Much of the investing content I read focuses on stock analysis — what companies to buy, why they’re cheap, and what they might be worth. In reality, that’s only a small part of the investing process.
The harder question is:
When do you commit capital — and how much of your portfolio should you put into the idea?
Over time, I’ve found that the difference between a good investment idea and a good outcome comes down to discipline — following a strategy that fits your temperament and allows you to stay invested through volatility. This means proper position sizing is a lot more important than most investors realize.
Below is the general framework I use before putting real money into an idea.
Step 1 — The Idea Enters the Funnel
Most of my ideas come from systematically working through a broad universe of stocks or using targeted screeners. I also monitor spinoffs and other special situations, such as mutual thrift conversions.
I generally look for low EV/EBIT, low price to book, a low price to earnings/free cash flow ratio or a combination of these. Many of my best ideas are in underfollowed microcaps and special situations.
When I am doing my initial screening, I’m not trying to get too excited about anything. I’m basically just asking myself: Is this worth spending more time on?
The reality is most ideas get filtered out quickly. I may have to look through thousands of securities before coming up with one or two good ideas.
Step 2 — Quick Kill Criteria
I’ve learned it’s better to reject ideas early than to try to convince yourself that something will work.
Here are some factors that will cause me to pass on an investment opportunity:
I don’t understand how the business really makes money
The balance sheet looks fragile – i.e. high debt levels, low interest coverage ratios, etc.
Earnings are not sustainable or very volatile and are driven by one-time factors
Management incentives don’t align with shareholders – I avoid companies that have issued large amounts of stock, have made bad acquisitions, have salaries that are too high and/or own a little amount of stock in the company
The industry is in structural decline
None of these automatically disqualify an investment, but if several show up at once, I usually move on.
There are too many opportunities to force something.
Step 3 — Can the Business Survive a Downturn?
Before thinking about upside, I want to understand the downside.
This is where I spend a lot of time.
I look at:
debt levels
liquidity
cyclicality
how the business performed in past downturns
The key question is:
Is this a temporary problem or a permanent impairment?
A cheap stock with a weak balance sheet is very different from a cheap stock with a strong one.
I’ve learned that the hard way.
Step 4 — What are “Real” Normalized Earnings?
Reported earnings can be misleading. A company can have large one-time expenses/income or large non-cash charges that can cause headline “GAAP” earnings to be distorted and differ greatly from the true earning power.
I try to get to something closer to normalized earnings:
What does the business actually generate over time?
What portion is recurring?
What needs to be reinvested just to maintain the business?
I typically look back and get an average of earnings over the last 5 – 10 years. Finding an average or “normalized earnings” will show an investor where the company is currently at in relation to their peak and trough level of earnings.
Cyclical companies such as auto manufacturers or homebuilders will often show low price to earnings at the peak of the cycle right before a downturn. Conversely, these companies will often show a high price to earnings ratio at the trough of a cycle right before an upturn. Thus, it becomes very important to know where the company is at in the cycle and where current earnings are in relation to prior earnings.
This usually means:
normalizing margins
adjusting for one-time items
I’m less interested in what the business did last year and more interested in what it can reasonably earn over time.
Step 5 — Is it Actually Cheap?
Once I’ve completed steps 1 – 4, I’ll begin to think about valuation.
I’m typically looking for:
low multiples on normalized earnings
a meaningful margin of safety
a path to a 15%-20%+ IRR under conservative assumptions
Importantly, I’m not relying on aggressive growth.
If the investment only works with optimistic assumptions, I’m probably not interested.
I’d rather find situations where:
Even mediocre outcomes still produce acceptable returns.
Step 6 — What Could Go Wrong?
This is one of the most important steps.
For every investment, I try to identify:
what assumptions I might be wrong about
what would cause the thesis to break
what a downside scenario actually looks like
Sometimes the conclusion is:
If this goes wrong, it goes really wrong.
In those cases, even if it looks cheap, I’ll either pass or size it very small.
Step 7 — Position Sizing (Where It Actually Matters)
This is where most of the decision is made.
I don’t think in terms of “buy or don’t buy.”
I think in terms of:
How much capital should this idea get?
Roughly speaking:
15–30% positions → rare, highest conviction
5–15% positions → strong ideas
1–5% positions → lower confidence or higher uncertainty
Sizing depends on:
downside risk
balance sheet strength
confidence in earnings
overall portfolio exposure
I could be wrong on any individual investment.
Sizing is how I manage that.
Step 8 — The Final Decision
At the end of this process, most ideas still don’t make it into the portfolio.
That’s intentional.
I’m not trying to own a lot of stocks.
I’m trying to: allocate capital where the odds are clearly in my favor
Sometimes that means doing nothing.
Two Recent Examples
Two of my larger positions in 2025 followed this general pattern.
IEH Corp. (up 122% since my first writeup) and Perimeter Solutions (up 131% since my initial writeup):
Both IEH and Perimeter were under the radar and trading at a low multiple of normalized earnings
Both companies had strong barriers to entry in niche, underfollowed industries (Perimeter operates as a virtual monopoly selling fire retardant to the US Forest Service, IEH has only one meaningful competitor)
IEH and Perimeter’s balance sheets had limited downside risk (IEH was trading for less than book value and just above net current asset value at the time I bought it around $9. It also traded at roughly 2.6x EV/normalized EBIT at the time I bought it.)
The market was offering up these companies at value multiples, and I believed the intrinsic value (or private market value) was worth much more than their stock price at the time I wrote about them
Both IEH and Perimeter Solutions were underfollowed and trading at a low multiple of normalized earnings. The balance sheet limited downside, and the market seemed to be pricing in overly pessimistic assumptions.
I sized it as a meaningful position based on:
downside protection
reasonable confidence in earnings
attractive expected return
As the business continued to perform and expectations improved, the stock re-rated and contributed meaningfully to returns.
Not every investment works this way.
But that’s the type of setup I’m generally looking for.
Final Thoughts
Investing is not about finding ideas.
There are always ideas.
It’s about:
filtering aggressively
thinking clearly about risk
and allocating capital efficiently when the opportunity is there and the odds are in your favor
Over time, I’ve found that discipline in this process matters far more than any individual stock.