Insist on the most knowable: Q125 letter to partners
Dear partners,
In Q1 2025, Stone Sentinel Capital (“SSC”) made 14.4% while the S&P 500 Index (“S&P”) lost 4.3%. In 2024, SSC made 29.8% while the S&P made 25.0%. SSC’s figures are gross returns. Quarterly returns are not annualized.
SSC mostly invests in a 3–5-year period. Hence it would be preferable to judge performance on a similar scale.
Your manager picked the S&P as a benchmark because it is the best alternative to SSC and most active funds for two reasons:
It is widely available as affordable ETFs, of which the cheapest appears to charge an expense ratio of only 2bps (0.02%).
It offers broad exposure to performing companies (criteria here) domiciled in the United States, which is the largest economy globally with GDP of roughly $30 trillion.
The S&P and its passive peers are formidable opponents. In 2024, two-thirds of active managers underperformed passive index funds. Over 20 years, 90% of active funds underperformed.
Your manager faces long odds in outperforming.
Yet there are reasons that may slightly tilt the odds in favor of outperformance.
Your manager is all-in. 99% of my net worth is invested in SSC.
Investing is my sole professional endeavor.
I have yet to find anything more rewarding and intellectually exciting than investing.
My returns have been reasonable.
Your manager has written since 2017 but has not often been public with writings. At the risk of boring long-time readers, this letter begins with SSC’s philosophy, which sets the context for a discussion of stocks that contributed to returns.
Insist on the most knowable
Nothing matters more to SSC than to be certain.
In investing, to be certain is to be right about the future.
Yet it is almost impossible to predict the future accurately. How can an investor be right in this seemingly insurmountable task?
One way is to focus on the knowable.
Repeating a previous discussion, when a stock would only appreciate in one specific version of the future, it is a tough opportunity. Hence an easier opportunity is a stock that would appreciate in more versions of the future.
The more versions of the future in which the stock would appreciate, the easier the opportunity.
Extending the discussion to a more elemental topic concerns the nature of knowledge itself. Can the knowledge actually be known?
Knowing whether a nuclear war will happen tomorrow is important but cannot be known with any certainty.
The value of a holding company with stakes in 50 companies of varying industries seems difficult to know. So are many technology companies that are prone to rapid disruption.
It seems obvious to only invest in what you know. And it is perhaps not challenging to do so if you are alone.
Most investors are, however, not alone. We are inundated by an endless barrage of information.
How do we know that we utterly understand knowledge when we are not the original authors? As readers we avoided the painful process of thinking and organizing knowledge that the authors did.
Hence your manager spends more time reflecting than reading to assimilate knowledge. It is only making the knowledge mine that I know how certain I am of it.
To summarize, knowable means can be known (related to nature of knowledge) and likely to be known (related to the range of the futures).
The concept of knowable may appear cryptic because of the lack of clear delineations. What exactly separates the can-be-known and cannot-be-known? What precise range of futures is acceptable?
While valid, the questions are not useful. A better question is to ask what is best.
Meaning it is more useful to ponder what can be known than to think about what separates the can-be-known and cannot-be-known.
And it is also more practical to only explore stocks with the largest range of futures which it would appreciate than to consider exactly what range passes and fails.
The point is to insist on the best.
When done correctly, the outcome is indisputable. The investor is certain that the stock can be known and have a large range of futures in which it would appreciate.
Everything else other than the best should be excluded from further research.
What should an investor do in borderline cases that require debate on whether a stock is knowable?
No debate is required. There is no need to spend more time because they aren’t the best.
Only look at the indisputably best.
If an investor cannot find any, just wait until one arrives. Your manager would rather wait for the sure thing.
When the investor is correctly certain, low downside risk naturally follows.
Because the stock is indisputably known to appreciate in a large range of futures. Hence it is unlikely for the stock to decline.
High upside potential is closely related to low downside risk. Your manager will discuss upside potential in the context of actual holdings later in this letter.
Beat the market by not aiming for it
Active managers exist to beat the market.
Yet your manager thinks that to beat the market, an investor cannot aim for it.
Because insisting on beating the market is what makes it difficult to achieve.
The paradox is perhaps best illuminated by the higher order effects of external benchmarking.
When the investor constantly compares his returns to the benchmark’s in finite periods (usually annual in industry practice), he is vulnerable to trade excessively so as to get ahead of market swings, to which he reacts impulsively with detrimental consequences in the form of unnecessary selling during panics or excessive chasing during bull runs.
He unconsciously but effectively mimics the crowd, a practice he swore to avoid during the initial setup of his value creation strategy. His mental resources would no longer be devoted to sustainable value creation but to the futile efforts of beating the market for the year.
So, what is an investor to do?
Author James Carse may have a solution when he contrasted finite players from infinite players in his book “Finite And Infinite Games”.
Finite players play to win. They see games as competitions with defined rules and endpoints. They focus on control to win as determined by external standards, measure success by external standards, and seek recognition and titles.
Investors focused on beating the market are keen on winning as measured by external benchmarks and thus engage as finite players.
Their counterparts, infinite players, engage differently.
Infinite players play to live. They see games as ongoing journeys with evolving rules and without endpoints. They focus on personal growth and continuous learning to continue playing the game. There is no winning like how finite players seek. Infinite players measure success by internal standards such as personal evolution and seek lasting growth.
An investor engaging as an infinite player “wins” by continuous learning and growth. Proper learning, reinforced by the lack of distractions caused by external benchmarking, results in correct judgment.
Correct judgment allows infinite players to create value and to eventually win by external standards, which paradoxically isn’t their focus in the first place.
In investing, another edge that infinite players have over their finite peers is openness to reality and change.
Carse deems infinite players as “playful” and finite players as “serious”. In his words:
“To be playful is not to be trivial or frivolous ... when we are playful with each other we relate as free persons, and the relationship is open to surprise ; everything that happens is of consequence. It is, in fact, seriousness that closes itself to consequence, for seriousness is a dread of the unpredictable outcome of open possibility. To be serious is to press for a specified conclusion. To be playful is to allow for possibility whatever the cost to oneself.”
When engaged as “serious” finite players, investors have specific expectations about markets and companies and are less likely to observe reality that indicate otherwise.
When engaged as “playful” infinite players, investors are open to possibility and can observe markets and companies for what they actually are.
Expectations are the sum of one’s learnings and are immensely helpful for correct judgment. The point isn’t to abandon expectations but to embrace observations that are contrary to expectations.
The surprising observations are often the ones worth exploring.
To top off this discussion: that an investor wants to observe reality doesn’t mean that he can.
Because his perceptions and interpretations are filtered through the human mind that is subject to cognitive biases and limitations. Richard Heuer, a former CIA intelligence analyst, discussed the topic at lengths in his seminal work “The Psychology of Intelligence Analysis”.
As riveting as the topic of human cognition is to your manager, the topic is best discussed in another letter. Your manager wishes letters to be more insightful than comprehensive.
Portfolio report
Grupo Empresarial San José (GSJ) and Claranova (CLA) contributed significantly to returns and Collegium Pharmaceutical (COLL) contributed most to losses. SSC is currently invested in 5 stocks and holds roughly 10% of total assets in cash.
Buyers of GSJ equity may be thrilled to find plenty of freebies with their purchase at the current price.
The price at which a buyer pays today is nearly equivalent to all cash at GSJ net of debt, which means everything else is free, including:
the core construction business with €116m LTM FCF (~MC €370m) led by a CEO who owns 50% of GSJ
a stake in Madrid’s largest real estate development (at a scale similar to London’s Canary Wharf)
1.2 million square meters of land in Argentina earmarked for private urban development
50% of a company that owns 2.2 billion square meters of land in Paraguay
Happy buyers exist only when there are discontented sellers. In the case of GSJ, the usual reasons apply, albeit with a few unique elements:
low trading volume (50k ADV) of a small-cap stock (GSJ’s MC €370m) in a small exchange (Bolsa de Madrid) with low turnover (€2-3b, about 1/10 of major peers)
almost non-existent sell-side coverage (1 analyst covers GSJ)
inactive IR. The full annual report is not published on the IR website but only on the regulator’s website. There are no investor days, no investor presentations, and no further explanations of the business other than a long list of representative projects
publicity-shy CEO. There’s almost no journalistic coverage of him as CEO and only one public photo of him
GSJ should continue to generate cash as it rides a construction boom in residential and infrastructure projects in Madrid. As it continues to execute well as a mid-sized construction contractor in Madrid, it may be an acquisition target for large peers, which have increasingly dominated the industry in the past two decades.
Your manager thinks that the CEO-owner would eventually do right by shareholders given that he’s the largest one and would benefit most from shareholder-friendly actions such as special dividends, buybacks, and realizing the values of assets among others.
In a different industry (DTC software) and country (France), CLA shareholders have much reason to celebrate.
After much effort from activists and management, the turnaround of the company has gathered pace, but the stock, which trades at only 3-5x trailing FCF, gives little credit for:
the new CEO who got the top job by turning around the most profitable segment of CLA
the Chairman who is a successful investor in technology and is also the largest shareholder of CLA with a 16% stake
the Board member who advocated for change as an activist, got the CEO and Chairman their current roles in CLA, and owns a 7% stake
the most profitable segment that saw 3y revenue and EBITDA CAGR of 12% and 42% respectively (EBITDA margin 2x in that period)
the potential sale of the second-most profitable segment which, if completed, would provide enough to repay all debt
If the sale is completed, CLA would be a pure-play DTC software business (i.e. most profitable segment) specializing in very affordable DTC software that AI startups would find difficult to price-match and disrupt profitably.
If the sale isn’t completed, CLA will retain both the software and personalized products platform (second most profitable segment) segments. Management, who have already proven their capabilities, have already released a 3-year plan to increase profits for both segments.
The future of CLA looks bright in both ways.
In yet another country (USA) and industry (pharmaceuticals), COLL has executed its playbook well. It has turned around a few pharmaceuticals bought at cheap prices and generated excellent cash flows. However, a series of management changes seem to signal internal conflict about the future of its playbook.
The CEO who has executed every M&A deal was shown the door only to be replaced by an executive who seems less well-versed in M&A. The Chairman, who is also the founder, was quietly replaced as well.
Your manager is disappointed with the series of unexpected management changes. Excellent management talent is rare and ought to be nurtured. While optimistic on the future of COLL’s business model, your manager is not ready to invest with a company and Board which appears ignorant of excellent managers.
Surprise, surprise
Macroeconomic conditions hardly influence your manager's investment decisions. In the words of John Maynard Keynes:
“The idea of wholesale shifts is for various reasons impracticable and indeed undesirable. Most of those who attempt to forecast economic developments beyond a very short period ahead make fools of themselves.”
And Buffett:
“We have never succeeded in making a good deal by reading the macro forecasts or listening to the macro or market predictions of others—and we have tried many times”
Yet amid recent market declines, some readers might find solace in your manager’s perspectives devoid of predictions.
The markets’ pessimism about Trump’s tariffs on corporate profits was expected. What’s less obvious (and perhaps forgotten in the panic) is just how shocked the markets were.
To illustrate, assume the S&P 500’s average daily volatility is 1%.
On April 4, 2025, the index fell about 5% (a 5σ event), and on the following day, it dropped around 6% (a 6σ event).
In statistical terms, a 5σ event occurs roughly 1 in 3.4 million times, and a 6σ event about 1 in 1 billion times.
For both to happen on consecutive days, the probability is very low to the tune of 1 in 3.3 quadrillion (6 more zeroes than a billion).
Large movements in market indices are rare. Consecutive large movements are even more rare. Betting on another large move after significant moves seems like an unwise bet statistically.
Surprises also tend to cut both ways at the most unexpected. While recent market reaction is negative, not all future surprises will be bad. Future surprises can just as well be positive.
Trump will continue to surprise when he is POTUS.
Your manager can be reached at mg@stonescap.com.
At Your Service,
Marcel Gozali
