The Aleph Blog » Blog Archive » Portfolio Rule Four

Portfolio Rule Four

I find myself in a different mindset, as I labor to start Aleph Investments, LLC.  I find myself both optimistic and fearful.  Optimistic, because this is what I’ve wanted to do for a long time, and I see the pieces coming together.  Fearful, well… I’m intellectually honest enough to know that even though I’ve done well over the last 10 years that may have no bearing over the next 10 years.  My greatest fear is that I start this business and I don’t do well for those who invest with me.

In the last week I’ve received confirmation from the state of Maryland that my LLC has been approved.  I have gotten my employer identification number from the IRS, and filed form 2553 to elect taxation as an S Corporation.  I have also begun filing with the state of Maryland and FINRA to register my investment advisory.

My next main task, while I am waiting for the state of Maryland to approve my filing, is to choose a clearing broker will be the custodian of funds for my clients.  I have five possible custodians that are willing to work with startup registered investment advisors.  This week I will send out some sort of RFQ to the five.

Beyond that, it’s time to get accounting and tax software for my firm, business cards, and help from someone who can help me in compliance matters, given that I would like to keep this blog not shut it down.  This blog is my greatest marketing asset, and yet my greatest compliance challenge.  Almost anything that an investment advisor might write on the web is regarded as advertising, even comments at someone else’s blog.  Part of the problem is that the rules regarding communications on the Internet for investment advisors are fuzzy to nonexistent.  If yhou have ideas, e-mail me.

To my readers: I want to keep this blog going.  Writing this blog allows me to do several things:

  • My first purpose was to give back to the general community.  If you have been given a gift, you should do some pro bono work.
  • Yes, to some degree, it does make me better known.  That is a help in attracting clients, but that wasn’t my first goal in starting this blog.
  • I like writing.  I like writing about economics, business and investments.  I enjoy being a bit of an iconoclast on economics.  I think business and investments are one of the greatest games in the world, and I like writing about it.  Even more, I enjoy playing the game.

So, I don’t want to lose the blog.  That said, if I can’t find a good compliance solution, I will sacrifice the blog for the good of the business.  My guess is that the odds are low that I will have to sacrifice the blog, so don’t worry.

Anyway, that’s what I’m up to.  If you want to talk to me about any of this, just e-mail me.


With that, here’s portfolio rule number four:

Purchase companies appropriately sized to serve their market niches.

A short rule, a simple rule – what could be better?  The basic idea here is to purchase companies that have room to grow, or have some sustainable competitive advantage that allows them to prosper in the market niche that they occupy.

Sustainable competitive advantage is an important concept.  If you read the works of Warren Buffett, he talks about a concept that he calls “a moat.”  The idea is, what does a company uniquely have that would be difficult for competitors to reverse engineer?  Granted, almost anything can be reverse engineered with enough money to do so, but that’s the game.  Is it worth a competitor’s time to spend that much money?  Will the business still be as profitable even if they do reverse engineer you?

Let me give you a more plebeian example.  The restaurant chain Applebee’s had a strategy of setting up restaurants in small towns.  They looked for places that did not have a dominant restaurant, and where the town was big enough to support one restaurant, but not two.  The size of the town was Applebee’s “moat.”

In investing, what you don’t want is a company so big in its niche that it cannot grow, unless the pricing of the equity is such that it resembles a junk-bond yield.  Also, you don’t want a small company that can’t compete against larger rivals.

Ideally, you want to find a management team that understands its competitive advantage and maximizes it.  I have found that many times in the last 20 years, and when that happens, it is a thing of beauty.

This rule is a little more squishy than the others.  There is a decent amount of qualitative judgment that must go into analyzing the competitive structure of the industry the company is in.  That doesn’t make the rule invalid.  Rather, I think that the average investor, unlike Peter Lynch, has the capacity to analyze industry trends and come to a correct decision on trends in pricing power.

Anyway, that’s rule number four, which can be otherwise summarized as pay attention to sustainable competitive advantage.

PS — for a set of articles I wrote three years ago on this topic that were a hit, please visit this page.

Blog News, Industry Rotation, Portfolio Management, Stocks | RSS 2.0 |

4 Responses to Portfolio Rule Four

  1. [...] David Merkel, “Purchase companies appropriately sized to serve their market niches.”  (Aleph Blog) [...]

  2. jeffpartlow says:

    Pleased to hear you’re planning to continue the blog.
    On the one extreme, you are “fearful” that you won’t do well for your investors. Won’t fear cause you to make more conservative investment decisions than you would otherwise make?
    On the other hand, you view business and investing as a “game” which implies a lack of serious purpose about your objectives. So, which is it? Could you clarify please?

  3. No, I’m going to do my best, regardless. I am conservative when opportunities are few, and risk-taking when opportunities are large.

    I just don’t want the embarrassment of failure, because a lot depends on the environment that you invest in, as well as how one responds to it.

    Yes, investing is a game, as is NFL Football, or ML Baseball. I come prepared to win every day. Lack of serious purpose? I play against the best and beat them regularly. If I show my track record to investors, most will say that I did well.

  4. marjone123 says:

    Portfolio Section Four am in a different mindset, I work to start Aleph Investments, LLC. I am optimistic and apprehension. Optimistic, because that is what I do for a long time coming and I see the pieces. Fearing the worst, well … I am intellectually honest enough to know that even if I did well in the last 10 years may have no impact over the next 10 years. My biggest fear is that I start this business and I do well for those who invest with me.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

 Subscribe in a reader

 Subscribe in a reader (comments)

Subscribe to RSS Feed

Enter your Email

Preview | Powered by FeedBlitz

Seeking Alpha Certified

Top markets blogs award

The Aleph Blog

Top markets blogs Bull, Boards & Blogs

Blog Directory - Blogged

IStockAnalyst supporter

All Economists Contributor

Business Finance Blogs
OnToplist is optimized by SEO
Add blog to our blog directory.

Page optimized by WP Minify WordPress Plugin