true in the world of small caps, where Katie Hudson from Yarra Capital Management operates.

“When they go wrong in small companies, they go wrong in a big way. It’s not uncommon to see a 50% reduction in the share price on the back of a company having a misstep.”

In this episode of The Rules of Investing podcast, Katie shares some strategies for avoiding portfolio bombs. She also tells us how she exploits inefficiencies in the markets to produce outsized returns and shares an Aussie small-cap that markets are underestimating.

Timestamps and discussion points

• 6:15 - The origins of Yarra Capital and the fund’s core strategy.
• 11:30 - The importance of cash flow.
• 13:13 - How to avoid big portfolio bombs, especially in small companies.
• 17:04 - What is an over-earner?
• 19:07 - How has the COVID-19 cycle shifted?
• 22:08 - Opportunities in tech small caps from a valuation conscious perspective.
• 26:51 - An investment thesis on Nanosonics.
• 28:56 - Katie answers our three favourite questions.

Content discussed:

• The Most Important Thing: Uncommon Sense for the Thoughtful Investor, by Howard Marks. Available on Amazon and Booktopia.
  
• Mastering the Market Cycle: Getting the Odds on Your Side, by Howard Marks. Available on Amazon and Booktopia.
  
• The Academy of Imperfection featuring Ben Crowe, hosted by Hugh van Cuylenburg and Ryan Shelton. Available on Apple Podcasts.