Episode 3: Part 2: Portfolio construction, position sizing and a typical “Paradice stock”

David Paradice is the founder of Paradice Investment Management. Paradice Investment Management began in 1999 with a single client. The firm now manages approximately $18.8 billion in equities around the world, with a team of 50 people in Australia and the USA.

We chat with David about what lead him to start his own firm at a time when boutique fund managers were the exception, not the rule.

David explains his firm's approach to stock selection and portfolio construction.

We how to find stocks with investment "moats" and whether these stocks are getting harder to find or more expensive to buy.

David is an astute judge of investment talent. We ask him what he looks for when hiring investment professionals. David also explains how he keeps his team motivated.

Transcript

SUMMARY KEYWORDS

the company, stock, earnings, portfolio, multiple, determining, valuation, risk, numbers, cash flows, podcast, upside, pe multiples, growing, weather, volatile, icebergs, fundamentals, position, informational purposes

SPEAKERS

Daniel Grioli, David Paradice 

Daniel Grioli  00:05

Where do you think that is for Aussie equities? So what? What number of stocks do you think gives you that balance between being a closet index or being taking too much risk?

David Paradice  00:17

So the smaller companies fun, where you're investing in small companies and lots of small companies associated with their small companies, like, for example, they're quite volatile, it's been out for stocks. So we will have about 60 stocks in a particular portfolio. Whereas if you were doing big cap portfolio and hapless stocks in our portfolio, and then if you're doing a large portfolio of a lot fewer stocks, and that's because the larger you get in company wise, the less stock specific wish you start taking on so bhp is not going to go, whereas I'm gonna be years ago, this is habits so many times that Strathfield stamp PGP Syncrude standard. So that's why this law provides. 

Daniel Grioli  01:06

A lot more GAP risk around earnings and other events with small caps. Would you equally weigh the portfolio or market cap weight or risk weight? So how do you think about position sizing?

David Paradice  01:21

Our portfolio is a certain amount of art, science in them. Science, but it's determining art and science is determining whether stocks would value then all models are as good as relief and future. Profits are all it's all about icebergs, the numbers that go in can determine future. And that is what, what's the Company Standard Bank, but what's important is that you do diversify the portfolio, but you will wipe stocks according to the risk of and volatility of a particular stock. That's about how certain you are about what the company's earnings outlook is, and what the upside valuations, say you'll have five or 6% positions in stock in small companies, five 5%, or one or 2% might help you up to 60 stocks, and the widest order higher shoe capture size. 

Daniel Grioli  02:35

Okay so, if I understood you correctly, the larger the stock, the greater the earnings visibility, and the cheaper the valuation, the more likely it is to be a larger position. Obviously, with a bit of flex around that, because nothing is set in stone.

David Paradice  02:53

Yeah, I think that's right. But there are small mean small companies that provide big dents big upside that a small and like many years ago, I bought a company called Queensland which was the biggest company it had just operations in Queensland, it was weather affected, so discounted valuation on the particular stock they bought etc. And yet, their output most of the revenue on the front cover costs out diversifying the weather risk as well. So, the stock got rerouted vigorously. So, you know, we say that we saw that I could do that particular the things that are telling us that really good management as well. And it's all about a lot of investing in companies in smaller companies that are waiting on those companies which are going to be era mark what they call multiple expansion and have spread between the upside.

Daniel Grioli  04:09

So, in terms of that multiple expansion, are you looking for that on the revenue side or on the margin side or if possible, both your hands go back

David Paradice  04:20

Key PE multiples look better. So, the lower the PE, so, the more volatile earnings and uncertainty you have on a  company's earnings stream, the  Blauer the audible right? But if you can find a company that people believe has answered earnings and bought holdings, then they will then people pay up for people over time to get more confident then Multiple P multiple will go from, like, for example with Queens A to B, I know what numbers were so long-handed went from, like 10 to 20 times. So, doubling block and have massive EPS growth. So you get those two effects on a massive amount of work because that's what our job is to find those stocks that are underpriced but grind up on the market. 

Daniel Grioli  05:27

In terms of the fundamentals that you're looking at, to try and identify those companies, we you're getting earnings growth or rewriting or preferably both? What are some of the fundamentals that you're looking at? How would you describe a typical paradise company? I guess there's maybe another way to ask the question.

David Paradice  05:49

A company that's got very cool, very strong. In other words, protect from its competitors. A stock that is, well really well managed to benefit from a stock that has got significant growth, not so much by that my company growing but by it growing other sectors or doing new things. And so, and that's why you've actually seen it. And these companies that are that like an Amazon or whatever it is that from obscurity at such short period of time, is something sticking with it continue to grow stock, right on the economy. It's just growing because there's been the adoption by people on technology into retail, or logistics. So it's important to have good management good mode, what they call is, you know, strong cash flows can we had good weather, cheap, so cheap valuation of the cheap could be a whole lot of things. It could be the P E multiples, price, wildcards, earnings per share, even multiples, and discounted cash flows. So those kinds of things go into determining that the stock has good value. And, and also, you know, just this whole business of getting other companies that have grown innovative benchmarks by the sacred conservative people that look after the community and cop to this stuff. So there's a whole lot of different things that swirl around.

Daniel Grioli  07:42

This podcast is for informational purposes only. It does not constitute financial advice or take into account the particular investment objectives, financial situations, or needs of individual listeners. Listeners should consider whether any opinions or recommendations in this podcast are suitable for their particular circumstances. And, if appropriate, seek professional advice including tax advice.