Mental Models discussed in this podcast:
- Opportunity Cost
- Margin of Safety
- Conviction
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Show Outline
Conviction Formula
Conviction is a function of Opportunity Cost, Margin of Safety, Position Sizing, and Upside
How much conviction do you need?
- Opportunity Cost – If you have a lot of good current positions, you need greater conviction to overcome that opportunity cost
- Position Sizing – Smaller positions need less conviction
How to build conviction in stocks
- Margin of Safety – You want it all! (Build a checklist)
- Above Average Industry
- Above Average Company within the industry
- High Returns on Capital
- Durable Business
- Skilled Management
- Management with skin-in-the-game
- No dilution with buybacks preferred
- Lower than average prices
- “Conviction is like a checklist. The more boxes you can check, the greater your conviction.”
- Upside – How high can this stock go? Is it possible to be a 10-bagger or 100-bagger?
Summary:
Conviction is a function of opportunity cost, the margin of safety, position-sizing, and upside. Your required conviction is determined by opportunity cost and position sizing. You increase conviction by improving the margin of safety and upside potential.
