U.S. Silica Holdings and Hierarchy Theory as an Approach to Discovering Potential Investments

U.S. Silica Holdings (SLCA) has performed nicely. The following synopsis of the company is excellent:

http://seekingalpha.com/article/1827892-strengthen-your-portfolio-with-u-s-silica-potential-double-in-12-18-months

While my analysis of the company incorporated elements of the approach in the later stages, I used a different approach to identify the opportunity.

In my search for potential investments, I take a top down approach by identifying strategic themes and then drilling down to find companies which are well positioned to profit from market demand. In adopting this approach, I have been greatly influenced by “hierarchy theory”. To simply things greatly, hierarchy theory contends that high order processes set the parameters for the processes of lower order processes. For example, the harsh climate of the arctic precludes the cultivation of rice. You can read about hierarchy theory here:

http://openlandscapes.zalf.de/openlandscapeswiki_glossaries/Ecosystem%20Theories%20-%20The%20Hierarchy%20Theory%20in%20Ecology.aspx

http://www.isss.org/hierarchy.htm

There are many types of hierarchies. Social organizations, economic systems, ecological systems and so on. All can be modelled in a way that describes key elements of the systems and the inter-relationships between components. In my use of the approach for investment purposes, I am particularly interested in identifying the components of systems (e.g. Oil and gas) and the inter-relationships between them – also how higher order elements can limit or create opportunities for entities which are lower in the hierarchy.
For example, in modelling the oil and gas system (which I selected for study due to the world's insatiable demand for high density portable sources of energy), I identified the transportation of petroleum products as a sub-theme. I modelled the sub-theme and identified government regulation and railways as some of the components. In the model, government regulators were higher in the hierarchical order than carriers and manufacturers in the sense that they could exercise controls or set limits to the activities of lower order entities. In the belief that regulators would invoke more stringent controls for rail safety due to the spate of highly publicized train derailments, I expanded the model to explore the “rail safety system”. Once I had identified various components of the rail safety system (e.g. tank car components, signals/communication etc.), I started to look for sound companies which were well-positioned to profit by meeting the market demand. As a result, I invested in Trinity Industries, Kelso Technologies, and Titan Logistics. A side benefit was that I was also exposed to SLCA as I modelled the fracking system and its needs for transportation. As Forrest opined, “Life is like a box of chocolates ....”

Without getting into too much detail, I find that the approach is very applicable (and effective) in the investment world for a variety of reasons:

• The upper level trends (e.g. increased demand for food due to population growth) are usually slow moving and sustained for many years. These trends, if exploited well, can lead to long-term gains for “buy and hold” type investments.
  
• Using the hierarchy approach, it is possible to build systems models to describe how the upper level trends are expressed in lower orders of the system. For example, one might wish to explore climate change in terms of the spatial expression of its impact and then to develop spatial/ecological models for agriculture at the regional level. The models could be refined by expanding on various components to estimate the likely consequences for various forms of agriculture and then subsequent responses of agricultural practices to these stresses. From there, one can progress to investigating the socio-economic response, including potential business opportunities.
  
• The approach provides a framework for disciplined (often quantitative) investigations, including a methodology which often unearths “surprises” which may be missed by more haphazard approaches.
  
• Since upper level trends are slow moving, investors can take the time to learn and think before acting precipitously.
  
• I have discovered that I do not get too concerned about short to intermediate fluctuations in the prices of stocks of companies I have purchased using this methodology. If one identifies a long-term trend and does one's homework diligently by selecting companies which are well-positioned to exploit the trend, I believe that the longer term “drivers” will win out over time. This is why, for example, I have managed my position with Polaris Minerals and Waterfurnace in the way I have and why I have established my positions in the petroleum sector.
  
• The approach provides a great opportunity for learning, understanding and appreciation for one's world – things which surpass pecuniary rewards.