We’re in the middle of a series exploring the meta skills used by world-class capital allocators. Last week, we explored the first column of the allocation pantheon: idea flow. Without regularly investigating new ideas and opportunities, capital allocators don’t know where to put their money. They have no idea whether to invest in a company or start their own endeavor. We learned how to easily start a flywheel of novel information and learning. Now we turn to the next skill. How do the best investors and entrepreneurs decide when an idea is worth pursuing?

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When I started investing, I was hooked. I read every book from the library. I learned to read financial statements and compute a seemingly endless variety of ratios. But nothing told me what I truly sought. I wanted someone to tell me how to invest. Look for X, Y, and Z, and, if all exist, then you have found a good investment. In retrospect, my teenage brain didn’t grasp the idea of edge and how someone publishing a working system naturally means that system stops working.

As I matured into a more informed investor, I noticed that while no investor analyzes stocks the same way, the best use a uniform checklist or framework. Experience has taught them what to look for and what to avoid. Warren Buffett touts the importance of existing management as well as competitive moat. Charlie Munger stressed the quality of the underlying business. Ray Dalio is obsessed with both risk neutrality through portfolio diversification and the cycles of history. The reliance on a reusable framework is not surprising.

In 1935, the U.S. military tested a new Boeing model. Sadly, one of the first flights ended tragically when the plane stalled before smashing into the ground. The pilot and a crew member died. Opponents argued the plane was too complicated to fly. Boeing disagreed.

Boeing engineers realized that while the plane might be too complicated for a human alone to fly, there was a simple solution: a checklist. So Boeing created a checklist, presented it to the Army Air Corps, and the rest is history. The Army ordered almost 13,000 planes while the checklist meant millions of miles were flown without incident. The plane? The B-17 Flying Fortress bomber. The same model that would fly in every zone of World War II and would be pivotal to crippling Nazi power.

Checklists have long been crucial to the success of top investors. One perfect example is the Turtle Traders. By 1983, Richard Dennis had become a trading legend. He turned less than $5,000 into tens of millions of dollars. Some believed Dennis had a gift; Dennis himself believed anyone could learn his secret. He put this to the test.

After selecting 14 applicants, Dennis taught them his exact methodology. Over the next five years, his “turtles” (Dennis felt he could “grow” traders like farmers raised turtles) would make over $100 million. While Dennis’ methodology remains unknown, we do know it was a checklist.

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Why is it so essential for capital allocators to develop an investment analysis checklist? Most people treat analysis as confirmation of what they already believe. They start with a thesis then try to find supporting evidence. A checklist eliminates this threat. No matter how strong your initial belief is, if the idea doesn’t pass, then it doesn’t pass.

For years, I used a checklist. I wanted to see growing revenue and net income, but, more importantly, I needed to see “positive cashflow coverage.” I would compare net income to (interest expense + current liabilities + capital expenditures + dividends paid). If the resulting fraction (with net income as the denominator) was under 1, it meant the company generated more income than its essential cash needs. The company would move on to the next stage of analysis. If the ratio was above 1 (or even close to 1), I immediately disqualified the company.

Unfortunately, this checklist eliminated 99% of the stocks I examined. Even financially strong companies would rarely qualify. One day, I bid this checklist adieu. I figured this freedom would give me greater results. Yet the result has left me aimless.

Don’t get me wrong, I’ve made some fabulous investment decisions, most notably gold and silver before the meteoric runup of 2024 and 2025. But I’ve also introduced drift. Instead of a portfolio focused on a specific edge or strategy, I’ve accumulated a myriad of positions because each seemed to have potential. While better than nothing, it’s nothing like the conviction of world-class capital allocators.

Abandoning any sort of analysis checklist was a mistake. I have loose criteria like growing sales and net income, nothing weird on the balance sheet, and more assets than liabilities. But this is like the pilots attempting to fly Boeing’s plane. Without a checklist, world-class allocation is just too complicated.

A checklist keeps you on track no matter what your emotions say. It reminds you of a variety of little details to check that your mind might otherwise forget. In investing, this is essential. We are constantly battling our emotions both before and after an allocation decision.

As we evaluate an opportunity, we must contend with the excitement of potential while also confirming this optimism doesn’t blind us to issues. Once we’ve invested, our pride wants us to stay in, while our fear of loss tempts us to sell any time the price falls.

A checklist resolves these pitfalls. While upside potential can impact the human mind, it has no ability to check off items. This forces us to stay grounded.

During the initial phase of analysis, a checklist streamlines the process. Last week we started a flywheel of ideas. If we don’t systematically evaluate opportunities, ideation turns from a bountiful well to an overwhelming flood. A checklist helps us quickly know which ideas to pursue and which to discard.

Even after you pursue an opportunity, the power of a checklist remains. Almost every opportunity has a point where you should exit (either for a gain or a loss). A checklist provides the exact criteria to look for when deciding if it’s time to sell.

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This meta skill is not a specific analytical method. It’s a mindset. It’s the constant refinement of what to look for in an investment. It’s a record of what matters and what doesn’t. This is how the best capital allocators learn which ideas are worth pursuing.

Furthermore, the best capital allocators don’t have a single master checklist. There isn’t a “theory of everything.” Instead, world-class investors use at least three checklists. The first is to quickly decide if an idea is worth spending more time on. While overly restrictive, my cash coverage requirement would fit nicely here. This is a quick go-no-go test. Next is the detailed analysis checklist. This lists everything to confirm before you invest. Finally, you proactively note how you will know your thesis failed while also creating a plan for how you will exit a successful future. Then you start tracking your investment to see when these benchmarks are reached.

How do we create a checklist? Honestly, over time. You start by researching companies and learning about investing. You start to figure out what matters and what doesn’t. You can also copy someone else’s list. This might be the easiest place to start. If you read enough investor letters or books on investing, you’ll undoubtedly discover a checklist you like. Here is an example based on Warren Buffett’s tenets:

• Is the business simple and understandable?

• Does the business have a consistent operating history?

• Does the business have favorable long-term prospects?

• Is management rational?

• Is management candid with its shareholders?

• Does management resist the institutional imperative?

• Calculate “owner earnings”

• What is the value of the business?

• Can the business be purchased at a significant discount from its value?

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Whether you start with someone else’s checklist or devise your own, the next step is to refine it. What works for one investor might not work for you. You might like elements of two separate lists and choose to combine them. You might decide that a very specific metric few others track is something you value immensely. This is how you develop checklists to match your own investment philosophy.

While a written framework for analysis is essential to strong investment decisions, the best capital allocators take this to another level. We’ve seen the first two skills used every day by world-class investors. Next week, we’ll learn the mindset that truly sets them apart. This mindset could even be viewed as its own checklist. You don’t want to miss it!

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Thank you for reading! This Substack explores whether an ordinary investor can become a world-class capital allocator. If you’d like to support this work, consider buying me a coffee.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

Why choose capital allocator instead of investor? I’ve always loved the financial markets. Since the age of 15, the idea of investing money has influenced my daily life. As the years have passed, my goals have expanded. I no longer want to just research public markets. I want to invest in private companies. I want to build my own company. Capital allocation is the pursuit of the best opportunity, whether it’s a stock or your own startup. This is exactly what I want to pursue.

But definitions only provide a starting point. To truly become world-class, we have to understand the key principles that underlie capital allocation. Only then can we chart a course to mastery. Over the last few months, I’ve pondered what these “metaskills” might be. I think I’ve finally figured out the four pillars that support world-class capital allocation.

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The first pillar, and the topic of today’s article, is deal/idea flow. Without deal flow, a capital allocator has no idea where to allocate capital. He/she can’t practice analysis, examine opportunities, or see how the world is evolving. Building a system that not only brings deals to you but also facilitates the discovery of new ideas is absolutely crucial.

Charlie Munger once described how to achieve this: “cultivate curiosity and strive to become a little wiser every day.” Constant learning is the easiest path to new investment opportunities. There are two components to this, and the best capital allocators do both.

First is to find a topic of interest and go deep. Seek to become an expert. Try to find the bottom of the rabbit hole. Once you understand the ins and outs, the optimal investments will be obvious.

A recent example of this is Leopold Aschenbrenner. In 2023, Aschenbrenner joined OpenAI, a stint that would last about a year. AI was Aschenbrenner’s life. Not only was he surrounded by cutting-edge technology in his professional life, but his social circle was also ingrained in the pursuit of a better model. After being let go, Aschenbrenner authored his pinnacle work: Situational Awareness, a 165-page treatise on AGI. From the resulting publicity, he opened a hedge fund to invest in AI companies, raising $225 million dollars.

Two years later, Aschenbrenner’s firm now manages over $15 billion, boasting triple digit returns for early investors. Aschenbrenner went deep on a single topic and used that knowledge to deploy capital incredibly effectively (though lately his excessive use of leverage threatened to destroy it all).

But capital allocators also don’t want to pigeonhole themselves. The best innovators succeed because they see something the world missed. More often than not, this insight stems from something called domain transfer.

Domain transfer is when someone takes a concept from one topic and merges it with a different subject to create something completely new. AirBnB’s success hinged on its founders’ vision to combine a peer-to-peer marketplace with short-term rentals. Uber took a decades-old industry (cabs) and combined it with modern technology. Domain transfer is how the world changes. It is paramount to successful capital allocation.

Jeff Bezos and the founding of Amazon is a fabulous example. As the 1990s unfolded, Bezos noticed that web usage was climbing over 2,000% a year. He also recognized that while millions of books existed, most bookstores could barely offer a hundred thousand. Bezos realized he could create something new. The result made him a billionaire.

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Fostering curiosity and exploring new ideas is the first step to building deal flow. Yet this can be taken to another level. Instead of relying only on your own exposure and curiosity, some of the best capital allocators further expand their idea flow with peers.

Charlie Munger and Warren Buffett were perhaps the quintessential example of this. After their first meeting in 1959, the two made a powerful investing duo. Munger once said, “We both insist on a lot of time being available almost every day to just sit and think.” This was their secret to success: spending hours a day reading and thinking. As a pair, they could bounce ideas off each other. With their own unique investing mentalities, each could see weaknesses the other missed.

A network of capital allocators also covers more ground. One person can only learn so much, no matter how much curiosity or free time they have. Moreover, an individual will typically have specific paths to which their curiosity drives them. More people means more possible ideas, more knowledge shared, and more potential opportunities.

So how do we build a system that regularly presents novel information and/or cultivates relationships that can transform our financial futures?

The first step is simple: read more. Find a few topics that fascinate you and explore them as much as possible. This creates a notable edge in a few select industries.

Then we need to find ways to expand our horizons. Perhaps the hardest part of exploring new subjects is learning they exist. It is easy to find yourself in a nook of the vast library of knowledge simply because that is what you typically go. Algorithms that present more of what you’ve already seen only compound this.

The trick is to automate a new source of unique information that you otherwise wouldn’t have encountered. Personally, I’ve found AI to be incredibly helpful for this.

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A few months ago, I noticed ChatGPT had a new feature: scheduled tasks. I quickly realized this could be a daily curator of interesting information. So I crafted a prompt and off we went. I designed it to be a five-part briefing. Four parts focused on specifically chosen subjects, but the first section was the one I was most excited by. My prompt described it as such: “The Rabbit Hole: This is the most important and longest section. Teach me something that I almost certainly would never have searched for myself.” With ChatGPT’s knowledge of my previous queries, I was curious to see how this section would evolve.

So far, I’ve yet to be disappointed. One day, it presented the history of double entry bookkeeping (dating back to the 1500s!). Another day, it discussed how Southern Italian society embraced olive oil while their Northern compatriots, thanks to the Po Valley, relied more on butter. Have I discovered new opportunities yet? No. But that’s not the goal. The point is to build a system that regularly exposes me to new ideas. This provides the breadth of knowledge to find inspiration where others simply see the status quo.

Another way to build deal flow is to ingest the thoughts of other capital allocators. This might mean pouring over the shareholder letters of giants like Warren Buffett. It might mean finding a few authors, analysts, or Substack authors and tracking their writings. Perhaps you find a few podcasts or YouTube shows to follow. Studying others creates an immediate entrance into a new analytical world that you otherwise might never encounter. Another benefit is this can possibly provide relationships (even if only online) that further your allocation goals. It requires you to comment on a post or email the author, but it starts building a network that can transform your investing journey.

Curating idea flow is foundational to capital allocation. But it is only the first of four key skills top capital allocators use daily. Next week we’ll explore how capital allocators move from ideation to capital deployment. Subscribe so you don’t miss it!

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Thank you for reading! This Substack explores whether an ordinary investor can become a world-class capital allocator. If you’d like to support this work, consider buying me a coffee.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

At face value, buying an existing business seems vastly different from picking a stock. First, the acquisition process is so much more complicated. Diving through usually disorganized documents, figuring out what price you actually want to pay, seeing if the seller even accepts your offer. Far different from equities, where you can fulfill a purchase in seconds.

I knew I wanted to focus on trade services. These companies won’t be disrupted by AI and may even benefit from continued advancements in robotics. A few quickly caught my eye: an HVAC company, a plumbing company, and a water filtration company. I signed the NDAs, received the confidential business information, and began my analysis.

I quickly eliminated the plumbing business. No employees, no systems, just the owner doing all the work. Pass. The HVAC company was more intriguing. But financing became a major concern. Could it cover the amount of debt I would need? What term could I get on an SBA (small business administration) loan? Yet before these were answered, the business was pulled from the market. Some kind of discrepancy with its accounting.

That left the water filtration company. I spent hours digging into its details, modeling past performance and future expectations. I dreamt up growth opportunities, then modeled what the financial impact might be. I even considered cold calling potential customers to gauge commercial demand. Yet in the end, I passed. As I reflected on the week of work, I realized I’d spent more time researching markets, questioning financials, and estimating a true value then I usually spend on stocks. I research any new stock, but this felt like a whole new level. Three revelations stood out.

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First, I became incredibly conscience of the destructive power of debt. Every business I looked at had free cashflow. However, once I modeled the impact of an acquisition loan, cashflow was usually decimated. In fact, one business could only handle debt if I fired half of the employees.

Second was sensitivity analysis. This modeling technique forecasts performance under at least three scenarios, typically a base case, a good case, and a very bad case. Here, my base case was essentially zero growth for a few years (not an uncommon situation when businesses change ownership). My good case was 5% growth, and my bad case illustrated loss of customers. In each case, I focused not only cash flow, but also on my investment return.

My final insight was pricing. The listed price for a business is often meant as the starting point. As I read the financials, researched the industry, and created my models, I kept asking a single question: what would I really pay to buy this company?

Each of these steps is absolutely crucial. A business might generate tens of thousands in monthly profits, but excessive debt can quickly reduce profitability to negligible levels.

Understanding how the company could perform both in good and bad times is also vital. Buying a business is not a small undertaking. You’re committed; the business is your responsibility to maintain. A large portion of your own capital is at risk, and any debt often requires a personal guarantee. If the business goes under, you still owe the money. These stakes make forecasting multiple futures paramount.

Finally, deciding what price you will pay has a number of trickle-down effects. It changes how much capital and debt you need. It dictates your (and/or any investors’) returns on investment and time. Constructing a strong thesis not only for what the company is worth but also backing the thesis up with projected performance is pivotal.

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While these steps make perfect sense for something like buying an entire company, each of these steps can (and should) be applied to stocks. While studying these private opportunities, the stark difference between this level of analysis and the less than 10 minutes the average investor spends was unavoidable.

I also suddenly realized that while most investors might not spend much time on research, the best investors always do. We’ve recently discussed how the best investors think in distributions. This is just another word for sensitivity analysis. The best investors look at the current situation then seek to understand various futures. This means knowing not only why a company will thrive, but also what could compromise its performance.

But the comparison goes deeper. Consider how Warren Buffett, Peter Lynch, and Bill Ackman evaluate opportunities. They aren’t looking at stocks as lottery tickets that could go up or down. They see them as the real businesses that they are. In the case of Buffett, and particularly Ackman, an investment usually comes with an active role in shaping how the business operates moving forward.

It’s not surprising that most investors don’t think of their investments as buying a business nor give it the time it deserves. A stock investment is usually a small amount of money. It is incredibly liquid, so a mistake can quickly be corrected. The implications of being wrong (while existent) just aren’t that high. Plus, unless you buy a lot of shares, you have no impact on the company. Why do all this analytical work? Yet the likes of Buffet and Ackman don’t do this just for grins and giggles.

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The rationale is clear: in the quest for optimal capital allocation, every decision matters. This isn’t an invitation to spend hours researching a company that you’ll put a wee amount of money into. This means choosing investments that have real opportunity and investing substantially.

As said earlier, the main reason most investors don’t research much is because their position is likely not very large. It might even be more of a YOLO investment than a true capital allocation decision. If wrong, the decision has less negative impact. But if right, the decision also has less beneficial impact. Compare this to evaluating a business. Because the capital at risk is so significant, you will naturally make sure you are choosing correctly. And because your stake is higher, your potential gains are also larger.

This is the first lesson that is changing how I invest. I have historically used small position sizes. My constant pursuit of new ideas led to a portfolio full of many small positions. Now, this is evolving. I’m starting to think about focusing on fewer positions, but increasing my size, likely to something that feels slightly uncomfortable.

The benefits of such an approach are two-fold. First, during the analysis process, it activates the same risk-adverse mindset as buying a business. Because the capital I will risk is more than I feel completely comfortable risking, I need to be much more sure in my decision. This means not only diving into the company, creating a list of questions to answer, but also figuring out the catalyst that makes this a smart choice now.

Perhaps more importantly, I also need to decide what I truly think a company is worth. Except for gold, I’ve never actually tried to price a tradable asset. I’ve fallen into the age-old fallacy of “if it’s worth X today and I think it will grow, it’ll be worth more in the future.” This is just a masked version of the greater fool philosophy. The best capital allocators don’t do this. If we want to join their ranks, we also must shed this mindset.

What does this mean in practice? I’ll save a discussion of valuation methods for another article, but I will share my own mental shift. With my current investment sizes, I’m buying an insignificant fraction of a fraction of a company. But what if I weren’t? If I woke up today with the money to buy it all, would I actually? What price would I be willing to pay?

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While the top investors ask this question because they often are actually buying a substantial share of the company, it is an intellectual simulation any investor can run. I think everyone who does will make better choices.

The final lesson learned is simply to actually forecast your expected returns under a distribution of scenarios and truly ask if it’s worth the risk. While modeling the water filtration company, I explored raising 100% of the capital from investors. But as I ran the numbers, I realized these hypothetical investors would only earn maybe 12% annually if everything ran smoothly. With the stock market’s historic 10%, no rational investor would take on the added risk for a mere 2%.

You might have a perfectly valid thesis, all the stars might align, but how capital is actually deployed could still cripple your return, especially when adjusted for risk. Or the time needed for your thesis could play out could depress your return. Afterall, doubling your money in a year is a 100% annualized return. Doubling your money over 20 years is only 3.5%. Taking the time to ask, “what do I actually expect my return to be?” and “how long will this take?” is a valuable exercise.

If this seems like a lot of work, it is. The quest to optimally deploy our capital is not easy. This is why most never become world-class capital allocators. For these people, index funds are the optimal choice. But for those willing to put in the effort, I think capital allocation can be honed. I’ve spent the last six months trying to determine a capital allocator’s meta skills, and I think I’ve finally figured it out. Next week, we’ll explore what truly makes a top capital allocator, and we’ll chart our course to becoming one ourselves. Subscribe so you don’t miss it!

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Thank you for reading! This Substack explores whether an ordinary investor can become a world-class capital allocator. If you’d like to support this work, consider buying me a coffee.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

In the last few years, this craze has vanished. The value of all NFTs has fallen 99%. An evolution toward infinite pump-and-dump schemes plus the collapse of FTX slammed the door on the exuberance. But investors learned what it felt like to see their money double overnight, and that craving began slipping into the stock market.

The first half of 2026 was insane. Micron soared 265%; SanDisk grew 726%. With chip companies (particularly those related to memory) flying high, infinite regret reemerged. Unless your picks and timing were perfect, a few different positions could have radically improved your portfolio.

Unfortunately, this is just the nature of investing. By choosing one company, you are implicitly rejecting all others. Personally, 2026 has not been a banner year. Blame my large metal mining positions, blame underperforming nuclear stocks, blame a notable lack of memory and chip companies. In the first six months, I’m basically flat. Surrounded by news of chip stocks that only seem to go up, I began wondering if I should reallocate capital. This prompted another question: how would the best investors in the world respond?

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At its core, this is a question of hindsight. How do we deal with the regret of not seeing an opportunity? How do we adjust when a decision ends poorly? This all stems from two features of the human mind.

The unfortunate reality is that we are compulsively short-term-minded beings. In a world where anything is a mouse click away, the patience and foresight to look beyond the present to the future are becoming harder to find. During the crypto hype, one study found that Gen Z and Millennial investors had 56% of their capital in cryptocurrencies plus another 26.5% in NFTs. The smallest category? Index funds (only 24.5%). While index funds have the best track record, it’s hard to compete against an asset that can double your money overnight. But long-term, this was disastrous.

Even for people invested in index funds, excessive focus on the short term damages long-term gains. Morningstar released a report showing that the average dollar invested in a mutual fund or ETF earned 7% annually between 2014 and 2024. But the funds themselves gained 8.2% annually. By trying to time the ups and downs of the market (based on short-term events), investors worsened their performance.

Then there is the way we judge decision making. Typically, we evaluate a decision on its outcome. Bet on the Broncos, and you made a smart choice only if the bet wins. Invest in a stock, and you’re only a success if the price climbs higher.

But this isn’t the right approach. While we think in terms of outcomes, decisions must be judged on the thoughts that went into them. This is the only thing we can control, so we must learn how to analyze our choices regardless of the outcome. Maybe our portfolio is up 100% this year, but did we underestimate the inherent risk? Maybe we’re down, but were our decisions based on reasonable ideas?

This is exactly how the best capital allocators evaluate their decisions. Instead of focusing on the outcome, they return to why they made the choice in the first place. Then they figure out if they need to adjust their process going forward.

In 2007, while reflecting on previous “unforced errors,” Buffett mentions he was previously offered an NBC station for about $35 million. He passed. In the decades that followed, Buffett estimates the total earnings would have exceeded $1 billion. Quite a spectacular return. If only he’d bought it…

Why didn’t he? Honestly, Buffett doesn’t know. The manager was a close friend whom Buffett trusted, and Buffett knew and liked the industry. Buffett says his “only explanation is that my brain had gone on vacation.” While this is perhaps not very instructive, it does show that even the best investors miss opportunities right in front of them.

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The next example is much more educational. In 1993, Buffett bought Dexter Shoe Company. Within a decade, the company was almost worthless, struggling to defend against an onslaught of foreign products. Buffett recognized two errors in his judgement. First, he thought Dexter’s competitive advantage would last. It didn’t. Second, Buffett financed the purchase with Berkshire Hathaway shares. While this might seem a minor point, those same shares would be worth over $15 billion thirty years later. Buffett called the acquisition of Dexter the “worst deal” of his career.

But instead of focusing on the negative outcome, notice what Buffett did. He returned to his original line of thinking. He tried to decipher why he made a decision that went poorly and see what he could learn for the future.

We can all do this. When you invest, record a few lines on why you think it is a good choice. Similarly, if you pass on an investment, a few notes about why you are passing can be invaluable. If and when regret strikes, you can quickly review why you acted how you did. By comparing your “pre-choice” analysis to the “post-choice” outcome, you can see if your “error” was simply bad luck or if your analysis lacked a key insight.

Tracking our theses also can help prevent regret from ever forming. By reviewing your thoughts regularly, you can quickly see how your thesis is manifesting and make adjustments. In a 2022 shareholders letter, Bill Ackman wrote, “One of our learnings from past mistakes is to act promptly when we discover new information…that is inconsistent with our original thesis.” If you don’t review your investments, or worse, don’t remember why you chose a stock, this critical step becomes impossible.

There’s one step further. The median investor spends six minutes researching an investment before making a decision. My breakfasts take longer. Even if investors record their brief thoughts, this indicates that many investors lack a specific philosophy toward investing.

Why does strategy matter? Regret is a feeling of disappointment or sadness over how something went. It has to be measured against a goal. If your investment philosophy is “to make as much money as possible,” then, of course, you will face regret. In fact, you’ll likely experience infinite regret. By chasing the highest possible returns, not only will you assume high levels of risk (which could destroy your bankroll), but you will also always be able to find stocks that performed better.

But if you have a specific investment approach, let’s say “invest in dividend paying companies with net income growth over the last five years,” then the fact that chip companies are soaring doesn’t matter. Sure, it would have been nice to have some money invested there, but that subset of stocks doesn’t fall into your philosophy. If, during reflection, you decide to tweak your approach due to some rational, non-emotional reason, do so. But earlier decisions can’t be judged on the lessons and adjustments you’ve learned since.

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I’d be remiss to not briefly mention the importance of patience. It can be incredibly easy to compare short-term performance and question your own thinking. If you are investing on short-term theses, this is fine. But most investors don’t. Most have years-long theses. This is once again why it is so important to know why you are investing the way you are, to actively review your theses, and to confirm they are proceeding as you had hoped. Then, try to tune out the noise.

No matter how you choose your investments, you will always be outperformed in the short run. Maybe someone knew something you didn’t; maybe they’re willing to take risks you weren’t. If you feel like chasing their gains, stop. It might be perfectly rational to do so, but you don’t know that yet. Instead, review why you didn’t make that choice in the first place. Did you miss something? Or is there just a strategic difference in how you approach investing?

Even better, try to figure out why they made their choice. In today’s world, it’s easy to find yourself in an intellectual echo chamber. If you can escape and see the world of investing through the eyes of someone else, you can expand your own thinking and investing.

As we invest, there will always be times when we wish we had chosen differently. But when this happens, it’s time to reflect. This what the best investors do. And this is how we can take a step closer to their ranks.

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Thank you for reading! This Substack explores whether an ordinary investor can become a world-class capital allocator. If you’d like to support this work, consider buying me a coffee.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

Last week we explored the similarities between the Industrial Revolution and the AI Revolution. We saw how technological development converted a nearly 90% agricultural workforce to a supermajority of service jobs by 2019. Along the way, we lost the natural exercise physical labor provided. The fitness industry filled this void. From the advent of body building competitions in 1901 to the first Gold’s Gym in 1983 to the tens of billions in revenue generated today, the Industrial Revolution created a brand-new industry.

History is repeating. Today, most jobs require mental effort. Whether it’s analyzing data, writing a report, or evaluating the last quarter, we use our brains a lot. AI is upending this. It won’t be long before AI replaces much of the cognitive effort currently deployed by the workforce. Like the Industrial Revolution replaced physical labor, the AI Revolution will replace cognitive labor.

Yet the importance of remaining cognitively sharp is well-documented. As workforce requirements wane, a new industry will emerge to fill the growing hole. Wordle and other NYT games like Connections are a first indication. The more than doubling of chess players on Chess.com is another. How can we catch this wave before other investors notice its swell? I believe the best opportunity is a company you’ve undoubtedly heard of. You might even have it on your phone.

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This company is Duolingo. You’re probably thinking, “Kaleb, Duolingo is for language learning. How could it become a ‘mental gym’?” Hear me out.

Duolingo has certainly focused on language learning. But in recent years, AI has already begun transforming foreign language communication. Recent versions of Apple’s AirPods offer live translation. Your iPhone captures the foreign speaker, and your AirPods immediately convert it to your preferred language, directly in your ear. This tool theoretically makes learning a second language obsolete, a relic of history. Duolingo needs a pivot.

While Duolingo is known as a language learning app, the founders have always considered it an educational platform. Duolingo’s mission is “to develop the best education in the world and make it universally available.” In the last few years, Duolingo has loosened the chains of foreign language. In 2023, Duolingo added music and math to its app. In 2025, chess joined the platform. Duolingo is expanding beyond languages to other intellectual topics.

Given the newness of the mental gym industry, several other companies could also pivot. Yet Duolingo is the only one that seems easily able to do so. For example, while Brilliant.org is a great platform, they explicitly focus on math, coding, and other STEM topics. Chess.com, another possibility, is far too ingrained in chess to successfully expand. Will both of these platforms benefit from growing mental fitness demand? Yes. But they will likely never become the “gym.”

Conversely, Duolingo has established a strong foothold in a notoriously hard task (learning another language) and has successfully added more topics to its portfolio. But Duolingo does have one issue that could compromise its ascendence. Duolingo is not inherently known for fully teaching languages. I’ve never met someone who has gone from newbie to conversational speaker simply through Duolingo. Instead, Duolingo is a fun tool (even game) people use to challenge their brain every day and become familiar with a new language.

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A true mental gym must have problems that require deep thought and problem solving. Think of today’s gyms. Yes, there are cardio machines that people can get on and mindlessly burn calories, but if you really want to build a strong body, you need to lift heavy things. You need to push your body just beyond what’s comfortable. As it currently stands, Duolingo is more the cardio of the mental fitness world. This doesn’t mean it can’t expand to harder, more time-consuming challenges, but it will require a deliberate expansion.

To bet that Duolingo will become a full mental gym is still premature. I have no doubt the mental fitness industry will become massive in the coming decades, but will Duolingo fully capitalize on this opportunity? If it only remains the “cardio” of the mental world, is that enough?

As we saw a few weeks ago, the best capital allocators view opportunities as distributions. The riskier the investment, the wider the distribution. An investment in Duolingo at this point is unquestionably speculative. But what is its distribution? Consider the following:

Blue is a typical distribution of events. The upside symmetrically matches the downside. Orange is much more interesting. Here, the fatter right side indicates that there are far more “good” possible events than “bad.” This is an asymmetric distribution because the downside is smaller than the upside. I believe this describes Duolingo.

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Since its first profits in 2023, Duolingo has grown rapidly. In 2025, revenue increased 33.3%, breaking above $1 billion. More impressively, net income before taxes surged 78.4%.

This is continuing in 2026. Duolingo recently reported revenue growth of 26.4% relative to its first quarter of 2025. This spurred a 58.9% increase in income before taxes. Net income grew 23.9%.

Digging deeper, new subscriptions accounted for more than 95% of revenue growth. This is fantastic. Instead of relying on advertisers to fund the company, Duolingo is gaining more paying customers. In fact, subscription revenue now makes up 86% of total revenue (compared to 82% in 2025).

The company is definitely growing, but how does its valuation look? Reviewing the balance sheet, it initially appears that Duolingo has about three times more assets than liabilities. But this isn’t quite right. More than 75% of Duolingo’s “liabilities” are deferred revenue. This is because most of Duolingo’s subscriptions are billed annually. Instead of recognizing this revenue all at once, Duolingo spreads it over the length of the subscription. In the waiting, it waits as a “liability.”

But it isn’t a true liability. It does not represent anything that the company owes. Hence, we can disregard it to calculate the company’s fair value. Ignoring deferred liabilities, Duolingo has a net asset value of $1.9 billion. More than half of this ($1.0 billion) is cash.

Dividing these by implied shares outstanding, Duolingo has $39.56 of net assets per share and $22.24 of cash per share. This is 32.6% and 18.3% of the current share price, respectively. Such high ratios offer investors some downside protection because if the stock falls too far, it becomes obviously undervalued.

To value the remaining, non-asset-based operations, we’ll discount free cash flow. In other words, what is the current value of Duolingo’s future projected cashflows? Comparing this to the company’s market value can provide insight on whether or not Duolingo is fairly priced.

More specifically, I’m curious at what rate Duolingo has to grow its free cash flow for its current non-asset value to make sense? Removing the $1.9 billion of net assets yields a $4.34 billion value to be justified. Because this is a higher risk investment, I will use a higher discount rate. This impacts the current value future cashflows have, such that a higher rate means a lower present value. In this case, I used 12%.

Looking at only the next five years, the current value makes no sense. Cashflows would have to average a 70% increase every year. This won’t happen. But I don’t think our thesis will fully materialize by then either.

Over the next 10 years, the current valuation looks much more reasonable. For today’s price to make sense, Duolingo needs to grow free cash flow by about 18% annually. Since Duolingo increased free cash flow by 36% between 2024 and 2025, this seems doable, especially if they embrace the mental fitness industry.

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Should we invest? It really comes down to how confident we are that Duolingo can grow its cashflow by more than 18% on average over the next decade. If it averages 25% growth, investors should see a 28% return just from the cashflow generated. Once you add the hype behind a growing company, the true gain could be much higher.

Personally, I think Duolingo can certainly hit a 18% growth rate over the next ten years, assuming it continues its current trend toward non-language intellectual pursuits. In an AI world where mental effort will be increasingly unneeded, mental gyms will only succeed with the subset of the population that wants to use their brain. Duolingo has a strong, growing user base that actively pursues a hard mental task (learning a language). The company already appeals to people who want to challenge their brains. As the mental fitness industry blossoms into its own, Duolingo stands ready to prosper.

Is this a speculative thesis? Yes. Duolingo could fumble the ball, losing out to another competitor or still-to-be-formed startup. But right now, the downside seems limited. Duolingo’s net assets make up about 37% of its total value. The remaining 63% appears perfectly valued if the company can grow its free cash flows at 18% over the next decade. Perhaps I’m too optimistic, but I think this can happen. Therefore, Duolingo seems like a well-valued opportunity with tremendous upside. Its current value minimizes risk. Its future potential provides upside. Let’s see if our green owl friend can soar!

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Researchers discovered that the brain-only group experienced the most, and the most widespread, brain activity, utilizing a variety of structures within the brain. The search engine group saw 34-48% less activity, while the LLM subset saw up to 55% less brain activation. People panicked, lauding this as proof that LLMs make us stupid.

It also furthered a growing furor against technology in general. People like Jonathan Haidt have documented the negative impact of social media on the brain, and more and more studies are indicating that short-form videos impair attention and self-control. The term “brain rot” has even joined the modern vernacular, referring to this effect. “Your Brain on ChatGPT” only fueled this fire.

For anyone who has used an LLM, this result isn’t surprising. That is often the point of using AI: to achieve a desired output without adding to your cognitive load. Is this a problem? Or is it how innovation always occurs? To answer, we’ll return to the first technological revolution. We’ll find surprising similarities that indicate a new industry might be on the horizon.

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Before the Industrial Revolution, 80-90% of people worked in agriculture. Not agriculture as in tending a garden or driving a tractor. Economist Robert Gordon put it this way: “Their hours were long and hard; they were exposed to heat in the summer and cold in the winter, and the fruits of their labor were at the mercy of droughts, floods, and infestations of insects…[J]obs…required sixty hours of work per week–ten hours per day, including Saturdays.” People worked hard almost every day,

The Industrial Revolution changed this. As machines began automating farms, jobs pivoted to a new industry: manufacturing. By 1939, 39% of the workforce toiled in factories. Then jobs evolved again. As technology advanced, services became the main employer. Financial services, information services, entertainment. In 2019, an estimated 71% of people worked in some service industry, working an average of 34 hours a week.

While this is first evidence that no matter the future, new jobs will be created, I want to focus on something else. As jobs transitioned from manual labor to working an assembly line to sitting in front of a computer, the need for physical work diminished. Jobs requiring hard physical effort are now in the minority. Put differently, jobs no longer create exercise.

This lack birthed opportunity. Since the time of the Greeks, people have obsessed over the human physique. But as Greek influence waned, so did this obsession… until the 1500s. Slowly, the concept of working out, of building a strong body, regained traction. Yet common people still didn’t have much need. If you’re already exerting yourself just to put dinner on the table, why would you exercise even more? For decades, what few gyms existed were only frequented by athletes and circus performers.

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Yet as the Industrial Revolution altered the nature of work, the gym industry crept from the shadows. In 1901, the first body building competition debuted in London. A few years later, another competition graced Madison Square Gardens. The Greek fascination with the human physique was regaining public popularity.

When jobs shifted from agriculture to manufacturing, work was still incredibly physically demanding. It wasn’t until after World War II that service jobs surpassed manufacturing, and the world’s pregnancy with a new industry reached maturity.

Delivery was slow. The New Deal’s Work Progress Administration created the first iteration of Muscle Beach. Between 1940 and 1960, a few recognizable names opened gyms, Jack Lalanne among them. Then the baby was born. By the 1980s, the fitness craze emerged full force. Jane Fonda graced televisions, Gold’s Gym opened its first location, and fitness landed on the cover of Time magazine. In 1983, the first 24 Hour Fitness opened, destined to become one of the largest gym operators.

Today, the fitness industry is estimated to exceed $134 billion. Millions of people work out weekly (or daily) as studies reinforce the multitude of benefits. What started as a result of job change has evolved into a highly profitable industry, all thanks to the Industrial Revolution.

Today, people fear what AI will do to jobs, to life, to human cognition. While we can’t know, history can provide clues. Most jobs today are the intellectual equivalent of agriculture. People sit in front of computers, analyzing information and using that data to make decisions or inform decision makers. It’s becoming increasingly clear that AI will replace many of these roles. During the Industrial Revolution, people deployed new technology to accelerate production. The modern equivalent is likely an AI agent manager. It’s probable that many jobs will manage AI agents as those agents complete specific business tasks.

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So what is the service industry equivalent of the future? I don’t know. The computer wasn’t invented until 1945. The internet didn’t exist until 1983. Without understanding those, today’s workforce would be unimaginable to the agriculture and manufacturing workers of bygone days.

Just like the Industrial Revolution stripped the need for most physical labor, the AI Revolution seems poised to eliminate the need for most thought. There will always been exceptions, but it seems that the majority of today’s mental effort will be unnecessary within a few years.

Yes, this creates a hazard. Dementia is to the brain what inactivity is to the body. How important is mental effort to avoiding (or at least delaying) dementia? One study indicated that bilingual individuals could delay the onset of dementia by up to four years compared to their single-languaged peers. Another study found that adults who participated in “brain training” were 25% less likely to deal with dementia over the next twenty years. Keeping your brain sharp is paramount to enhance life- and health-spans. AI seems to threaten this.

Much like the Industrial Revolution birthed the fitness industry, I expect the AI Revolution will create a “mental fitness” industry. Unlike the nearly 100 years it took for the fitness industry to reach fruition, the mental fitness industry will grow much faster. We already see signs of this budding niche. Wordle launched in October of 2021. Three months later, New York Times bought the viral sensation for seven figures. Brain training apps like Lumosity and Peak continue to attract users. But these are just the beginnings. A different company stands in this industry’s doorway. Not only is it already approaching this opportunity, but it also seems to present a decent balance of risk with speculation. Next week we’ll dive into this company. Subscribe so you don’t miss it!

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

Today’s article headlines some heavy hitters: Warren Buffett, Stanley Druckenmiller, and Howard Marks. These capital allocators follow very different investing philosophies. Buffett is the classic value investor. Druckenmiller starts with macroeconomic principles. Marks is obsessed with consistency and risk management. But despite these differences, they are all paranoid about minimizing one thing: losses.

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On the surface, this shouldn’t be surprising. Buffett is famous for his two rules of investing: Rule #1 Don’t Lose Money. Rule #2 Don’t Forget Rule #1. But how do you achieve this? After all, investing is inherently risky. You could know everything about a company, and yet the stock might still dramatically underperform. Should we focus only on quality companies? What about the old mantra “more risk, more reward”? Marks addressed this in his 2014 investor newsletter, summing it up perfectly: “if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier.” This is only the tip of the iceberg.

What does riskier really mean? We live in a probabilistic world. On any day, a multitude of possible futures lay before us. As the day progresses, these converge into our lived reality. When your alarm goes off, you could immediately get up, or you could hit snooze. From there, the timeline further branches. Will you scramble eggs? Make coffee? Go for a run? Trip over your kid’s Legos? Every choice destroys infinite possibilities as one future becomes your life.

Much like each person has an infinite tree of possible futures, every company has a plethora of potential outcomes. When we analyze companies, we are attempting to determine which outcome is most likely, and if that future makes the company more valuable.

“Risky” simply means a wider array of possible outcomes. Imagine two companies. Company A has been around for 30 years with consistent profits, while company B is a startup still struggling to generate revenue. If we graphed possible futures, it might look like this (blue is A, and red is B):

Each bell curve represents the company’s future. The left side of the curve is negative outcomes (loss of a customer, industry declines, etc.), while the right side is positive events (growing revenue, more profitability, etc.). For sake of argument, let’s assume that the farther to the right the future is, the more reward investors receive. How does this inform an investor?

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First, an investment in company A is much more of a sure thing. When looking at distributions, we care about the area under the curve. In this case, the region under company A’s curve is highly concentrated around the midpoint. There is some room to the left and right, but most normal events don’t deviate from current operations. Black swan events (while always possible) are unlikely.

Compare this to company B. Now, the area under the curve is distributed across a wider array of possibilities. Some of these futures come with large reward, while others punish investors. Marks correctly points out that riskier doesn’t mean more reward, it simply means the range of possible futures is wider.

To deal with this, we must know each investment well enough to have an educated reason why the right side of the curve is more likely than the left. This leads us to the insight that has me rethinking everything.

Everyone has heard of diversification, but what about “diworsification”? Coined by Peter Lynch, diworsification is when you diversify your portfolio so much that you negate potential gains. Half your portfolio may be up, but because you own so much, the other half is down, reducing your gains. Over time, this hampers your compounding potential.

Countering this is simple in theory. Instead of pursuing a variety of theses, focus on a few. Start with a small position, then incrementally add to it as you learn more. This is exactly what Druckenmiller did as he invested in Nvidia. When a friend first tipped him off to its potential, he opened a small position. Enough to feel pain if the price fell, but not enough to risk the house. As he learned more, as he considered how retail investors would react to the growing AI craze, he doubled down, then doubled down again. He didn’t open his position then gallivant to another opportunity. He kept learning and kept adding.

The top echelon of investors reuse this strategy time and again. Lynch argues in each of his books that investors should only invest in companies they understand. Buffett mirrors this sentiment with his circle of competence. He argues investors should know which industries they truly understand and only focus on those. Even if opportunities seem to abound elsewhere, Buffett warns you must stick to what you know. By grasping an industry’s or company’s intricacies, we can more accurately predict when the right side of the curve is more likely than the left.

This upended my own thinking. As I write this, my personal portfolio has 38 individual positions. I can give you a reason why I chose each company and why I think it has potential, but I did not do a deep dive on many. Even for the companies I spent a few weeks studying, my research usually stops as soon as I open my position. I have a 5+ year outlook (my justification for inaction), but inaction also means I’m not truly capitalizing on the few positions from which most of my returns will come from.

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There’s a frequently cited idea called the 80/20 rule. In investing, it says that 80% of your returns will come from 20% of your positions. The true percentage will differ, but the concept remains true: most of your returns will come from a few investments. This is why top capital allocators focus only on ideas that they truly know, understand, and believe in.

But avoiding diworsification introduces new risk, the risk of choosing wrongly. If you only own a handful of companies, just one could undermine your entire portfolio. The reason people advocate for diversification is because it reduces your exposure to any single position. This is exactly why an index fund can be so powerful. For anyone who wants to start investing without spending hours researching companies, an index fund provides more safety than individual stocks.

But if we want to become world-class capital allocators, we need to move beyond index funds. The only way to reduce the risk of choosing poorly is through research. Losses are inevitable. Risk is inevitable. A company that has been operating strongly for years could suddenly see demand collapse. The company that seemed destined for bankruptcy could miraculously turn itself around. Yet if we do sufficient research, we can hopefully find the few breadcrumbs that indicate which future is more likely.

Is that our takeaway? Simply do more research? No. Paralysis by analysis is an omnipresent threat to all investors. The top investors don’t think in terms of “do I know enough about this company to invest?” They ask, “do I know enough to legitimately believe the future is more likely to land on the right side of the curve than the left?” Druckenmiller didn’t wait to invest in Nvidia until he had all the information. He got enough to make a first move, then increased the ante as he learned more. It doesn’t matter how “risky” the opportunity is, it only matters how you think the world will evolve and with what degree of certainty you believe that.

Beyond this belief, you must also identify what threatens your thesis. How will you know if the investment is drifting to the left? In his 2024 investor letter, Buffett wrote, “[t]he cardinal sin is delaying the correction of mistakes.” When the best capital allocators realize a position isn’t moving in their favor, they cut it loose. This is why it is so important to build a thesis, know what determines if that thesis is failing, and monitor how reality unfolds. AI can be incredibly helpful here. Chatbots are fabulous devil’s advocates and can see issues we might otherwise miss.

In 1990, Marks said that “The best [portfolio] foundation…is an absence of disasters.” While this makes intuitive sense, it is only by studying the masters that we learn how this is achieved. The top investors think in probabilities. They know that any number of futures could occur; their job is simply to identify which seems most probable. Leaning heavily on a specific area of expertise and/or in-depth research, the best capital allocators learn which opportunities are likely to have a right-sided outcome, and which remain unforeseeable. This is how they find their edge. With time and practice, we too can learn to think this way. As for me, perhaps it’s time to prune my portfolio…

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

In my eyes, the strongest argument for BSX is its current valuation. Thanks to this year’s 51% decline, BSX is trading at levels last seen in 2023. But the company’s EPS is 81% higher; its net margin is up 29.8%. This company is still growing. In the first quarter of 2026, BSX’s revenue increased 11.6%, and operating income climbed 19.5%. For a company abandoned by the markets, it is performing incredibly well.

But this is also my hesitation with BSX. Despite its continued operational strength, investors don’t care. Investors have become so blinded by the company’s guidance and warnings of slowing demand that they are ignoring the underlying performance.

Interestingly, we’ve yet to really see demand slow. In fact, Watchman, the main product said to be waning, saw sales surge 19.1% in Q1 2026. While this is marginally down from Q3 2025 (-1.7%), it is still far above the average quarterly sales of 2025. For now, it seems the bogey man remains a ghost. But it is still frightening investors.

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Does this matter? If we only followed investor sentiment, we’d be piling into the latest chip company, not evaluating a biotech firm. The fact that BSX has been neglected despite underlying strength is a point in its favor. But I do find its chart worrisome.

We’ve yet to see any consolidation. Looking back to 2023 (not pictured), the $48-$49 price range seems to be decent support. But in this year’s race downward, each historic support line held briefly before shattering to downward pressure. We’ve only been at the current $47-49 level for about a [month]. Will the floor break again?

BWAY has the opposite issue. It is not undervalued. Over the last year, its price has soared over 140%, only faltering in the last [month].

Such growth is impressive, but so is the company’s performance. In the most recent quarter, BWAY reported 34.6% revenue growth, 248% operating income growth, and 106% net income growth. Its balance sheet is strong, touting $2.84 of assets for every dollar of liability. BWAY is pursuing multiple financing operations that strengthen its ties with the healthcare companies that can later become clients.

But BWAY is still a small company. While this gives it agility, it also creates fragility. BWAY has one, undisclosed customer that generates a “significant portion of…revenues.” BWAY further warns that this concentration is expected to continue, even as it expands into other partnerships. If BWAY continues to provide cutting-edge mental therapies, this won’t become an issue, and the investment in clinics should help minimize the risk. Nevertheless, it remains a threat.

This also introduces another risk with BWAY: concentration. BWAY exclusively focuses on deep transcranial magnetic stimulation (dTMS) to treat OCD, major depressive disorder, and smoking addiction. In the range of bioelectronic-possibilities (everything from pain management to cancer therapies to dTMS), this is a small corner. By investing in BWAY, you risk isolating yourself to one facet of a far larger industry, missing out on other areas of growth.

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This is where BSX returns to favor. BSX already offers two very distinct lines of neuromodulation technology. It produces pain management devices and technology for bladder control. Each of these products separately has a customer base estimated at 20% of the global population.

BSX’s size has yet to reduce its own agility. In the latest quarter, BSX saw 17% growth in its neuromodulation division, outpacing everything but its cardiovascular products. BSX also has the financial power to acquire other companies, adding to its arsenal of biotech solutions. Earlier this year, BSX bought the cardiovascular device company, Penumbra.

In comparison, BWAY is much more narrowly focused. While dTMS can be applied to addiction, OCD, and MDD (with the company working on FDA approval for PTSD treatment), the percent of the population with these maladies ranges from 1.2% (OCD) to 20% (smoking). Still a large addressable market, but much more niche.

Let’s directly compare BSX to BWAY. BSX is about 140-times larger than BWAY. In fact, BSX could buy BWAY with only 30% of its cash. More importantly, BSX generates 372-times more profit than BWAY ($2.9 billion vs. $7.8 million). Similarly, for every dollar invested in BSX, you are “paying” for $0.05 of net profit. For every dollar in BWAY, you get $0.027. Given BSX’s size, its price seems shockingly cheap and an incredible opportunity.

As capital allocators, we seek to maximize return while minimizing risk. In a budding industry like bioelectronics, risks are inevitable. But we can reduce them. I believe both BWAY and BSX have potential. But if I had to choose one, I would choose BSX. And because it’s a larger company, we can pursue a unique strategy to reduce our risk. Before explaining, a word of warning: this is an advanced strategy. The simplest approach is to buy the stock. While my strategy could reduce your downside, it could also leave you high and dry if the stock moves too quickly.

I am pursuing BSX by selling options. Do I think BSX is undervalued? Yes. The challenge is that I don’t necessarily see a strong catalyst for why the price will reverse course immediately. The company could report better than expect earnings. Management could reveal that slipping demand isn’t hampering performance as much as anticipated. Investors could decide they need a place to put their money that is safe from AI-induced volatility. But these are not guaranteed. BSX seems to be an opportunity, but I don’t see a pending catalyst to cause other investors to realize this.

To minimize my risk, I am looking to generate cashflow while I wait for my thesis to manifest. If BSX paid a dividend, that would be one solution. They don’t. This is where options can help. I can use options to create a synthetic dividend.

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I am selling put options slightly below the current price, with the first sold last for at a $46 strike price. For those unfamiliar with options, this means I am promising to buy 100 shares of BSX at $46 if the closing price is below $46 by expiration (July 10^th). For this promise, I earn $130, and $4,600 is set aside as collateral. In other words, I’m making 2.8% for a month’s promise. If I get assigned, I’m happy because I wanted to own shares. If I don’t get assigned (i.e. the price stays above $46), I’ll sell another option next month.

There is an obvious risk to this approach. If the stock suddenly gaps upward, I’ll miss out. For example, if BSX were to jump 10% tomorrow, 100 shares would gain about $450. My puts would be nearly worthless, so I could probably close early for a $125 profit. That is substantially less than I would have made by owning shares. To counteract this risk, I am also going to slowly acquire shares directly. Not many, just enough to have skin in the game.

Alternatively, I could buy 100 shares and start selling calls. This could cap my upside a little (for example, selling a $55 call means I promise to sell at $55, so any move higher would be lost), but it would also continue to provide monthly premiums (about 1% a month) to offset any downside risk.

Over the last four weeks, we’ve explored the world of bioelectronics. Now I’ve outlined what I think the best stock is, as well as how I personally plan to pursue it. For now, I’ll be selling puts. If I get assigned or buy 100 shares, I’ll switch to selling calls to keep the cashflow and risk mitigation going. BSX is definitely an opportunity. Now we’ll see if I’m seizing it correctly.

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Thank you for reading! I’m on a mission to help everyone become an investor, and I can’t do it alone. Please share this article with everyone you know and help spread the word on how easy good investing truly is!

Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

We’ve been exploring how to invest in bioelectronics. The potential is there. This field will likely revolutionize modern medicine but figuring out where to invest (or if we can invest) is much trickier. Last week we evaluated the megalodons of the medical device world, with Boston Scientific Corp. landing on top. While it seems grossly oversold, it also only offers 6% exposure to neuromodulation. Now we turn to small caps, firms worth less than $2 billion, which exist solely to advance bioelectronics.

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Before diving into specific companies, a word of warning. These companies are inherently speculative. A failed FDA approval could decimate our position. Replimune collapsed 77% after a failed attempt to earn FDA approval. But the reward could be great. Novocure (a company we’ll discuss) jumped 20% after receiving FDA approval. High risk, high reward.

In such an environment, I become more selective. Warren Buffet famously quipped that the first rule of investing is “Don’t lose money” and the second is “Don’t forget rule #1.” As we venture into small caps, it’s important to avoid seduction by the company story, revenue growth, or investor sentiment. We must ensure we are investing in operationally sound companies.

As I began my search, I expected to encounter many companies without revenues. I was pleasantly surprised. Each of the six companies I explored had not only revenues but growing revenues. But few were profitable. It didn’t take long to narrow it down to three companies. Today, we will be looking at Novocure (NVCR), NeuroPace (NPCE), and BrainsWay (BWAY). While each shows promise, one is undeniably the best.

NVCR focuses on battling cancer with tumor treating fields (TTFields). This non-invasive treatment targets and disrupts cancer cells with electric currents, specifically inhibiting the cancer cells’ ability to replicate. The results are promising. In one study of glioblastoma, the overall survival rate improved 30%. In another study of pancreatic cancer, survival increased 14%. It’s important to note that remission doesn’t show much improvement. Additionally, TTFields seem to work best against glioblastoma. Nevertheless, NVCR has set itself apart, not only by being the only company with an FDA-approved TTField device, but also by having three such products.

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NPCE has developed something called Responsive Neurostimulation (RNS) system for epilepsy patients. Once inside a patient’s skull, this device continuously monitors brain activity and responds to neural misfirings. The RNS system notices potential abnormal electric signals (the typical cause of a seizure) and creates its own pulse to prevent them. Because of this, the RNS system is often called the pacemaker of the brain. As of now, NPCE’s device treats patients with drug resistant, focal epilepsy (where the faulty electric signal comes from a specific region of the brain), but the company is hoping to apply its products to generalized epilepsy as well as other mental conditions like PTSD and memory disorders. These would require additional FDA approval.

Finally, BWAY uses deep transcranial magnetic stimulation (dTMS) to counteract depression, OCD, and, most recently, smoking addiction. While not fully understood, this noninvasive technology sends magnetic fields through the skull to stimulate neural activity. In one study of moderate to severe depression, patients who received dTMS were twice as likely to be in remission after a 12-week protocol. BWAY has the only FDA approved dTMS device, including recent approval for teen depression, and is the first company addressing OCD and smoking addiction.

These companies are on the frontier of their niches, but they aren’t all equal. All three are seeing year-over-year revenue growth of 27-28%; but only BWAY is profitable. In fact, BWAY saw net income more than double to $7.6 million in 2025. This is where the other companies become less attractive.

When I’m looking at any company, one of my biggest red flags is general & administrative (G&A) costs growing faster than anything else. Research and cost of sales I can accept, not G&A. Unfortunately, this means NVCR is eliminated. While its G&A actually fell between 2024 and 2025, in the first quarter of 2026, G&A costs were almost 50% of 2025’s total G&A. Not only did this expense grow more than twice as fast as revenue, but this also meant net income fell from a $34 million loss in Q1 2025 to a $71 million loss in Q1 2026.

Furthermore, TTFields are not nearly as backed by research. Don’t get me wrong, TTFields do seem to help patients with pancreatic and GBA cancers. Pancreatic cancer is particularly fatal (13% 5-year survival rate), so any improvement is helpful. But that’s the issue. TTFields currently do little more than improve quality of life while adding a few months to the survival period. Hugely beneficial to patients, but not nearly the catalyst we want in an investment.

Similarly, NPCE doesn’t hold up to BWAY. NPCE is certainly improving its operations. Revenues continue to grow, and net income loss is marching closer to positive territory. But we’re still not there. In 2025, the company lost over $20 million. In the latest quarter, revenue growth slowed markedly, and net loss slightly worsened (in part, due to a 20% increase in G&A). Finally, while NPCE’s device does help epilepsy patients, the total addressable market is probably 1% of the total population at most. Again, very helpful to patients, but not as scalable an investment as we can achieve elsewhere.

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During my research, BWAY quickly became the frontrunner. The more I looked, the more I liked what I saw. It started simply with its profitability. In 2025, BWAY generated $7.6 million in profits off revenues of $52 million. These were both considerable improvements from 2024. In Q1 of 2026, the strong performance continued. Revenue grew 35% year-over-over, and both operating and net income more than doubled.

Even better, net profit has become less dependent on interest income. For the last several years, interest income played a substantial role in the company’s profitability. While profit is profit, we’d prefer to see the company generate most of its profits from its operations. While in 2025, interest income contributed 44% of net income, in the first quarter of 2026, this fell precipitously to 17.7%. This is a fabulous improvement.

BWAY’s balance sheet is also impressive. BWAY currently has 2.84 times as many assets as liabilities. In fact, it could eliminate every liability and still have cash remaining. While some might see this as a company not fully utilizing debt to enhance its operations, I see it as a strength. This company knows it is still a somewhat speculative (though proven) firm and is maintaining the firepower to last.

Then there’s the addressable market. While NVCR and NPCE both target small populations, BWAY can serve a much broader group. It’s estimated that 8.3% of the U.S. population suffers from major depressive disorder, the main use of dTMS. Meanwhile the additional markets of OCD and smoking addiction treatments only expand the company’s possible reach.

At this point, I already knew BWAY would be today’s victor, but then I made a massive discovery. Something that sealed the deal. As previously mentioned, BWAY has a robust balance sheet, about 50% of which is cash. One fear might be that the company fails to use this cash in a way that benefits shareholders. Let’s put this fear to rest.

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In 2025, BWAY began a spree of investments in other biotech companies. It opened a 4.7% stake in Stella, a health clinic administrative company operating across the U.S. and Israel. A few months later, BWAY financed another management company, again collecting equity. Tangient ATX Inc. became the third company to receive equity financing from BWAY. In 2026, this trend is continuing. BWAY is targeting specific partnerships with the very companies that can become customers. The CEO summed it up perfectly. “These minority stake investments support our broader strategic initiative to expand access to and awareness of cutting-edge mental health interventions such as Deep TMS, while allowing BrainsWay to continue focusing on the scientific and clinical advancement of its technology, working to expand its range of cleared clinical indications, and delivering best-in-class support to all its customers.” BWAY is taking steps to expand and secure its future.

When venturing into smaller companies, risks increase. But so does reward. BWAY is only a $550 million company. Compared to the billion- and trillion-dollar behemoths of the day, this is tiny. Yet the company is growing. Is this the bioelectric opportunity we’ve been looking for? At this point, we have two candidates. The large, seemingly undervalued, conglomerate that is BSX, and the small, highly focused operation of BWAY. Next week, we’ll conclude our journey by comparing these companies, exploring different routes of investment, and finally choosing an action plan. Subscribe so you don’t miss it!

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Thank you for reading! I’m on a mission to help everyone become an investor, and I can’t do it alone. Please share this article with everyone you know and help spread the word!

Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

As capital allocators, this is incredibly exciting. Bioelectronics is proving itself to be a viable treatment method, often better than traditional methods. Can we profit from its potential?

There are a few routes we could take. Equity in a private company might be the most profitable, but it is inaccessible to most (including myself) and laden with risk. There is a better option. Despite the industry’s relative newness, several public companies manufacture bioelectronic products. Today, we’ll explore three of the biggest medical device companies to decide if one (or more) is the opportunity we’re looking for. All three share much in common, but one seems more promising than the rest.

The three companies we’ll examine today are Abbott Laboratories (ABT), Medtronic PLC (MDT), and Boston Scientific Corp. (BSX).

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ABT is the largest, both in company valuation and product offerings. Boasting a $150 billion market cap (even after its recent 30% price decline), ABT sells a wide range of products from pharmaceuticals to diagnostic tools to medical devices. Diabetes is its highest earning segment, stemming from continuous glucose monitors. Looking specifically at bioelectronics, ABT focuses on spinal cord stimulation for pain management as well as deep brain stimulation for movement disorders like Parkinson’s disease. In 2025, these neuromodulation devices generated 2% of ABT’s total sales.

Unlike the multidisciplinary approach of ABT, MDT focuses exclusively on medical devices. While its cardiovascular and surgical products dominate, its neuromodulation division created 5.8% of 2025 sales. Furthermore, these revenues are almost twice as large as ABT’s similar sales. MDT offers devices not only for pain management but also bladder control, epilepsy, tremors, and Parkinson’s. In 2025, sales of these products grew by 10.7%, faster than any other sector.

Much like MDT, BSX only produces medical technology. In fact, its similarities to MDT continue. While 66% of its revenue stems from cardiovascular products, 6.0% comes from neuromodulation technology. But there are also similarities to ABT. For example, instead of a wide array of bioelectronic solutions, BSX only offers two: pain management and bladder control.

With that background, let’s zoom out. 2026 has been hard for these companies. ABT is down 31.1%; MDT has fallen 23.2%; BSX has plummeted 49.0%. Compared to high flying AI stocks or even the general market, this is a substantial underperformance. What’s happening?

There isn’t just one cause. Across the board, these companies are reducing guidance (i.e. executives are less optimistic about the near future). ABT reduced its expected earnings by 3.5%, citing the acquisition of an oncology company. But the firm also dealt with a glucose monitor recall in February. MDT’s cost of goods climbed 6%, while the company also spun off its diabetes division. With diabetes devices once generating 8.6% of MDT’s total sales, this spin-off will have an impact. Finally, BSX has reported slowing sales as new competition enters the market. This motivated the CEO to warn that sales growth could be 30% lower than previously expected.

This is the inherent issue with attempting to gain exposure to a niche industry through massive corporations. Major companies have so much going on that growth of a small product line could take years to truly impact the stock price. Nevertheless, there could be an opportunity.

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As I’ve said previously, when analyzing individual stocks, we’re looking for any red flags that immediately eliminates the company from our consideration. While the current industry background isn’t ideal, I don’t think it warrants the type of price declines we’ve seen. For example, the idea that slowing demand for BSX’s products means the company is worth half as much seems irrational. The declines we’ve seen make me wonder about undervalue possibility instead of worry about continued downside.

That said, company-specific concerns would certainly be problematic. Unfortunately, MDT falls squarely into this category. I had high hopes for MDT. It offers a myriad of bioelectronic products and pays a 3.85% dividend. But digging into its financials raises some flags. Revenue is growing, but net income fluctuates between growth and stagnation depending on the quarter. What I find more troubling is the balance sheet. Goodwill currently comprises 45.8% of total assets. On one hand, this is somewhat ubiquitous. BSX’s goodwill is 41.9%, and ABT’s is 27.7% of their respective assets. So MDT’s number is high, but not irrationally high. But I still don’t like it. Combined with the recent spin-off of its diabetes division, I don’t believe MDT is the best play. There’s too much uncertainty.

We’re down to a showdown to gain our investment capital. Since both ABT and BSX offer similar products, let’s start with stock performance. This is the last ten years of ABT:

Honestly, not that impressive. We had a fabulous run up through 2021, but ever since, the stock has been stagnant. Last year, the price attempted to break above the $135 price level but failed. Since then, the price has fallen 37%. I have mixed feelings about technical analysis, but despite my hesitations, the double top here is worrisome, especially since the price has since broken below $90.

What’s more interesting about this is that ABT doesn’t seem to be deteriorating. In 2025, revenue grew 5.7%, and earnings before taxes surged 20.7%. Technically EPS did plummet compared to 2024, but that was only due to a $7.5 billion tax gain in 2024 from foreign consolidation. A strong company that the markets have seemingly abandoned… sounds tantalizing. Its 2.8% dividend only sweetens the deal.

The issue is the most recent data. Since ABT’s strong financial performance in 2025, things have soured. First, ABT faced a class 1 recall of its FreeStyle Libre 3 glucose sensors in February. Class 1 is the most significant type of FDA recall, alerting consumers to a potentially lethal issue. In fact, as of January 2026, ABT reported 860 serious injuries and 7 deaths attributable to this problem.

Revenue still grew, but net earnings fell 18.7%. The company also saw a 27% increase in assets, which sounds great until you realize the only change was in goodwill and intangible assets. This was due to its acquisition of Exact Sciences, something that apparently had little impact on overall financial performance.

Even if these issues didn’t exist, ABT loses more luster. We are investigating ABT because of its neuromodulation products. In 2025, these generated 2.3% of total revenue. While technically growing, 2.3% is hardly anything. Moreover, in the last quarterly filing, neuromodulation sales only increased internationally. U.S. sales were flat. I don’t think ABT is a good play for bioelectronics.

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Will BSX be the lone survivor? Here is its 10-year chart:

This is one of the wildest charts I’ve seen lately. The company had an incredible run starting in late 2023 but now has surrendered everything. What happened in 2024? First, EPS grew 16.8%. The company was firing on all cylinders, launching a new atrial fibrillation therapy device and seeing soaring demand for its Watchman device (another atrial fibrillation device). Since then, executives have warned about slowing demand. This, combined with a general collapse of the sector, pushed BSX’s price off a cliff.

But I believe this sell-off has been overdone. To be fair, the meteoric surge was probably a little overexuberant, but this company should not be trading at 2023 levels. In 2023, BSX generated $1.6 billion of net income off revenue of $9.9 billion. This is an EPS of $1.07 with a net profit margin of 16.1%. In 2025, BSX earned $2.9 billion from sales of $13.9 billion. Not only is this an 81% increase in EPS (to $1.94), but the net profit margin also improved to 20.9%. This is not the sign of a defunct company.

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This growth is continuing. In the first quarter of 2026, revenue increased 11% year-over-year. Technically, net income more than doubled. However, this appears to be more from one-off benefits than true financial performance. Still, operating income (unadulterated by these miscellaneous additions) surged by 19.5%. Even though the company is warning of slowing growth, it doesn’t seem to be materializing (or it has yet to impact the company’s performance). In fact, almost every product category saw year-over-year growth (except “cardiac rhythm management,” which saw no change).

What about neuromodulation? After all, that is why we’re looking as BSX. In 2025, neuromodulation generated 6.0% of BSX’s total sales. So far this year, this remains true. Neuromodulation created 6.1% of BSX’s Q1 sales. More impressively, neuromodulation sales are up 17% across both international and U.S. markets. This is one of BSX’s fastest growing sectors (behind cardiovascular products).

All in all, investing in bioelectronics is going to be challenging. Of the major medical device companies, BSX seems the most promising, but it really only offers 6% exposure to bioelectronics. As this segment continues its earnest growth, perhaps it will become more important, but that is hard to predict. Still, BSX seems like a true opportunity.

But we’ve only just begun! Now we turn to the more speculative stocks of the biotech world. Unlike this article’s conglomerates, these companies are unilaterally focused on biotech solutions. That doesn’t necessarily mean they are the best horse to bet on though. Subscribe so you don’t miss next week’s dive into these companies as we near a final decision on investing in bioelectronics!

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Thank you for reading! I’m on a mission to help everyone become an investor, and I can’t do it alone. Please share this article with everyone you know and help spread the word on how easy good investing truly is!

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

The same is true of investing. If you wait until a company or asset is making headlines, chances are you’ve already missed out. At the same time, you don’t want to be so early to the game that your thesis might never play out. There’s a middle ground, a place where an idea is gaining traction but is still unknown enough to offer massive upside. Right now, bioelectronic medicine seems to be in this goldilocks zone.

While dissecting frogs in 1780, Luigi Galvani and his assistants suddenly saw a frog leg twitch. Further investigation revealed that an assistant had grazed a nerve with a scalpel, causing an involuntary contraction of the leg muscles. Galvani deemed this phenomenon “animal electricity,” thinking the electrical pulse emanated from the frog itself. While this idea would quickly be refuted, Galvani’s observation birthed a new scientific field: bioelectricity.

Two hundred years later (1958), scientists finally developed a use case. Pacemakers are remarkably simple. They monitor your heartbeat, watching for abnormalities. Should the heart’s rhythm falter, the pacemaker immediately sends an electrical signal to stimulate a contraction.

It didn’t take long for a second device to reach production. In 1961, the cochlear implant became available. Instead of using electrical signals to create muscle contractions, a cochlear implant interacts directly with the auditory nerve. Sound is converted into electricity. which then stimulates the auditory nerve, allowing the user to hear the original sound.

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Today, bioelectronics seems to have the potential to solve almost any malady. Bioelectric medicine has a few premises, depending on the researcher. Some cite inflammation as the core commonality of disease and how the vagus nerve can control inflammation. Others argue that current therapies (particularly oral drugs) work by triggering a specific response in the body. They then ask, what if the body could induce that same response itself?

This is where bioelectronics is a gamechanger. If a drug works, it typically means the body is already capable of producing that biochemical response itself. It just needed a push. Meanwhile, drugs introduce a host of potential secondary issues. They flood the entire body, not just the suffering area, and metabolic and body size differences dramatically impact efficacy. Combining several drugs into a medicinal cocktail creates nearly infinite potential for unknown, possibly fatal, interactions.

Today’s drugs could soon pass into the archives of history. Galvani noticed that electricity can cause muscle contractions. Now we’re learning that the human nervous system delivers electrical signals to every muscle and organ in the body, prompting molecule creation, generating delivery instructions, and reading molecule levels. Using techniques of neuromodulation, we are learning how to receive these signals, interpret them, and send our own pulse to create a desired biological response. All through the power of electricity.

One recent example is a potential therapy for rheumatoid arthritis. Rheumatoid arthritis (RA) is an autoimmune disease in which white blood cells attack otherwise normal joint tissue, destroying connective tissue and bone. Treatment ranges from basic NSAIDs like Advil to immunosuppressants like Methotrexate. These work by suppressing inflammation across the entire body and by inhibiting immune function. Methotrexate, in particular, halts DNA replication, slowing cell division and immune cell proliferation. While this reduces RA symptoms, it comes at a cost, namely a compromised immune system.

SetPoint Medical, a bioelectronics company focused on vagus nerve stimulation, may have a solution, a therapy the FDA approved last summer. It starts with a small device placed on the vagus nerve during an outpatient operation. This device stimulates the vagus nerve to trigger the release of acetylcholine from the spleen. This neurotransmitter interacts with the alpha7 receptor of white blood cells, telling the immune system to calm down. It doesn’t suppress the immune system; it simply regulates it. A 2024 study indicated that SetPoint’s device helped people who had failed to see results from drugs. We’re still waiting on a direct comparison of traditional treatments to SetPoint’s device, but it seems encouraging.

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What about fatal diseases? Cancer is perhaps the white whale of the medical world. For years, researchers have been hunting for something better than chemotherapy to treat the second leading cause of death in the U.S. Perhaps bioelectronics can help.

First, let’s dive a little more into the technical details of how bioelectric medicine can work. The following study did not use an invasive device. Instead, it used modulated electro-hyperthermia (mEHT).

A core tenet of bioelectric medicine is that different tissues and biological responses have unique electromagnetic signatures. Understand the signature, and you can theoretically engineer the result you want. A perfect example shows up in cancer. Every cell has something called a resting membrane potential. This is the electrical difference between the inside of the cell and its surroundings. For normal cells, this ranges from -50 microvolts (mV) to -90 mV. Many cancer cells have resting membrane potentials between -5 and -40 mV, a significant difference. Additionally, due to increased metabolism, cancer cells are often warmer than normal cells.

mEHT capitalizes on these slight differences to target cancer cells while minimizing any impact on healthy cells. It uses electromagnetism, specifically radiofrequency fields, to disrupt cell membranes and ion channels. Membrane disruption is facilitated through tissue heating, while hampering ion channels (a non-thermal impact) significantly alters intracellular activity.

The difference in electrical potential offers a first wall of defense for healthy cells. mEHT is highly tuned to impact only cells with specific characteristics. Moreover, mEHT works with the natural functions of healthy tissue. Cells produce chaperone proteins to protect themselves from heat. Healthy cells can generate far more of these than cancer cells. Unlike other thermal treatments, mEHT also does not disrupt the body’s homeostatic regulation. In fact, there is some evidence that mEHT even helps the body recognize malignant cells, improving immune response across the entire body.

The preliminary results of mEHT are quite encouraging. For patients with advanced cervical cancer, the six-month local disease-free survival rate (i.e., the original location remaining cancer-free 6-months later), doubled from 19.8% to 38.6% with mEHT. When treating pancreatic cancer, the partial remission/reduction rate was only 8.3% for the group without mEHT. The group that received mEHT saw a 64.8% partial remission rate. Furthermore, overall survival time lengthened from 10.9 months to 18 months. Patients with relapsed gliomas (spinal cord/brain cancer) improved their 5-year survival rate from 25% to 83% with mEHT. These are impressive results.

Bioelectric medicine could change the medical industry. Whether it’s an implant like the SetPoint device or a noninvasive treatment like mEHT, this blossoming field has tremendous potential. For a capital allocator, this means there could be opportunity to profit from its continued growth and (hopefully) adoption. However, this is where it gets tricky. When ideas are new, they are often difficult to invest in, especially for retail investors. The industry is often confined to inaccessible private companies. You could start your own firm, but that is a challenging task. Fortunately, there are several public companies offering bioelectric products. Starting next week, we will explore these options to decide if bioelectronics is currently an investable opportunity. Subscribe so you don’t miss it!

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Banana Ball began with a new college team. In 2016, Jesse Cole created a baseball team in Savannah, Georgia, to join the Coastal Plain League (CPL). Everyone thought he would fail. He almost did, at one point selling his house to keep the team funded. Then Cole had a revelation. He already had a reputation for his bright yellow tuxedo. He rebranded his team to match this color scheme, christening it the Savannah Bananas. As the 2016 season ended, the team’s games were the second most attended of all CPL games. The Savannah Bananas were awarded “organization of the league,” a title it would earn again in 2017.

Banana Ball finally emerged in 2018. Baseball has one main issue: it can be boring. There isn’t much tension; there isn’t much entertainment. Between the 1980s and 2023, MLB World Series viewership plummeted almost 75%. Cole saw this decline and knew something could be done. So he added exhibition games. The Savannah Banana’s CPL games followed baseball rules. The exhibition games embraced “banana” rules with the Savannah Bananas dividing into two competing teams.

These games introduced Banana Ball which became official in 2020. While drawing much from traditional baseball, Banana Ball made notable changes. Instead of every run counting as a point, teams only earn a point if they have the most runs in an inning. New innings cannot be started after two hours of game play. This plus a prohibition on mound visits keeps the game moving. Some rules also incorporate the audience. If a foul ball is caught by a fan, it’s considered an out. Add in guest performances, choreographed dances, and other fun novelties, and baseball transformed into a show.

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Banana Ball was an immediate success driven by the virality of its performances. In 2022, a second team, the Party Animals, was introduced, and the Savannah Bananas left the CPL to focus exclusively on Banana Ball.

Flashforward to today. Banana Ball has evolved into a show: a display of athletics, viral dances, and guest appearances that keep fans on their toes. There are 6 teams, and Banana Ball is in its World Tour. For an organization 8 years in the making, its results are impressive. In 2025, they sold over 2 million tickets to their various events. Brilliantly, the mother company, Fan’s First Entertainment, owns and operates the ticketing service. It doesn’t rely on third parties, meaning lower prices. In 2025, they played 113 games, selling out huge venues including NFL and MLB stadiums. Moreover, its ticket redemption rate (i.e. the number of paid tickets actually used) is 91%, notably higher than the MLB’s 75-85% number.

Part of Banana Ball’s success is simply its form. MLB teams play 162 games, 81 away and 81 at home. Viewership fatigue is a real risk. Conversely, Banana Ball teams only play around 65 games across the country. Not only does the entertainment drive attendance, but the sparsity of games also boosts viewership. During one game, live attendance exceeded 100,000; with the game also broadcast on ESPN, total viewership was much, much higher.

Banana Ball is also generating considerable revenue. While exact numbers aren’t available, the league is estimated to have generated over $100 million of revenue in 2025. To be fair, the average MLB team creates two to seven times that, but this is still an impressive feat for a relatively new company.

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The success of Banana Ball reveals a greater trend. We live in a world dominated by AI. People worry about job displacement. Investors nervously wonder if the tech startups of the last decade are a model away from extinction. The future has never seemed so uncertain.

Yet some things will never change. Humans are inherently social. We will always want to interact with likeminded people. We will always want entertainment. This has been true since the first stories told around a fire to Greek plays to the advent of movies and later YouTube. Will AI change the digital entertainment industry? Probably. But live entertainment will only gain importance.

We are barely on the cusp of the AI revolution, and signs of this future are already emerging. Live Nation Entertainment (LYV), the premier provider of live event ticketing via Ticketmaster, has seen its revenue surge 12% year-over-year. Madison Square Garden Entertainment (MSGE) increased its revenue 9.6% between its 2025 and 2026 fiscal year. More impressively, MSGE has translated this into a nearly 19% growth of net income.

Then you have Taylor Swift’s Eras tour. This tour was originally meant to run for 18 months. She extended it to 22. Over the course of those two years, her tour generated $2 billion in total sales (tickets, merchandise, etc.), making Swift a billionaire.

We can’t all be Taylor Swift, but even YouTubers are getting in on demand for live entertainment. In recent years, going live has become a growing trend. Streamers pioneered this by playing video games live for anyone to watch. Now creators in all spaces, from finance to cooking to Mr. Beast himself, are capitalizing on this transition.

Why? People want to see the real person, not the cleaned up version in an edited video. There is a massive difference between a 40-minute video and multi-hour-long stream in which the person has nowhere to hide. Plus, these streams provide a sense of community. You are watching with hundreds or thousands of other people. There is often a chat in which people can interact and ask questions, either of each other or of the content creator.

Society is turning a corner. For years, technology reduced the need for human contact, accidentally hampering the human experience. This is the true fear around AI. If AI can do anything a human can do, what will the human experience become?

Many investors are trying to find the AI companies that will skyrocket their portfolios to the moon. Opportunities undoubtedly abound, but I fear they are becoming harder to find, and the gains may not last. SanDisk has grown over 3,800% in the last year. Do I wish I owned it? Of course. But this incredible surge is fueled by a current shortage in memory. What happens when chip companies find new ways to solve their memory needs (something we are already starting to see)?

There is a fascination with the novel, with the latest and greatest craze. But sometimes you have to look beyond. Morgan Housel has a great book called Same as Ever. The world is constantly changing, but some things will always remain constant. More and more, I find myself drawn to these investment ideas, the ones AI can’t upend because they require a human touch. We will always need social interaction. We will always want to be entertained. Put together, I believe the live entertainment industry is on the verge of a new age. Banana Ball is a great example of the first step toward this new world.

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Over the last few months, this is exactly what I’ve done. I never expected some of the experiences I’ve had. Talking with fellow Substackers, seeing the hearty reception of some ideas while others fell flat (then analyzing both to figure out why), learning how to use Notes (something I still haven’t fully figured out).

I’ve been writing about investing in one form or another for the last four years, so the impact this latest evolution had on my own investing shocked me too. In my quest to find the next great company, I had begun to neglect the basics. The simplicity of putting a little money every month into an index fund. The power of dividends compounding every quarter. I’m still hunting for capital growth, but this search can take a while. In the meantime, dividend and index funds have become a new home for my capital.

The last months have also honed what I want this newsletter to become. A variety of Substack authors do incredible work analyzing stocks: , , and , to name a few. I will never create the deep dives they produce. I don’t want to. I’ve realized that my Billionaire or Bust articles would likely need to follow this route to maximize their success. It’s a proven route, but not a path I want to trek.

So what do I want to write about? Definitely investing. One of my lifetime goals is to become a world-class capital allocator. I just read an article about an individual investor who became a billionaire from long-term investing. Inspirational! Investing is the single best wealth creator I know of, and this Substack will track my evolution as I learn. The topics will remain very similar: the core concepts of investing, the investors I’m learning about and their frameworks, specific trends and ideas. Heck, I’ll probably even throw in the occasional lengthy analysis just for fun.

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Honestly, this change won’t be massive. I’ll be cutting back on my articles, publishing only once a week instead of twice. This serves both personal and Substack goals. Personally, I’ve realized that Substack has become a crutch, a way to avoid the deeper thinking that remains on my whiteboard for weeks on end. I love writing; I love formulating my thoughts and finding ways to communicate them. I’m not going anywhere, but I think a step back is best.

From a Substack perspective, I hope this slowed pace will allow me to provide a better newsletter. In the last month, I’ve noticed that the rate required to publish biweekly has me rushing to research, write and edit pieces as quickly as possible. I’m not providing the value I want to create. Slowing to one article a week should generate the time needed for me to be proud of the research that goes into every article.

Finally, I will be starting a weekly chat soon. No idea what this will look like yet, so I’d love to hear any ideas you might have!

As we enter this new stage of the Millionaire Manifesto, I also want to say thank you. Without you, this Substack wouldn’t exist and wouldn’t be nearly the fun endeavor it has become. Thanks for joining me as this newsletter becomes a better version of itself. Let’s build something great!

– Kaleb

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Last week, we reduced the world of stocks to a list of dividend-paying candidates. We excluded unprofitable companies (via the P/E ratio) and those that distribute too much of their net income (with the payout ratio). Now it’s time to analyze them!

We are embarking on the most time-consuming part of investing. You’ll be tempted to rush it. Don’t. An index fund requires minimal research because the innate diversification protects our portfolio from a poorly performing company. Individual stocks remove that safety net. Fortunately, we can use a simple checklist to jumpstart our analysis. Feel free to go as deep as you want, but this list is where I always start. It often provides everything I need to finalize my decision.

1. How has the stock been performing?

2. Research the company, its industry, and its competitors

3. Are revenues and net income growing? What about expenses?

4. Does the company’s balance sheet look strong?

5. Are there any news stories I should investigate?

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If you’ve been part of our dividend journey, this checklist should remind you of how we analyzed master limited partnerships. Those are also individual companies, so we use a very similar checklist. Let’s walk through each step using an example from our filtered list.

One reason I recommend FinViz for filtration is because they make it easy to quickly review the charts of all results. A typical filter lands you on the financial tab. Now look across. See “Charts”? This feature of FinViz makes our first step incredibly easy.

Instead of a list of companies, we now see:

As we begin, we are browsing for a stock that has been growing recently. The above are monthly charts. This means each candlestick represents one month of price activity. More importantly, this allows us to see several years of stock performance. Typically, I’ll peruse these charts, looking for uptrends that catch my eye. In this case, the first candidate, HSBC, has had strong growth since 2020. It will be our example as we work through the remaining steps.

Right now, we only know that HSBC offers a 4.16% dividend (projected to be 4.55%) and that its stock price has grown 184% in the last five years. We don’t know anything else: its industry, its competitors, etc. Time for step two.

Previously, this step would take lots of Google searches, reading report after report, and hours of time. Now, ChatGPT and other chatbots have made this process incredibly simple. All you need is your favorite LLM and the following prompt (being sure to update the company name and ticker). Personally, I always use the deep research tool, but not everyone has access to this. Here, I will use base ChatGPT. Just know you will get better results using deep research. My research prompt is:

You are a world-class stock analyst focusing on companies with strong dividend yields. I am researching [company] which trades under ticker [ticker]. Please create a world-class report evaluating this company, its competitors, the industry, and the current macroenvironment. In particular, focus on:

1. The company’s financial performance over the last year, looking at revenue, expense and net income growth. The balance sheet is also essential to evaluate, particularly cash, current assets and liabilities. Be sure to investigate and note any oddities you discover.

2. The company’s competitive edge and competitor’s performance. This should be a comparative analysis highlighting the company’s strategy and how its competitors fit around this. Please be sure to summarize competitors’ financial performance as well.

3. A detailed overview of the industry in which this company operates. It should highlight challenges faced by both this company and the industry in general as well as current trends/opportunities that could unfold in the next 5 years.

4. Please conclude with a general overview of the specific risks that could compromise this company, its financial performance, and the dividend or stock price.

The resulting report is far too long to include here, but here are the highlights. HSBC is a global bank with an emphasis in Asianic markets. It has almost $2 trillion in deposits. ChatGPT notes that while revenue and net income have been growing, income before taxes actually declined. The company has been restructuring, selling it bond portfolios, and paying for legal matters. Total expenses grew 10%, while expenses related to the actual underlying business only increased 3%. ChatGPT mentions this discrepancy is important to watch as the company continues streamlining its operations.

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The biggest risk identified is HSBC’s loans. Expected credit losses have grown 13%. Here, the Asianic focus becomes a weakness. China’s and Hong Kong’s real estate markets, to which HSBC is highly exposed, are struggling. This could threaten the bank’s viability. Finally, the chatbot summarized various competitors. It mostly focused on larger companies like JP Morgan and Citigroup, but it did include a smaller firm, Standard Charter.

The beauty of using AI to do this work is we are simply collecting information. In a few minutes, a chatbot can aggregate what would take us hours to find. This provides a direct roadmap for our later analysis. The chatbot noted expenses, exposure to credit losses, and growing revenue. All three can later be evaluated when we dive into the financials. It may be worth researching the real estate industry of China and Hong Kong, but we’ll decide later.

Now we turn to the company’s financials. Because HSBC is a foreign company, its annual report is called a 20-F and can be found through the SEC’s Edgar search engine. We’ll begin with the income statement.

I see something worrisome right away. Net operating income has had decent growth. The same is not true of “Profit for the Year.” Even more concerning, operating profit is in a three-year downtrend. Honestly, this alone would end my research. When analyzing individual companies, you are looking for reasons not to invest in the company. You can always find a reason to invest, some story that persuades you to overlook everything else. Instead, our mentality should be to figure out what’s wrong with the company. Research until you either find something that disqualifies the company or until you realize there’s no reason not to invest.

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For example’s sake, I will stick with HSBC. After examining the income statement, we turn to the balance sheet. Given HSBC industry and geographic focus, this is important.

Almost one third of HSBC’s assets are loans. And expected losses are growing. It took some digging to find, but expected losses are actually up 14.7% year-over-year. This is particularly worrisome because this ratio is declining at other banks. Blame the concentration on Asia’s real estate. I briefly checked China’s real estate market, and it’s not good. I’m not surprised HSBC expects growing credit losses.

The final step is our catchall. If, unlike with HSBC, you are still optimistic about the company, a quick Google search of company ticker with “news” will often return a myriad of articles about the company. ChatGPT will usually have already identified these sources in our initial summary, but occasionally you’ll find something it missed.

Once your analysis is complete, you either pull the trigger and buy the stock, or you move on to the next company. At risk of repeating myself, don’t rush the process. It can be demoralizing to analyze company after company, always finding a reason not to invest. Don’t lower your standards. Investing in individual companies isn’t easy. You must put in the work to find the truly worthwhile investments. This is why an index fund is so much easier for many people. You gain the benefits of investing, but at a fraction of the needed research. But if you’re willing to take on the challenge, individual stocks, especially stocks with dividend yields, can be very rewarding. This checklist should give you a place to begin, and as you learn and conduct your own analysis, your personal checklist will undoubtedly evolve. The world of stocks lays before you. Good luck!

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I’ve been on a dividend soap box for a while. My last five Thursday articles have detailed how investors can improve their passive income by focusing on various opportunities. But this ignores a bigger question. Should companies even pay dividends?

Investors make money through capital appreciation or when a company returns cash. Most people will immediately think of dividends as the second option, but they aren’t the only way. Companies also return capital by buying their own shares.

How does this return capital to investors? In terms of cashflow, it doesn’t. Suppose company ABC has 1 million shares outstanding, trading at $100 per share. The company is worth $100 million. ABC has $10 million in excess cash, and, instead of paying a dividend, it decides to buy shares. It buys approximately 100,000 shares and then cancels them (i.e. destroys them). With less cash, the company is now worth $90 million dollars. But with only 900,000 shares outstanding, the price doesn’t change. It’s still $100.

How does this help investors? It’s nuanced. For the investors who sold 100,000 shares to the company, they received cash. For every other shareholder, the reward is simply that they now own more of the company. Previously, a 10,000-share position was 1% of the company. Now it’s 1.1%. In theory, this could also buoy the stock price because now each share is worth a little more of the pie.

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In recent years, buybacks have become increasingly popular.

This growing utilization has sparked a major debate both inside and outside the financial world. Investors debate whether dividends or buybacks are superior. Politicians argue whether buybacks are anything other than price manipulation.

Senator Elizabeth Warren has claimed that buybacks are manipulation and allow companies to avoid benefiting their investors. During the Biden Administration, President Biden implemented a 1% tax on buybacks. Many politicians see buybacks as some form of corporate greed that must be irradicated.

It’s easy to see their confusion. Buybacks seem to almost magically vanish cash with no impact on the underlying share price. It’s only when you consider equity ownership that buybacks look attractive. Nevertheless, these politicians might be on to something. Companies often have a perverse incentive to implement a buyback policy.

Executive compensation is often tied to per share metrics like EPS (earnings per share). If the company fails to hit its target organically, a buyback program finish the job. Suppose the CEO of ABC will receive a bonus if the company earns $1.50 per share in the next fiscal year. By month eleven, the company is projected to barely reach $1.35. Based on the initial million shares, this corresponds to $1.35 million in net income. After the share buyback, there are only 900,000 shares. The EPS jumps from 1.35 to 1.5 ($1,350,000 / 900,000), and the CEO gets his bonus. With this incentive, it’s easy to understand the worries around manipulation.

Technically, this isn’t real price manipulation, at least not manipulation that can be punished. For years, stock buybacks were completely outlawed over fears of manipulation. For example, a company could artificially boost its own stock price through enough buying. Then in 1982, the SEC implemented Rule 10b-18 (catchy name, right?), creating a checklist through which companies could purchase shares while avoiding charges of price manipulation.

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Executives can certainly benefit from buybacks, but do they help investors? One of the main arguments in their favor is tax efficiency. A dividend creates an immediate tax obligation for investors. This also introduces double taxation on net income. The company already paid income tax, and now its investors must do the same on their dividends. A buyback avoids all of this by simply boosting ownership. Investors see their holding grow without facing any tax obligation until they sell their shares. This means investors keep more of their wealth over time.

There is also evidence that buybacks improve market functionality. A 2021 study found that buybacks shrink the shares’ bid-ask spread by almost 15%. This means better liquidity when investors buy or sell the stock, and theoretically slightly better cost basis. Improving liquidity makes markets operate more smoothly, and a 15% improvement is fantastic.

The study also identified a 17% reduction in volatility for stocks with buyback programs. This is a tremendous reduction, and if you’ve been a reader for some time, you know how dangerous volatility can be. Less volatility means your gains stay around longer and your portfolio grows less chaotically.

These findings are certainly good news for investors, but what are the cons? From a corporate perspective, buybacks create the risk that the company burns cash. If the company buys shares, only for the share price to fall even further, the company has nothing to show for its efforts. It has weakened its balance sheet, and shareholders gained nothing. This ties into why some investors dislike buybacks. Buybacks give an investor zero control over their allocation. And unlike the permanence of cash, price appreciation can quickly vanish.

We’ll return to ABC to highlight both objections. As the company goes from one million shares to 900,000, imagine Bob, an investor who owns 100 shares. As the buyback concludes, he owns more of the company. If the price grows, perhaps as the higher EPS attracts new investors, Bob will be rewarded. But if the stock price does nothing, Bob received nothing more than intangible equity. Or maybe Bob is perfectly happy with his ABC ownership and doesn’t want any more. If he received a dividend, he could take that payment and invest it elsewhere. But with a buyback, he has no choice but to receive more ABC.

The flexibility of dividends is part of why investors love them. Investors can use dividends to reinvest; to deploy into another opportunity; to live on. Yes, dividends create an immediate tax liability (either as ordinary income or as long-term capital gains), but that is the price of flexibility.

Dividends also have a notable impact on investor returns. In a 50+ year study, researchers compared the returns and volatility of dividend-paying stocks to both non-payers and the general market.

Stocks with dividends saw 25% more price growth than the broad market, and more than double that of non-paying stocks. Meanwhile, volatility fell by 6.8%. Not quite as high as buybacks, but when you consider the added price growth and the flexibility of dividends, this seems to give dividends an edge.

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Here’s the catch. Consider companies that cut dividends. Over a period in which the market returned more than 7.5%, this group saw negative annual returns. While this is not surprising, it highlights a key threat any company faces by paying dividends.

Investors like dividends. Many choose investments based solely on dividend yield. This means once a company starts paying dividends, there is pressure to keep the checks coming. Failure to do so is often punished with a lower stock price. Lumen Technologies cut its dividend in November 2022. Over the next 6 months, the stock collapsed 60%. To be fair, there were also operational issues, but cutting the dividend only exasperated the situation.

In comparison, buybacks don’t carry the same weight. Companies can start a buyback program without worrying about it going in perpetuity. After all, buybacks are poised as, “we don’t see anything else of value, so we’re going to buy our own shares.” It’s easy to later change your tune when opportunities arise.

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So how best to return capital to investors? In my eyes, it really comes down what the investor wants. Buybacks are certainly more tax efficient and can boost your personal ownership of the company. But there isn’t any other obvious upside.

Conversely, dividends offer a world of opportunity. You can invest it, live off it, put it under your pillow, you have complete control because you received cash. This cash historically comes with an equal dose of capital appreciation. Additionally, dividend stocks continue to have strong performance while simultaneously reducing volatility. But, of course, there is the extra tax burden to bear.

The point of returning capital is to benefit investors when the company sees nothing new to pursue. Instead of the cash sitting around (or worse, squandered on meaningless projects), it is returned to investors. In industries that have strong cashflows, dividends excel. These companies have the strength to maintain the dividend for the foreseeable future. For companies that require more agility, buybacks may be better. These offer the flexibility to return capital without the looming threat of a later cut. Both approaches have strengths; both have weaknesses. Nevertheless, dividends are usually the best way to return capital.

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We’ve reached the end. In the last month, we’ve explored how we as investors can increase our passive income. Whether you are looking for additional capital to invest or hoping to build cashflow to live on, everyone can benefit from dividends.

We started with the simplest approach: dividend index funds. This choice combines the power of averaging with a dividend focus to more than double yield without much research. Then we tackled the complexities of income funds, enticing investments that require detailed investigation to match our investment goals. Finally, the last two weeks have explored two specific company types: REITs (real estate investment trusts) and MLPs (master limited partnerships). We noted potential diversification, improved returns (especially with REITs), and the tax advantages of partnerships. One avenue remains untouched.

The final stop on our journey is the riskiest. By now, hopefully you are more familiar with conducting analysis on funds and companies. These skills will be tested as we delve into the world of individual stocks with above average yields.

Even before starting, the first risk appears. This category lacks constraints. Previously, we focused on specific asset classes: index funds, income funds, REITs, and MLPs. Now, almost anything goes. If it pays a dividend, it has potential. How do we begin our search?

The best approach is to use a stock screener. There are many options, but FinViz offers a great one. It can be a little overwhelming for new users, so let’s break it down (You can use the same premade filter at this link).

This screener uses three criteria:

1. Dividend yield greater than 4%.

2. P/E ratio greater than 0.

3. Payout ratio under 50%.

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Dividend yield is the most subjective. As of this writing, the average S&P 500 company pays 1.41%. Cash in a bank account often earns a little over 3%. If I’m trying to increase my portfolio’s income, I’m personally going to look at options above the 3% level. There’s a bit more risk, but if I’m already looking at individual stocks, it’s a risk I’m willing to take. It’s a personal choice. Just know that as dividend yields climb, the amount of research needed also increases. If something is paying 6% or more, you need to know how and why.

One possibility is that the stock price has recently collapsed. Suppose a stock trades at $100 per share and pays $5 annually. This stock has a 5% dividend yield. If this stock then declines to $50, the yield becomes 10% because it only cares about historic dividends.

This is not an immediate deal killer. Perhaps you’ve stumbled upon a stock the markets have abandoned despite financial strength. Or perhaps the markets know something you don’t. Maybe earnings are falling, the company’s competitive edge is crumbling, or the industry is changing. A few weeks ago, we saw how rising rates halved the value of some REITs. This didn’t inherently impact their fiscal operations, but it did dramatically change the value of the underlying properties. If the dividend yield is only high because the stock price is falling, you know what caused the price declined.

Additionally, companies with super high dividend yields often just don’t perform as well. In a near century long study, researchers divided companies into five groups based on dividend yield. You might expect the first quintile (the highest yields) to outperform the markets. They didn’t.

Over the 95-year period, quintiles 1, 3, 4, and 5 beat the S&P 500 50% of the time. If they had no distinct edge, this is exactly what we would expect. But the second quintile outperformed the market 60% of time. Why did the second group do what the first couldn’t? Likely because the first group got ahead of itself.

The key to dividend investing is to find well-established companies. This is exactly what the second group included. The first quintile fell victim to the example given earlier: companies that boast high yields simply because the underlying company is weakening. Remember, dividend yield is calculated using the last twelve months of dividend activity. It takes time for the realities of the present to impact it. This means higher yields even as the stock’s performance eliminates those gains.

Ultimately, the dividend yield you screen for is your choice, but this hopefully can guide your decision. Once we’ve narrowed the field of companies to those offering dividends, the next two filters help us find established companies.

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The price to earnings ratio, typically known as the P/E ratio, takes the market cap of a company and divides it by net income. It measures how much investors pay for each dollar of net income. For example, the average company in the S&P 500 has a P/E ratio of 31.5. This means an investor is paying $31.50 for each $1 of earnings from the underlying company. In comparison, a company like Tesla trades in the 380s. Investors are paying a lot more for the same $1 of profit.

In most cases, the P/E ratio is used as an initial proxy for valuation. But in our case, the P/E ratio filters out unprofitable companies. We want strong companies; we want profitable companies. If a company can’t earn a profit, it has no business paying a dividend. Sometimes unprofitable companies do pay dividends, but this is not sustainable. Hence, we want to avoid it. Preferably the company has a long history of profitability, but that’s something we’ll explore later.

The final criteria is a payout ratio below 50%. The payout ratio compares total dividends paid to the company’s net income. If a stock has a payout ratio of 50%, 50% of its net income was paid to shareholders. This is why the ratio must be under 100%. If the ratio is higher, say 110%, the company is distributing more in dividends than it’s earning from its operations. This is unsustainable.

Returning to our 95-year study, the first quintile had an average payout ratio of 74%. The second group had an average ratio of 49%. These companies had more cash to reinvest, more cash to grow, more cash to pay down debt. No wonder these companies performed better. They had the financial flexibility to do so.

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If you’ve been on this journey with me since the beginning, you’re probably wondering how REITs fit into this. After all, REITs payout at least 90% of their net income. Is this an issue? No. REITs don’t have a choice. They are meant to be a vehicle through which retail investors can access real estate. In comparison, individual companies have a responsibility to grow, to expand operations, and to seize upon new opportunities. As such, the differences are significant enough that a REIT’s higher payout ratio is not a concern.

And just like that, we’ve reduced thousands of stocks to an approachable starting place. We haven’t constrained ourselves by industry or company type, but we have filtered out unprofitable companies and those that pay too much. Now we need to analyze them. I’ll be honest. When I started this article, I thought it would be the conclusion of our 5-week journey. I was wrong. The avenue of individual stocks is longer than initially expected. We’re only halfway there. Next week, we’ll learn what to do with this curated list of candidates. Subscribe so you don’t miss it!

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

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My mom and sister recently returned from a trip across Germanic Europe. As we drove home from the airport, their stories filled the car. The German bicyclist who biked up a steep flight of stairs. The Swiss woman who refused to fulfill their fondue order because it was “too much cheese.” The Swiss tour guide who mentioned that very few people truly own, or even want to own, their home in Switzerland. Per Swiss tax law, the mere ownership of a home creates a significant tax burden. To avoid this, most citizens rent or hold decades-long mortgages (sometimes up to 100 years). I had to know more.

The law is called eigenmietwert and means “imputed rental value,” a direct nod to its functionality. In any real estate market, there are two broad categories of homes: rental homes and owner-occupied properties. In 1934, Switzerland found itself facing a severe budget crisis. It needed tax revenue. Someone discovered a loophole. The Swiss government received money from landlords who paid income tax on rent from their rental properties. But private estates? Those properties were untaxed.

Eigenmietwert was born. Every year, the local government (the canton) determines what the theoretical rental rate would be for every privately owned property. This is annualized and discounted, with the final amount attributed to the homeowner as taxable income. For example:

In this case, the individual makes 100,000 CHF (about $127,500) and owns an approximately $1.3 million dollar home (assuming the mortgage is 80% of the home’s value). Working through the table, the canton decides that such a home could rent for 3,000 CHF per month, providing 36,000 CHF per year to a hypothetical landlord. Since this is really a private property, a discount rate of 70% is applied, yielding 25,200 CHF of taxable income.

Then the deductions arrive. Mortgage interest is deductible as are repair and maintenance costs. These offset almost 80% of the phantom income, but the homeowner still sees a 4.95% increase in their taxable income simply for owning their home.

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This has created an environment in Switzerland in which few now own homes. Switzerland ranks far below any other European country in home ownership rates. Official numbers vary, but between 36% and 47% of the country own a (typically mortgaged) home. In some cities like Geneva, this rate drops below 20%. Comparatively, the average country sees a 74% ownership rate. This makes sense. Who wants to sign up for taxable income that you didn’t even earn?

The impact goes deeper. Switzerland is one of a few countries that is constitutionally required to maintain a balanced budget. Since its implementation in 2003, this has tremendously improved government debt. Before the constraint, the public debt to gross domestic product (GDP) ratio had grown to 25% and looked to be on its way higher. Now, this ratio hovers near 15%. Compared to its GDP, Switzerland’s government has less debt than 95% of other countries. The same can’t be said of its populace.

Eigenmietwert creates two tiers of incentives: 1) don’t buy a home, or 2) if you do, use as much debt as possible and refurbish it as frequently as you can. Both reduce the phantom income. The Swiss population has embraced this to the fullest. In 2023, Swiss household debt exceeded 120% of the country’s GDP and ranked it the #1 country in the world for most household debt. In 2025, Switzerland was the only European country whose household debt exceeded its GDP.

Maybe Switzerland just doesn’t produce much. This would suppress GDP, so any amount of debt could create a high debt to GDP ratio. Unfortunately, this isn’t the case. Switzerland has the 8^th highest GDP in Europe, outperforming the likes of Poland and Austria. It ranks 20^th globally.

Its GDP per capita is even more impressive. Among its European peers, Switzerland ranks 5^th. Compared to the world, only the addition of Bermuda knocks Switzerland down to 6^th place. Switzerland does not lack GDP, so the level of household debt clearly shows the impact of its tax code.

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This gets to the heart of what a tax code is. Most people view it simply as the primary way governments earn revenue. While true, this is only the tip of reality. A tax code is a set of incentives. Do the right things, finance the right projects, etc., and the tax code works in your favor. Fail to do so, and you’ll feel the full extent of its greed.

One recent example is electric vehicle (EV) tax credits in the U.S. For many years, the purchase of an electric vehicle came with a juicy incentive: a $7,500 tax credit. Something that would reduce your tax bill dollar-for-dollar. Individual states often added their own tax benefit, furthering the gain. Why? The federal government wanted to increase the number of EVs on the road. Subsidizing consumers with extra money is a great way to accomplish this.

The true impact has only recently become apparent. With the passage of the Big Beautiful Bill last July, the tax code changed. The federal EV tax credit would cease to exist. Within months, EV sales collapsed. Incentives changed; behavior changed.

This is why tax law projections are typically off by hundreds of millions of dollars. The model fails to consider how consumer behavior will change to avoid taxation. It assumes the world will continue to operate as it currently does, or, if behavior change is included, it assumes behavior will evolve slower than it does.

In 2008, Maryland increased its top income tax rate to 6.25%. This was projected to increase revenue by $106 million. Instead, revenues fell $257 million. While the talons of the Great Recession could be blamed, a Bank of America study found that in the wake of this increase, $1 billion of wealth left Maryland. Behavior change more than expected and annihilated the projected benefits.

Avoidance doesn’t have to mean physically leaving the state either. In 2019, Illinois increased its tax on cigarettes by 50% to $2.98 per 20 cigarettes. Consumption didn’t change. But smuggling did. In the next year, cigarette smuggling increased 14%, launching Illinois to 7^th place for most smuggling activity in the country (in 2019, it ranked 16^th). This surge in smuggling avoided $334 million of taxes.

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Why bring this up? Time and again, changes in tax code alter human behavior, yet politicians continue to underestimate this. The Californian populace is likely to vote soon on whether a 5% net income tax should be levied on the state’s billionaires. Setting aside any potential constitutional debates, merely the possibility motivated six billionaires to already relocate. Even crazier, while only six billionaires left, those few individuals would have generated 27% of the tax’s projected $100 million of tax revenue.

Meanwhile, just a month ago, politicians in New York proposed a tax on second homes valued at over $5 million dollars. Advocates claim it will increase tax revenue by at least $500 million. But if incentives change, so will behavior. New York City’s current Comptroller has warned that incremental revenue could be as low as $340 million as property owners sell, rent out, or return to live in their New York residences. U.S. politicians still haven’t learned the lessons of eigenmietwert.

Tax code isn’t a revenue generator; it’s an incentive machine. People will go to great lengths to avoid higher taxes. In Switzerland, the populace assumed massive amounts of debt to avoid the phantom income of home ownership. But this is about to change. In 2025, the Swiss successfully abolished eigenmietwert. By 2028 or 2029, homeowners there will face a simple property tax, and mortgage interest and repair deductions will end. The tax code is once again changing. Now the question becomes: how will behavior change?

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Thank you for reading! I strive to help everyone understand the financial world and gain the skills needed to have financial success. But I need your help. Please share this article so we can help others start building lasting wealth.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

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What if your dividends were tax deferred? You receive the money now but don’t pay taxes on it until much later. Seem too good to be true? It isn’t. Over the last three weeks, we’ve explored various ways investors can increase their passive income. We started simple with dividend index funds. Then we navigated the complex strategies of income funds. Last week, we surveyed how real estate investment trusts (REITs) provide diversification, reduce volatility and can even outperform the markets. Now we turn to a new entity: master limited partnerships (MLPs). MLPs not only provide strong passive income but also offer distinct advantages not found elsewhere.

While corporations are divided into shares and have shareholders, partnerships are very different. Partnerships have two components: the general partner (GP) and a set number of limited parters (LPs). The GP is responsible to operate the business and is often its own entity, such as a corporation. LPs, on the other hand, often provide the partnership with capital. As such, they are entitled to a portion of any income or loss the partnership incurs.

For example, almost all hedge funds operate as partnerships. The GP is the asset manager. It is responsible for managing the money and hopefully generating returns. The LPs are the investors. When the fund generates income, this profit flows through the partnership to the LPs. As such, partnerships are pass-through entities, which has important tax implications.

A corporation pays income tax on any profits. If it then decides to pay its shareholders a dividend, guess what? That dividend is considered income to the investor, so each investor must also pay taxes. Dividends from a corporation are double-taxed.

Partnerships sidestep this. Instead of the company paying income tax, all profits (and the subsequent tax obligation) are simply passed through to the individual partners. As such, partnerships are considered more tax efficient.

An MLP combines the benefits of a partnership with the liquidity of the public markets. On any given day, you can buy and sell shares (technically “units”) of the partnership and, come tax time, you’ll receive a K-1 (partnership tax form) instead of a 1099-DIV (dividend tax form). While this can make your taxes slightly more complicated, it typically is more minor inconvenience than true complication.

That said, investors can encounter issues with MLPs in retirement accounts. Buying units in a retirement account makes the account a partner. But retirement accounts weren’t meant to play this role. As such, MLPs can trigger Unrelated Business Income Tax (UBIT). Since the shared profit/loss flows through to the retirement account, the retirement account itself might need to file a tax return. While many brokerage firms will do this for you if needed (and UBIT under $1,000 is rarely a concern), it is worth mentioning.

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While the MLP structure could originally be used by any company, Congress quickly worried that too many MLPs would significantly reduce tax revenue since they essentially eliminate double taxation. In 1987, Congress restricted which companies could become an MLP to natural resource companies and some real estate or capital asset managers.

In fact, almost all MLPs operate in the oil and gas industries, particularly as midstream servicers. These partnerships fill the role of transporting and storing energy products between extraction and final processing. While not as beneficial as the addition of REITs, this emphasis on energy does provide some diversification.

Additionally, the taxation of MLP distributions is a powerful attractant. Most dividends are taxed as ordinary income or long-term capital gains (in the case of qualified dividends). Either way, every dividend creates an immediate tax liability. Distributions from MLPs are tax deferred. When you receive a distribution from an MLP, it isn’t considered a dividend. It is considered a return of capital. Remember, traditional LPs often supply capital to initiate the partnership. Any distributions received reduce the capital at risk. In practice, this means MLP distributions reduce your cost basis.

Suppose you buy units of an MLP called “MM’s Energy” for $100 a unit. Over the next year, the partnership distributes $8 per unit. Instead of earning taxable income, this $8 marks down your purchase price. Your units now have a cost basis of $92, not $100. Hence, your lower cost basis means a higher tax bill, but only if you sell your units.

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Now we understand MLPs. Are they worth pursuing? With any high dividend company or fund, it is important to not only examine the dividend yield but also consider capital appreciation. Theoretically, dividends act as a damper on price growth, so there is always a risk that high dividends essentially trade capital gains for current income.

Fortunately, MLPs have historically provided both. The three biggest MLPs trade under the tickers ET, EPD, and MPLX. Over the last 5 years, ET has grown 133% and today boasts a 6.73% distribution yield; EPD has increased 67% while paying 5.73%; MPLX has risen 109% and currently distributes 7.63%. Even an index fund of MLPs (MLPA) has grown 57% over the last 5 years and returns 7.08% of distributions. With the S&P 500 up 70% in the last half decade, many MLPs have dramatically outperformed the market even before considering their distributions.

How do we choose an MLP? The process is the same as evaluating any individual company. Stock analysis can become a complicated and time-consuming process, especially if you dive into the minute details. It also tends to evolve as you continue investing. Nevertheless, this checklist is where I start and should provide a good launching point.

1. What is the structure of the MLP?

2. Are revenues and net income growing? What about expenses?

3. Does the company’s balance sheet look strong?

4. Are there any news stories about this company I should investigate?

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An MLP’s structure is important. We want to know who the GP is and how the MLP is connected. These outlines also reveal the number of existing units and who owns what. Here are two examples from MPLX and ET.

As you can see, the structure is very different. ET has a private GP while the MLP itself owns not only interests in other MLPs but also another publicly traded company. MPLX, on the other hand, stems from Marathon Petroleum Corporation (MPC) which owns the GP. Since MPC is a public stock, I’ll probably spend some time reviewing its financials when analyzing MPLX. But in ET’s case, evaluating subsidiaries is not nearly as important.

Finding these structures is simple. Every publicly traded company or partnership files quarterly reports with the SEC. These are accessible via https://www.sec.gov/search-filings. You can search an MLP’s ticker and navigate to the annual report (typically the 10-K). There, you should find the flowchart in the Business Overview section.

Once we’re in the annual report, we can begin step 2. While the business overview is at the top of a 10-K, the financial statements are found in the middle or toward the end. Use the table of contents to find them.

The first thing I check is revenue and net income growth.

As we can see from ET’s latest 10-K, its revenue has grown steadily from $78.5 billion in 2023 to $85.5 billion last year. But check out total costs and expenses. Expenses are growing, and they’re outpacing revenue. You can tell because operating income is lower in 2025 than in 2024. This led to a 5% decline in net income in 2025 (not pictured). This prompted me to wonder why. Part of the reason is a 5x increase in impairment loss, due to a suspended natural gas project. This type of insight is exactly why we start with the income statement.

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Next, we move to the balance sheet, where we can evaluate the MLP’s assets and liabilities. If long-term debt is growing, I want to know why.

Per MPLX’s balance sheet, debt has grown more than 25% in the last year. Notable. But I couldn’t find a truly worrisome reason, and it only marginally impacted the asset to liability ratio. Could I be missing something? Of course. But for now I don’t see anything troubling.

The final step is a catchall to confirm we didn’t miss something obvious. I will typically google the ticker plus “news.” This returns news articles, analyst reports, or other content related to the MLP. Sometimes you’ll find something interesting; sometimes you won’t. With today’s AI tools, another fabulous strategy is to explain you are researching an MLP and would like the chatbot to do a deep dive into the company and its financials, consider current trends in the industry, and identify key threats and risks. If you have access to an LLM’s deep research functionality, this becomes even more powerful.

Once your research is complete, it’s the moment of truth: will the MLP join your portfolio? Or will you pass? Jeff Bezos offers wise words for this situation. In his 2016 shareholder’s letter, Bezos argued that decisions should be made once you have 70% of the information you wish you had. Waiting for the final 30% often means you move too slowly and miss an opportunity.

MLPs provide a valuable opportunity to investors seeking not only energy exposure but also higher dividends. While many stocks pay less than 2%, MLPs often distribute 6% or more annually. Moreover, since MLP ownership is measured in units, the tax deferment is yet another benefit, especially for long-term investors. Is the research more time-consuming? Yes. You are evaluating the performance of an individual company and formulating a theory about its future. But this work can pay for itself when distributions and (hopefully) capital growth prove your thesis right. For some, checking a dividend index fund is all the work they want to do. But if you are willing to take a step into riskier territory, your portfolio could find a profitable partner.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

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Imagine an asset that returns nothing. It fluctuates up and down, but over any stretch of time, your return is 0%. This seems like a worthless asset. But what if you could take this useless entity and create positive annual returns? Your portfolio would go from the orange line to the blue.

What’s the secret? A little-known strategy called Shannon’s Demon.

Claude Shannon was a brilliant mathematician who lived from 1916 to 2001. I’m guessing you’ve never heard of him, but without his ideas, our world wouldn’t exist. As a simple example, all computers use something called a bit. This is a numeric representation of data and is something computers rely on. Shannon was the first person to mathematically explore bits. He is rightfully known as the father of Information Theory.

But when he wasn’t creating the future, he also tinkered. He built the first juggling robot (out of an Erector set). He published one of the first papers on how to teach a computer to play chess. He also turned his mind toward the mathematics of volatility.

Shannon proposed an experiment. Imagine you have a coin. Every time you flip a head, you gain 50% of your current bankroll. Every time it lands on tails, you lose 33%. Seems like a good deal, until you actually run the numbers. For simplicity’s sake, we’ll assume we get an oscillating sequence of heads and tails. Despite earning seventeen percentage points more on heads, you will barely breakeven.

This is because a gain and a loss are very different. Suppose you start with $100. If you lose 10%, your balance falls to $90. You might intuitively think a 10% gain would correct this. It won’t. In fact, you need an 11.1% gain to return to your starting point. This phenomenon is called volatility drag and is exactly why investors should avoid volatility at all costs.

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The S&P 500 moves about 1% each day on average, either up or down. But because each gain fails to compensate for a similarly sized decline, your portfolio will slowly erode. Over the course of a year, you will lose about 1.25% simply due to the S&P 500’s volatility drag.

Claude Shannon found a solution that not only eliminates this loss but also can provide a marginal gain. Instead of allocating 100% of your portfolio to an asset, you split it between two uncorrelated assets, typically a stock/index and cash. You begin with 50% cash and 50% stock/index.

Shannon’s Demon only has one requirement: the 50/50 split must be maintained. Suppose you start with $5,000 in SPY (an index based on the S&P 500) and $5,000 in cash. On day one, SPY falls 1%, so you have $4,950 of SPY and $5,000 in cash. To keep the 50/50 split, just before the market closes you buy $25 more of SPY. The next day, SPY rallies 2%, so your SPY position is now $5,075. Again, the 50/50 balance must be conserved, so you sell $50 of SPY, converting it into cash. This is the core of Shannon’s Demon. Every day you rebalance your portfolio to an even split.

At first glance, this seems wrong. You are deliberately reducing your position when it performs well. You are increasing your position as the stock/index falls. This seems to be the opposite of “sell your losers and hold your winners.” How does it perform?

Let’s return to the original coin flip and a $20,000 bankroll. Heads you win 50% of your current balance, tails you lose 33%. Assuming we get an alternating sequence of heads and tails, your account will oscillate between $13,333.33 and $20,000. But apply Shannon’s Demon and your $20,000 turns into over $120,000 after 90 flips.

This is the most fascinating application of Shannon’s Demon. A situation in which you will only break even becomes a money-printing machine.

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Of course, the real world isn’t so simple. Let’s model a 1% random daily move, mimicking the S&P 500. Unfortunately, the results are much less impressive. Here are four simulated bankrolls with orange being 100% asset and blue being Shannon’s Demon.

When the markets rip, Shannon’s Demon underperforms. This is expected. After all, every good day reduces your exposure to that asset. During a winning streak, your gains will be less than had if you never readjusted. But while the gains might not be as massive, neither are the losses. The biggest takeaway from these four graphs is that Shannon’s Demon dramatically reduces volatility. In these simulations, portfolio volatility fell by 50% on average.

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How is it that rebalancing creates returns out of thin air (the coin flip) or reduces market volatility? Consider volatility drag. Every loss requires a greater gain to compensate. Shannon’s Demon works by capturing the gains of good days. There is less at risk for a potential bad day. And when bad days come, you add to your holdings, thus increasing the gains from future good days. Over time, this slowly turns the mathematics of volatility in your favor.

While a fascinating concept, it isn’t without its flaws. When Shannon first developed this idea, trading was incredibly expensive. You might pay $15 or more just to place an order. This environment annihilates the benefits of Shannon’s Demon.

The modern situation is drastically different. Thanks to Robinhood, trading is essentially free. Moreover, the advent of fractional shares means it’s easier than ever to maintain a perfect 50/50 split. Nevertheless, there is one impediment: taxes.

Actively trading is one of the least tax efficient things a person can do in a non-retirement account. Every realized gain is taxable, and Shannon’s Demon requires realizing gains before downward volatility can steal them away. As such, implementation often comes with a higher tax burden than simply holding the underlying account and dealing with its volatility. In a retirement account, however, this concern is mitigated since capital isn’t taxed until it’s withdrawn.

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Should you implement Shannon’s Demon into your own portfolio? The reduction in volatility is certainly attractive. By smoothing the swings of the market, you not only create a less emotionally taxing portfolio, but you also minimize the devastation of market falls. But it is a lot of work, especially for a retail investor. You must trade every day, balancing your account perfectly. Even if you avoid the tax implications by trading in a retirement account, this is time-consuming.

For retail investors, the lesson from Shannon’s Demon is less its application and more the impact volatility has on your portfolio. Few realize that a 10% loss is not recovered by a 10% gain. That alone is worth acknowledging. From a portfolio perspective, this means evaluating the beta (volatility of a position relative to the S&P 500) and asking if extra volatility is really worth it.

For those wanting to take a step further, Shannon’s Demon can offer an edge. I once modeled the results of balancing between a stock and an ETF that shorted the stock, essentially harvesting the daily volatility. It didn’t beat the market, but it was still profitable with much less volatility. But is it worth the effort? I don’t know.

Much like the man who discovered it, Shannon’s Demon has been forgotten by most. But it is a fascinating tale of taking a volatile environment and turning it into something truly beneficial.

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.

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Real estate is often touted as the answer to passive income needs. Buy a property, rent it, then let the passive income flow. But this dream is often far from reality. Assuming you have the required capital, owning real estate opens Pandora’s Box. Perhaps a tenant violates the lease, parks on the yard, and kills the grass. Maybe a picture falls off a bathroom wall, miraculously slices a water line and floods the downstairs unit (real example!). Expenses can add up. The possibility of passive income exists, but there are many risks.

Over the last two weeks, we explored how dividend index funds and income funds can provide passive income. Now we’re surveying a new asset class: real estate investment trusts (REITs).

A REIT produces income by owning and operating real estate (or from real estate adjacent assets like mortgage-backed securities). Originally introduced in 1960, REITs were pitched as a way any investor could access real estate. To achieve this, REITs are required to distribute at least 90% of their income through dividends.

In the 65 years since, REITs have expanded into every niche of real estate. Apartments and single-family homes, yes, but also shopping centers and hotels, data centers and communication towers, public storage and hospitals. REITs no longer offer exposure just to real estate; they provide access to otherwise untouchable markets.

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A main lure of REITs is the dividend. The average S&P 500 company boasts a 1.41% dividend yield. Many companies don’t even pay dividends. In comparison, an index of all REITs pays 4%. I’ve found individual REITs with yields from 2.4% to 13.1%. The potential to dramatically improve your passive income is high.

Incidentally, the REIT with the 13.1% yield was the topic of last week’s Billionaire or Bust newsletter. I highly recommend you check it out.

While a higher dividend yield is certainly nice, REITs offer more benefits. REITs allow investors to diversify their portfolios beyond the stock market. This diversification can even improve returns. Fidelity found that portfolios with REITs had better risk adjusted returns, meaning investors saw better results with less overall risk. In fact, over the last 25 to 50 years, REITs have outperformed the S&P 500.

This outperformance comes with 25% less beta. Beta measures how an asset’s volatility compares to the volatility of the S&P 500. A beta of 1 means the asset moves in tandem with the S&P, while a beta of 2 indicates the asset sees swings twice as big as the S&P. An index of all REITs has a beta of 0.75. Not only can REITs beat the market, but they can do so with less volatility.

But in the last 10 years, REITS have severely underperformed the markets. There are two reasons for this. The first is simply the rise of trillion-dollar companies. A select few companies (mostly technological ones) are growing faster and becoming bigger than we’ve ever seen. Because the S&P 500 aggregates the market, it embraces these companies. REITs are left to fend for themselves, and real estate rarely moves as quickly.

But that only accounts for some of the underperformance. Between 2009 and 2022, the NAREIT index saw an annualized return of 13.2%, compared to the S&P’s 15.4%. A slight underperformance, but not too bad. Yet in the last 4 years, NAREIT returned -3.7% on average. What happened? Interest rates.

Real estate is intrinsically linked to interest rates. Properties are typically financed with debt, especially at the institutional level. So when interest rates climb, new debt becomes increasingly expensive. Real estate then becomes more challenging to finance, demand falters, and values fall.

Responding to COVID-induced inflation, the Federal Reserve (the Fed) started hiking rates in early 2022. Within 18 months, the federal funds rate surged from zero to 5.33%. Interest rates on real estate climbed even higher.

REITs tanked. The NAREIT index fell 37%. Individual REITs fell even further. PK, a REIT of hotels and resorts, dropped 50%. CCI collapsed 54%. Changing interest rates can decimate a REIT’s market cap, simply because the underlying properties are now less valuable.

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All real estate faces this risk, so has private real estate performed just as poorly? A recent study asked this very question.

As shown above, between 1998 and 2023, it found that REITs performed 1.93 percentage points better than private real estate. Moreover, the expenses of private real estate were more than double that of REITs. This makes sense. A REIT (if well managed) should act almost like an index fund of real estate, smoothing the performance of many properties. Private real estate, on the other hand, has more exposure to individual properties.

So how do we evaluate a REIT? We can use a simple checklist to accelerate our search. But unlike the checklists of previous articles, this one will take some time. If you want to skip the work, there is an easier approach (with less potential return) that we’ll discuss after the checklist. There are three steps:

1. Analyze the industry/sector.

2. Evaluate the REIT’s historic performance.

3. Review the company’s financial statements, particularly if the stock has been falling.

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Step 1 is the longest. One approach is to start with a specific sector of real estate. Perhaps you think healthcare real estate could start growing. You begin your search with this theory, then look for data to support it before identifying REITs that operating in that industry. Alternatively, you could start with a list of possible REITS, then research each company and its industry. This is my preferred approach. Essentially, we are looking to answer the questions: how does this REIT make money, and will that continue? Put even simpler, we are trying to gauge demand and estimate how it might change.

One dramatic example is BXP Inc. (BXP). BXP is a REIT specializing in offices and workplace properties. In 2019, they were thriving. Revenue was up 8.9%, and net income looked strong. Then COVID hit. Working from home became the norm. Office buildings plummeted in value. BXP is down 60% from its 2020 high. Even with revenue remaining strong and the company staying profitable, the evolution of the industry upended investor returns.

But find the right trend, and your portfolio will fly. In 1985, 3% of the population used a storage facility. Now 10% do. Since 1994, this tripling of demand has made self-storage REITs the best performing type.

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In today’s world, conducting this analysis is as simple as using Google and ChatGPT to start asking questions, taking notes, and deciding what sectors of real estate look poised for success.

Once we understand the industry in which a REIT operates, we want to examine its historic stock performance. While we are hoping to see a growing stock price, we can also evaluate if the dividend yield is being artificially inflated.

One danger of dividend investing is yield-chasing. Dividend yield is calculated as historic dividends paid divided by share price. If a stock has a shockingly high dividend yield, it could be because the stock price has fallen considerably. When share price falls, the dividend yield will climb. This is not inherently an issue, but it is something to keep in mind as we move into the final step.

The last action is simply to review the company’s financial performance. Is revenue and net income growing? What does the company pay? How much debt and cash does the company have? One of the difficulties with individual companies is that analysis becomes much more subjective. Every investor has their own process that usually evolves with time and practice.

If researching individual REITs seems like too much work, there’s one final subgroup we’ve briefly mentioned: REIT indices. Much like an index fund combines a multitude of stocks into one vehicle, a REIT index consolidates multiple REITs. Unlike the complicated process just outlined, evaluating a REIT index is the same as an index fund: check the expense ratio, confirm the dividend yield and review its historic performance. Will the dividend yield be less than an individual REIT? Most likely, but this is the tradeoff for less research. Two REIT indices you could begin your search with are SCHH and REET.

For passive income investors, REITS offer a unique opportunity. They add real estate diversification without the need to finance and operate properties yourself. They can match the general market’s return with less volatility. But like anything, risks remain. REITs are incredibly exposed to interest rates. As we saw in 2022 and 2023, a five-percentage point increase in rates correlated with a 30-50% fall in most REIT market caps. If you choose individual REITs, you are signing up for a few hours of in-depth research. Or you can utilize a REIT index fund that merges the averaging power of index funds with the real estate potential of REITs. You may never own a rental property, but that doesn’t mean real estate is out of reach. REITs unlock the door to a world of passive income.

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Thank you for reading! I’m on a mission to help everyone become an investor, and I can’t do it alone. Please share this article with everyone you know and help spread the word on how easy good investing truly is!

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Disclaimer: This newsletter is for educational and entertainment purposes only and should not be construed as financial, investment, legal, or tax advice. You should always do your own research before making any investment decisions. Past performance does not guarantee future results.