Part 2 of 3: A 10-Year Project for My Traditional IRA account

This month, Part 2 of Project $350K elaborates on the quantitative criteria in assembling positions for my Traditional IRA account. By Benjamin Tan.

Hurdle Rates: Size, Growth, Leverage, and More

This article is a continuation from Part 1.

In assembling my Traditional IRA portfolio, I will apply the following quantitative criteria to mitigate risks and ensure their long-term potential to thrive:

1. Revenue and Market Capitalization

Companies must have a minimum revenue and market capitalization of $1 billion each, ensuring a focus on companies that have crossed the chasm (in the words of Geoffrey A. Moore). Smaller players that are still subscale—think the likes of Oatly ( OTLY 0.00%↑ ) and Peloton ( PTON 0.00%↑ ) when they became popular—can quickly run into execution issues that derail operations and impair financial health. I should know since I invested in them years ago and took losses. These guardrails are essential to limit speculative risks. There is no upper limit since the big can get bigger.

2. Topline Growth

Each investee company must be expected to grow its top line consistently by at least 10%. Given the project's targeted IRR, this is an appropriate hurdle rate to impose.

3. Profitability

While looking for companies that have crossed the chasm, I am not necessarily imposing profitability measures in selecting my stocks for Project $350K. Growth requires heavy investments, many of which cannot be capitalized on the balance sheet. Accordingly, expenses like R&D and marketing will impact the income statement and often result in reported GAAP losses, regardless of the company's efficiency. Names like Datadog ( DDOG 0.00%↑ ) and Zscaler ( ZS 0.00%↑ ) would meet the criteria. That said, companies must have clear targets to show profitability (think Block $XYZ and their path towards Rule of 40) and establish meaningful inflections in their financial statements.

4. Debt and Cashflows

This is the part where I will impose stricter guideposts. Companies with net debt/EBITDA of more than ~2.5x will be avoided. A combination of negative operating cashflows and a high debt load is a recipe for trouble and a prelude for heightened price volatility when markets turn bearish, no matter how strong topline growth may be. When a company desperately depends on external fundraising—whether from banks, markets, debt, or equity—for survival, it entails too much risk with skeletal safety margins. Accordingly, names like Rivian ( RIVN 0.00%↑ ) and Lucid ( LCID 0.00%↑ ) are not for Project $350K.

5. Valuation

Having invested in technology names that do not even have positive book values (thus failing the cardinal Benjamin Graham rule) or report operating income, I am nevertheless of the belief that valuation guardrails are essential. Overpaying for a stock, even for the best-of-breed companies, can make a difference between market-beating returns and underperformance. “Price is what you pay, but value is what you get” is a mantra I live by, and it has proven useful when investing in value and growth names. In addition, especially when buying smaller companies that may become acquisition targets, paying multiples that exceed what private equity firms would pay might result in permanent loss, should acquisitions transpire. I have learned this the hard way with Avalara and Coupa Software. For profitable plays, my focus metrics are EV/EBITDA, and for growth stories, EV/Sales is key. Both will be evaluated as expensive or reasonable in the context of individual topline and bottom-line growth.

My natural tendency towards intellectual exploration can lead me to overanalyze and gravitate toward niche, smaller-cap companies while losing the plot. Hence, the above criteria provide structure, limit risks, and impose the often-hard lessons I have learned as an investor in clear terms.

Part 3 to come - stay tuned!

Update as of Feb 28, 2025: I have initiated Trapanion TRUP 0.00%↑ at $35 and Life Time LTH 0.00%↑ at $33 in my Traditional IRA account.

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