The Benefits of Investing in Low Hurdle Ideas

We’ve reached the final part in this three part series from my conversation with Dr. Andrew Wittman. If this is your first time reading this series, check out parts one and two. Also, if you haven’t listened to my podcast with Dr. Wittman, check it out here. I promise that’s the last time I’ll bug you about it!

Before we dive in, let’s review the three main lessons:

    • Be Proactive, Not Reactive
    • Knowing Your Mission and Purpose
    • Clear Thinking = Clear Communication

Today we’ll cover the third lesson, Clear Thinking = Clear Communication. As always, here’s the main takeaway:

Clear thinking translates to clear communication. If you’re not thinking clearly, you won’t communicate clearly. Writing down your investment ideas helps you think clearly, which in turn helps you communicate clearly.

Let’s bring this home.

Lesson #3: Clear Thinking = Clear Communication

“The root cause of every real problem is lack of clear thinking” – Dr. Andrew Wittman

Dr. Wittman stressed the correlation between internal thought process and communication ability. If you have a cluttered mind, you’ll have cluttered communication. If you’re not clear in your head, you’ll relay murky messages. These ideas are powerful in the game of investing. As value investors, we need to know why a company’s cheap, its various growth levers and where we might be wrong. If we can’t translate that in a clear and concise manner to others, we shouldn’t invest in the company. Don’t invest in clouded stories. Invest in clear, concise theses.

When it comes to investment writing and thinking, there’s two mantras I like to practice:

    1. Write about simple ideas and simple stories
    2. Write like you’re talking to a fourth grader

Both practices dramatically improved my thinking, writing and communication. It’s one, giant positive feedback loop. Clearer thinking leads to clearer writing. Clearer writing leads to better communication. But like Dr. Wittman said, it all starts in the mind.

Write About Simple Ideas and Simple Stories

The worst performing stock I’ve ever written about was Estre Ambiental (ESTR). The company went public via SPAC merger at the initial price of $10/share. I found ESTR around $6/share. Already 40% below IPO price.

“That’s fine”, I thought to myself. “SPACs always sell-off after IPO.”

What happened next was nothing short of insanity. I spent the next three weeks (multiple hours each day) trying to understand the story and the valuation. Not three weeks writing my thoughts and ideas. Three weeks thinking about how this idea makes sense.

Not good!

I should’ve stopped right there. Why? I wasn’t clear on what the thesis was. I wasn’t clear on how this stock was cheap. I wasn’t clear in my thinking. In the spirit of Mohnish Pabrai, ESTR didn’t, “hit me over the head with a 2-by-4!”

Complex investment ideas can easily clutter your thinking. That’s not to say you can’t make money investing in complex situations. But I prefer Buffett’s “low hurdle” strategy. In doing so, I increase my chances of focusing on clear ideas.

Takeaway: Pick simple ideas and low hurdles. Ideas should hit you in the face. If not, wait for the next pitch.

Write Like You’re Talking to a Fourth Grader

If you can’t explain an investment idea to a fourth grader, rethink your thesis. Investing is an intellectually stimulating endeavor. There’s the thrill of finding an off-the-beaten path idea that nobody’s seen. The shot of dopamine when you work out a special situation. Sometimes that mires the true power of investing: finding simple ideas.

I became a much better investor, thinker and writer when I stopped trying to sound smart. Instead, I focused on simple ideas that could work under conservative assumptions. I don’t want five things to have to go right for my idea to work. Complexity doesn’t show your genius, simplicity does.

Before I dive any further into an investment idea, I ask myself, “could I explain this situation to a fourth grader?” If I can, I will take my research deeper. If I can’t, I pass. Remember, there’s thousands of potential no-brainers out there. Don’t get bogged down by the one, hard-to-understand SPAC reverse merger.

The Consequences of Clearer Thinking

Change brings consequences, emphasizing clear thinking is no different. The first consequence of prioritizing clear thinking is passing on ideas. You’ll pass on a lot more investment ideas. This is a good thing.

Ted Wiliams swung at a handful of pitches in his strike zone. He’s also the only player to hit over .400 for an entire season. But we have an advantage over Ted Williams. There are no looking strikes in markets. Mr. Market can throw us pitch after pitch. We don’t have to swing if we don’t want to.

Like Ted, we can wait until a pitch (i.e., investment opportunity) comes right down our sweet spot. When it does, we’ll be ready. We’ll have a clear mind, clear thinking and clear communication.

That’s all I got for today. Shoot me an email if you come across something interesting this week at brandon@macro-ops.com.

Your Value Operator,

Brandon


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A Former Marine’s Answer To Finding Your Mission & Purpose in Markets

Yesterday I introduced the three lessons I learned from my conversation with Dr. Andrew Wittman. If you haven’t read the intro post, check it out here. Also, make sure to listen to our conversation on the Value Hive podcast.

To review, the three main lessons I learned were:

    • Be Proactive, Not Reactive
    • Knowing Your Mission and Purpose
    • Clear Thinking = Clear Communication

Today we’ll chat about the second lesson, Knowing Your Mission and Purpose. If you don’t read past this, here’s the main takeaway:

If you don’t know your mission or your purpose you’ll fall victim to the random gyrations of the market. If you don’t have an anchor, how can you stand firm amongst the waves of volatility?

Let’s get it!

Lesson #2: Know Your Mission and Purpose

“Without purpose or identity, you’re floundering. There’s no anchoring, there’s no anchor.” – Dr. Andrew Wittman

Knowing your purpose and mission is top-priority. It’s crucial in life and relationships. It’s also vital in financial markets. In a world where there’s thousands of ways to skin the cat, knowing your identity gives you a foundation on which you (hope to) build market fortunes.

During our conversation, Dr. Wittman used the analogy of Dorothy and the Yellowbrick Road. Each character had a reason for walking that road. As Dr. Wittman eluded to, “the only reason they put up with [the witch and storms] is because they had a final destination.”

At the end of the day, market participants have two main purposes:

    1. Not to lose money
    2. Make money

That’s it.

Sure there’s nuances and variations to strategies. But at first principles, those are the only reasons people engage in financial markets.

So we know our purpose. Do we know our mission? Can you define your mission? The purpose is to not lose money and to make money. The mission provides the steps necessary to get to your purpose. Our mission is our Investment Style.

The Different Colors of Mission

Like we mentioned earlier, there’s thousands of ways to make money in markets. Even where we live — the value investing space — there’s different styles. Walter Schloss invested in hundreds of stocks at a time. He allocated around 1% of his capital to each investment. His returns? Over 20% compounded for 18 years.

Ben Graham invested in a less diversified manner, but still owned around 50 net-net stocks. He did well. Charlie Munger’s early partnership days involved large bets on three-to-five stocks. While more volatile, Munger walked away with market-beating returns for over a decade.

In each example, the mission differed, but the purpose stayed the same.

Mission also applies to geographic regions. For example, Prem Watsa delivers his mission in Canada. Li Lu enacts his mission in China. Where will you make your mark? Where will you deliver your mission?

How To Find Your Mission

Finding your mission takes time. Your mission, your investment style, should hit certain criteria:

    1. Does it fit your personality?
    2. Does it fit your time horizon?
    3. Does it work within your schedule?
    4. Does it stand the test of time?

These are questions you’ll find out as you learn, study and try out various strategies (various missions) throughout your learning process. What works for one person might not work for you. And that’s okay. You’ll grow as an investor and find out what works best for you.

Maybe you’re a fan of Schloss and want to spread your bets. Maybe you don’t have enough time to search for one hundred net nets and decide Munger’s old way works best.

Don’t Be Afraid To Optimize Your Mission

Markets don’t exist in a vacuum, neither should your investment style. Don’t believe me? Look at Warren Buffett. Buffett went from Ben Graham cigar butts to great companies at decent prices.

If Buffett (perhaps the greatest value investor of all time) can change his mind, why can’t you?

Remember, it boils down to mission and purpose. Your purpose stays the same. Your purpose never changes. The mission is what gets you to your purpose.

Look Ahead

Tomorrow we’ll discuss the third and final lesson learned: Clear Thinking. In the meantime, check out my conversation with Dr. Wittman here.

That’s all I got for today. Shoot me an email if you come across something interesting this week at brandon@macro-ops.com.

Your Value Operator,

Brandon

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Dr. Andrew Wittman on Proactive Thinking & Beating Mr. Market

A few weeks ago I sat down with former Marine veteran, Dr. Andrew Wittman for Episode 7 of the Value Hive Podcast. Dr. Wittman’s resume is impressive. He’s the founder of the Mental Toughness Training Center, and author of the book, “Ground Zero Leadership: CEO of You”.

A Marine Corps infantry combat veteran and former federal agent, Andrew holds a Doctorate of Philosophy in Theology. He’s a guest lecturer at Clemson University, and co-hosts the radio call-in show, “Get Warrior Tough.”

You can check out the podcast here.

There’s three main lessons I took from my conversation with Dr. Wittman:

    • Be Proactive, Not Reactive
    • Know Your Mission and Purpose
    • Clear Thinking = Clear Communication

We’ll break down each lesson in this three-part series. If you don’t read any further, here’s the main point:

Proactive thinking enables you to take advantage of Mr. Market’s radical mood swings. Reactive thinking victimizes you to the swaying emotions of short-term oriented crowds.

Let’s dive in.

Lesson #1: Be Proactive, Not Reactive

“A large part of reducing stress and inoculating yourself against the kind of pressure that stymies performance is being able to see ahead and execute. In order to anticipate problems or mere course changes, one must raise their perspective to the 50,000 feet level.”

Dr. Wittman explains in his article, From Reactive to Proactive, that the key difference between proactive and reactive thinking is preparation. This has myriad investing applications. Where does proactive vs. reactive show most?

Sudden share price movements.

Example of Reactionary Thinking

Imagine you’ve invested in Company XYZ at $10/share. You thought the company was cheap because an analyst slapped a high P/E ratio on a Year 10 earnings figure. They then spat out $25/share in valuation. This doesn’t sound like proper due diligence, but it’s what you did.

Two weeks later the stock plummets 25% on a single trading day. What do you do?

At this point you’re lost.

You’re stuck.

Your anchor? Some random analyst’s price target based on a flimsy, haphazard price-to-earnings figure.

In other words, you have nothing to fall back on. No due diligence. No understanding of the business fundamentals. You have zero idea how to interpret the recent price action. If it was an earnings miss, you wouldn’t know if it was long-term issues or short-term hiccups.

The only thing you’re left to do is wait for that analyst’s interpretation of the share price drop. That’s a position of weakness — of relinquished control over your investment process.

This is reactive thinking. Reacting — not responding — to price actions movements. Letting Mr. Market dictate your next moves instead of the other way around. It’s a losers game. What happens if you own your investment process? What happens if you shift from reactive to proactive thinking?

Example of Proactive Thinking

Let’s use the same Company XYZ and the same price of $10/share. But there’s one major difference. Before you bought XYZ, you did your due diligence. You learned about the business, it’s drivers and its historical financials. You know what levers they can pull to speed up growth, cut costs and return capital to shareholders.

In fact, you’ve mapped a simple, five year discounted cash-flow model and estimate that the company’s worth $25/share. Assuming the company meets conservative growth estimates.

You accumulate a position, confident that Mr. Market is mispricing Company XYZ by $15/share.

Two weeks later you wake up and find XYZ down 25%. Shares are trading hands for $7.50. Your initial cost-basis is $10. What do you do? Do you react or do you respond?

You check the news. It’s an earnings miss.

“These things happen”, you mumble to yourself as you read the earnings call transcript.

One sentence catches your eye halfway down the page. Management says the earnings miss was due to a delay in a purchase order from one of their customers. The relationship with that customer remains strong. Management also expects business to resume as normal in the coming quarters.

Not only have you done your due diligence on the company, but now you know that the earnings miss was a temporary headwind. In other words, one quarter doesn’t affect the long-term cash flow power of the business. After all, you modeled out the next five years. You have some reasonable estimation of what those cash flows look like.

After finishing the earnings call, you don’t see any reason why the stock should be down 25%.

So you buy more. Confident that your 60% discount is now closer to 70%. Future returns look even better.

The Power of Proactive Thinking

There’s tremendous power in proactive thinking. Proactive thinking turns Mr. Market from maniacal to generous. From unruly to opportunistic. It’s all in how you frame your mind. But before you do that, you have to earn the right to use proactive thinking.

It isn’t something you “decide” to do. You earn it through deep work on individual businesses. Understanding what makes them work. Understanding the valuation and embedded expectations within the current stock price. Then, only then, can you have a proactive mindset and use Mr. Market to your advantage.

If you haven’t already, listen to the interview here.

We’ll touch on the other two lessons later this week.

That’s all I got for today. Shoot me an email if you come across something interesting this week at brandon@macro-ops.com.


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The Catalyst for MSG’s Potential Breakout

If you haven’t heard by now, Madison Square Garden (MSG) is an interesting value play. The thesis is simple. It’s a sum of the parts (SOTP) play on some valuable assets.

The idea is well covered in the value investing space and I’ve curated some of the best resources for us to dive deeper.

Why am I doing this now? Let’s go to the charts …

Some of you are spraying holy water right now.

Using technical analysis with value investing!? Heresy… I say!”

I get it.

Here’s what I know. MSG’s stock is close to breaking out of a six-month consolidation. This isn’t to say the stock won’t head lower, go up, or go up and then head lower. All I’m doing is showing a period of consolidation that’s currently showing signs of breaking.

We also “know” that the company’s trading for a significant discount to its collective asset values.

So, for those that are interested in the idea, here’s a list of my favorite resources:

Resource #1: Richard Howe of Stock Spin-Off Investing

Richard Howe runs stockspinoffinvesting.com. He conducts killer research and his website is the first place I go for new spin-off ideas. You can find his MSG write-up here. Here are my favorite sections:

“The primary reason MSG trades at a discount to its private market value is because the company is controlled by the Dolan family (over 70% of voting stock and over 20% of common equity). And investors generally don’t believe that the Dolan family wants to sell the Knicks or Rangers, thus, the true valuation of the franchises will be hidden for the foreseeable future.

However, the structure of the spin-off may solve this problem.

The remainco (the entertainment company) plans to retain a ⅓ interest in the spin-off (sports company). Why? Because it needs to finance the construction of the “Sphere” venues in Las Vegas and London which will cost more than the $1BN of cash that it has on hand. It will have the ability to sell a portion of the sports company.”

Here’s Richard’s back-of-the-envelope valuation:

Richard and I also chatted MSG on the Value Hive Podcast. You can listen to that episode here.

Resource #2: Barron’s Article, Andrew Bary

Barron’s released a great article back in 2016 summarizing the MSG thesis. You can read that here. Here’s my favorite section from the article:

“MSG has a strong balance sheet with nearly $1.5 billion, or about $60 per share, of cash, and no debt, reflecting a payment from MSG Networks at the time of the spinoff. The company has earmarked $525 million for share repurchases. So far, it has bought back $78 million of stock at an average cost of $151 a share—a pace that has disappointed some investors. The company pays no dividend.

MSG is asset-rich but doesn’t generate much annual income, reflecting in part the high cost of player salaries in both the NBA and NHL. MSG inked a favorable cable deal with MSG Networks prior to the spinoff that results in annual payments of $130 million, with annual escalators.”

Resource #3: Andrew Walker Interview with HedgEye

Back in 2017, Andrew Walker of Rangeley Capital sat down with HedgEye to discuss the MSG idea. You can check out the video here. Here’s one of my favorite bits from the interview:

“Consider a simple sum of its parts valuation for each of MSG’s four main businesses: Forbes currently values the Knicks and Rangers at $3.3 billion and $1.25 billion respectively. The Madison Square Garden arena was recently tax assessed at $1.2 billion (but that doesn’t include the value of the arena’s air rights).

That’s already $5.7 billion.

But don’t forget to add in $1.2 billion in net cash and investments, plus various other assets like the Rockettes and LA concert venue The Forum. Add it all together, Walker says, “Shares could double over the next couple years very easily.”

I had the privilege of having Andrew on the podcast, which you can check out here.

Question From Readers: Systematizing Idea Generation

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Last week I received an email from a reader, David. Here’s the text:

I’ve found what you have been doing to be interesting. I’m wondering if you follow any funds to get ideas from. Quite honestly, I haven’t been able to think of any good ideas on stocks in awhile, and it has lead me to aimlessly reading 10-k’s of random companies. Obviously, it’s not a waste of time but I’d like to be more systematic in my approach.

I love when readers reach out to me with questions/comments. It lets me know that readers are engaging with my work, which is incredibly humbling. Please keep them coming.

There are three questions/comments I pulled from this email:

    1. If I follow any funds to get ideas from
    2. Aimlessly reading 10-k’s of random companies
    3. Would like to be more systematic in my [research] approach

I’m going to dive into each one of these and do my best to answer.

The Funds I Follow

I follow a long list of value-oriented investment funds. Most of the funds I follow are small/micro-cap centered with smaller AUM. If my investment philosophy aligns with theirs, I add them to my list.

I don’t blindly follow these managers into their latest ideas. Rather, I use their holdings as guideposts along our off-the-beaten-path. Sometimes there’s stocks I see that I’m already a part-owner in. Other times I find entire sub-sectors worth digging into. Don’t get me wrong. There’s nothing wrong with cloning. But the key is to clone ideas and not philosophies. In other words, it’s fine to clone an individual stock idea. But make sure it goes through your unique investment process (ie, you do your own diligence and the stock checks all your boxes).

Here’s a list of the funds I follow:

I know. It’s a lot. How can I possibly read all those letters? It takes a while, but I do. Some letters I skim until I reach the new ideas section. Other letters I read word-for-word. It all depends on what catches my eye at the time.

Here’s how I categorize all the ideas from one:

    • Create a “Hedge Fund Letter” notebook in Evernote.
    • I save each PDF into the notebook and highlight the sections I want to look into further.
    • Then, in the notes section of the individual Evernote, I list new positions from the letter. This makes it easy for me to skim through each PDF and find which ideas I want to look at.

I encourage you to try a similar approach. It doesn’t have to look exactly like mine. Tailor it to your own preferences and style.

A 10-K Read Is Never Wasted

I’m of the opinion that reading a 10-K is never a waste of time. Even if you don’t invest in the company. Even if you hate their business model. You learned something that you didn’t otherwise know. Sometimes learning what not to invest in, makes it worth the read.

That said, you don’t want to aimlessly read 10-Ks. There needs to be purpose and structure to how you spend your time.

Here’s some thoughts on how to improve 10-K reading time.

1. Create a list of companies you want to study

These can come from screens (we’ll touch on this later) or hedge fund letters you follow, etc. Assign one 10-K to each day of the week (M-F). Read each 10-K on its assigned day.  At the end of the week, whichever 10-K (or company) appeared most interesting, save it for further research.

Lather, rinse and repeat next week.

2. Take notes when you read a 10-K.

You don’t have to physically write them down. They can live in an Evernote note or a Google Doc. Where you store them isn’t important. It’s that you store them. If you’re wondering where to start, Aswath Damodaran has a fantastic YouTube video on how to read a 10-K.

This brings us to our final question … systematizing the research process.

Creating a Research System That Doesn’t Waste Time

I’m not claiming that my research system is the best system. I guarantee it’s not. But I’ve found that it works for me. And in return, it might help others that are looking for a place to start.

The research system combines elements of what we’ve discussed above. Now it’s about putting it on schedule.

The system is also event-dependent. In other words, when quarterly letters roll around, I devote most of my time to reading each letter. In these situations, screening for companies and reading 10-Ks take a back seat.

I’m also assuming the average investor works a standard 9-5 office job and researches in their free time. This won’t be the case for every reader. But generalizing it this way adds greater value.

Screening, Filtering and Fast-Tracking

Every two weeks I run a stock screener. I try to do it on a Saturday morning. It’s not the same stock screen each time, though. But one thing does stay the same. All screens are high-level filters. This means I’m screening on factors like:

    • Market cap/EV
    • debt/equity ratio
    • EV/EBITDA

The screen spits out a lot of names, which is the goal.

On Monday (screen on Saturday), I go through the screen and pick out my favorite/most interesting ideas. At this point, I download the 10-Ks and put them on my calendar to read. Tuesday – Friday. You can read one 10-K a day during your lunch break, or before bed.

On Saturday, after reading each 10-K, I pick my favorites out of the filtered screen to do deeper work. I don’t put a time limit on the deep work. It’s different for each stock. Some ideas take me a few days to flesh out. Others take months.

The TL;DR Summary:

    • Screen on Saturday
    • Filter on Monday
    • Read 10-Ks Tuesday – Friday
    • Filter the 10-K companies down to my favorites on Saturday
    • Spend the rest of the next two weeks (give or take) diving deeper into my favorite ideas

There are a few benefits to this system.

First, it self-allocates the bulk of your time to your best ideas. In other words, you’re not going to spend a lot of time on ideas you don’t like. You pass on bad ideas and channel your time into your favorites.

Second, you’re always looking at new ideas. Remember, this is a game of turning over the most rocks. The more rocks you turn over, the greater your odds of finding a hidden gem.

Concluding Thoughts

This is one process out of a thousand that can work for you. The beauty of investing is you get to find what fits your style. What matches your personality. Tinker with this system and make it your own.

Want to screen once a month? Have at it! Don’t like the idea of using high-level screens? Refine it as much as you want. Make it work for you.

A Value Investor’s Guide To Stoicism

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You don’t need Stoicism to be a value investor. In the same way you don’t need a killer step-back jump shot to play basketball. Yet if you want to excel as a value investor, you must embrace a form of this ancient philosophical practice.

Think about it.

Ben Graham, Warren Buffett, Michael Burry.

They all share a similar Stoic thread. A principled fabric that once pulled, reveals underpinnings in Epictetus and Marcus Aurelius. These great investors abide by common Stoic ways of thinking. They have an innate ability to detach themselves from an investment idea. A knack for testing ideas through unbiased, unemotional eyes.  A desire to focus on the process of their strategy instead of n=1 results.

I’m not asking you to devote your life to Stoicism. That’s not the purpose of this article. All I’m doing is offering an idea. A tool in your tool-belt. Giving you a new way to view the investment landscape. I’m offering a guide for how we — value investors — can leverage Stoicism into our investment process.

What is Stoicism?

If you’re familiar with Stoic philosophy, it will come as no surprise that most of my research includes Ryan Holiday’s works. According to The Daily Stoic (a site run by Ryan Holiday), Stoicism is (emphasis mine):

“The philosophy asserts that virtue (such as wisdom) is happiness and judgment should be based on behavior, rather than words. That we don’t control and cannot rely on external events, only ourselves and our responses.”

In the same article, Holiday notes that Stoicism teaches four main tenets:

    1. It reminds us how unpredictable the world can be
    2. How brief our moment of life is
    3. How to be steadfast, strong and in control of your life
    4. The source of our dissatisfaction lies on our impulsive dependency on our emotions, rather than logic

You already see the similarities between Stoicism and value investing form. But we’re not there yet.

When people read about Stoicism, they read of Seneca, Epictetus and Marcus Aurelius. These three men are the “Mt. Rushmore” of Stoicism. If you want to learn more about them, check out the following books:

    1. Meditations, Marcus Aurelius
    2. Complete Works of Seneca The Younger, Seneca
    3. The Works of Epictetus, Epictetus

Before diving into the investment application of this philosophy, we must espouse a few common misconceptions regarding Stoicism. Once again, we go to Ryan Holiday for answers.

Common Misconceptions About Stoicism

Holiday outlines three common misconceptions around Stoicism:

    • Stoicism encourages a withdrawal from the world
    • Stoicism promotes a grim and dreary view of life
    • Stoicism means not feeling anything towards others

I can hear the perma-bears rejoice. A philosophy that requires constant pessimism in the face of optimism? Where can they sign up? If any of these misconceptions worries you, I recommend reading Holiday’s post. He expands upon each misconception and offers rebuttals from the three men above.

With our background details out of the way, we can dive right into Stoicism’s impact on investing. We start with (of course), Ben Graham.

Ben Graham Was A Stoic

Benjamin Graham, the father of Value Investing, was a Stoic. Don’t take my word for it. Here’s Graham’s in his autobiography (emphasis mine):

“[I] embraced stoicism as a gospel sent to him from heaven.”

This shouldn’t come as a surprise to us. Graham’s most famous book, The Intelligent Investor, harbors vast quantities of Stoic thinking. Let’s run through a few examples. Page 120-121 (emphasis mine):

The investor’s chief problem – and even his worst enemy – is likely to be himself. (“The fault, dear investor, is not in our stars – and not in our stocks – but in ourselves” …) [Hence] by arguments, examples and exhortation … we hope to aid our readers to establish the proper mental and emotional attitudes toward their investment decisions. We have seen much more money made and kept by “ordinary people” who were temperamentally well suited for the investment process than by those who lacked this quality, even though they lacked an extensive knowledge of finance, accounting, and stock-market lore

Graham stresses the importance of proper temperament when investing in markets. And what better temperment to have than a Stoic one? Take this Marcus Aurelius quote for example:

“In your actions, don’t procrastinate. In your conversations, don’t confuse. In your thoughts, don’t wander. In your soul, don’t be passive or aggressive. In your life, don’t be all about business.”

The similarities between Graham’s thoughts and those of the Stoics are plenty.

Here’s another quote from page 203 (emphasis mine):

“The true investor … is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits [him], and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines … is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if … stocks had no market quotation after all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment”

Again we see a common thread. That not letting the market dictate your feelings matters. If you replace the word “market” with “other people” or “society”, you sound like one of the Stoic greats. To back this up, check out this quote from Epictetus (emphasis mine):

“The chief task in life is simply this: to identify and separate matters so that I can say clearly to myself which are externals not under my control, and which have to do with the choices I actually control. Where then do I look for good and evil? Not to uncontrollable externals, but within myself to the choices that are my own…”

Identify and separate what matters. This is powerful.

Think in the context of stock prices. If we can identify that stock prices don’t state the intrinsic value of a business, we can separate them from our control. We cannot control stock price movements.

Knowing that Graham practiced Stoicism, it’s a good bet that Warren Buffett dabbled in similar philosophy. (Spoiler, he did).

Warren Buffett, The Investor Stoic

Warren Buffett’s known for a lot of things. Greatest investor of all time. Avid Coke drinker, etc. But Stoic philosophy isn’t always the first thing that comes to mind. Yet its this Stoic philosophy that propelled Buffett towards investing lore.

A few Buffett-isms off the top of my head are:

    • Long-term mindset
    • Independent Thinking
    • An unemotional view towards Investment Appraisal
    • Intellectual Framework to view the investing landscape

All these ideas — these Buffett-isms — sound like Stoicism. We see more evidence of Buffett’s Stoicism in his forward to The Intelligent Investor (emphasis mine):

“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline.”

Then there’s this quote from Buffett on how to control your emotions (emphasis mine):

“You will continue to suffer if you have an emotional reaction to everything that is said to you. True power is sitting back and observing things with magic. True power is restraint. If words control you that means everyone else can control you. Breathe and allow things to pass.

Who knows how successful Buffett would’ve (or wouldn’t have) been had he not controlled his emotions. Yet there’s another element, one far greater than Buffett’s ability to control his emotions.

That element is sitting. Waiting. Doing a whole lot of nothing. Buffett expounds on this idea of ‘doing nothing’ in another quote (emphasis mine):

“I insist on a lot of time being spent, almost every day, to just sit and think. That is very uncommon in American business. I read and think. So I do more reading and thinking, and make less impulse decisions than most people in business. I do it because I like this kind of life.”

I love this quote. But what amazes me most about it is its similarity to a quote from Stoic pioneer, Seneca. Here’s Seneca’s take on the same idea:

“Nothing, to my way of thinking, is a better proof of a well ordered mind than a man’s ability to stop just where he is and pass some time in his own company.”

The parallels are striking. It’s evidence of Buffett’s commitment to a Stoic way of life. Even if he doesn’t parade the actual name, Stoicism.

Three Stoic Strategies For Your investment Process

Now you might think, “that’s nice Brandon. But how do I implement these ideas/framework into my investment practice? Here’s three easy steps:

    1. Stop Looking at Stock Prices Every Day
    2. Write a Pre-Mortem Before You Buy a Stock
    3. Get Comfortable With Losing Investments

Let’s break each down further.

Stop Looking at Stock Prices Every Day

Separate what you can control from what you can’t control. You control when you buy a stock. And you control when you sell a stock. You should have both of those prices in mind before placing an order. Christian Ryther of Curreen Capital had a rule that stuck with me. He would check stock prices once a week (Friday). That’s it.

Doing so, he’s always redirecting his focus to the long-term time horizon. I try to adhere to this rule but often break it. With 2020 around the corner, I’ve got a solid candidate for a Resolution.

Write a Pre-Mortem Before You Buy

I got this idea from (you guessed it) Christian Ryther. You can check out his YouTube video on the subject here. In short, a pre-mortem is the act of writing out how your investment will go against you over time. In other words — what would have to happen for your thesis to crumble? Figure that out before you invest a dime into the business.

When you do this, you familiarize yourself with various bearish theses. There’s a sense of comfort in pre-mortems. You know it might not work. You know why it might not work. That’s downside protection.

Get Comfortable With Losses

Stoics adhere to a healthy acknowledgement of their own mortality. Epictetus said, ““I cannot escape death, but at least I can escape the fear of it.” How true is that with stock market losses.

As investors we will experience losses. There’s no way around it. Whether your strategy offers a high slugging percentage or a low one. You will lose money. Applying Stoic thinking towards our losses helps us reckon with that inevitable result.

We can rephrase Epictetus’ quote another way, “I cannot escape market losses, but at least I can escape the fear of it.”

 

website sources: http://www.quebecoislibre.org/15/151215-2.html, http://www.quebecoislibre.org/16/160115-2.html

book sources: Intelligent Investor, Benjamin Graham

The Dangers of Intellectual Brothels & “Yes-Man” Syndrome

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A crucial point in an investor’s journey is the realization that they can say “no” more often. It’s at this moment where maturity begins, thoughtfulness resonates and decision-making improves. Saying “no” more often leads to a better portfolio, a less stressful idea generation process and a greater sense of control.

We can also apply these lessons outside of markets. The framework of hurdle rates, IRR and a “too hard” pile add value to our everyday lives.

Outside financial markets, there are two resources we allocate most:

    1. Time
    2. Energy

Yet like any investment, it’s vital we measure the return on our energy and time spent. Saying yes (or, saying no less) leads to low rates of return on our time and energy.

It’s easy to say yes to everything. It’s easy to stretch yourself too thin. In fact, there’s comfort in saying yes all the time. By saying yes to everything, you free yourself from creating a hierarchy of importance. Without saying no, you avoid the arduous task of scrutinizing your own decisions, friends and commitments. Why do you do this? Because it feels good. And how do I know? Because I used to do it all the time.

Saying No: Where Better Investments Happen

I’ll admit it. I was a “yes man”. Starting out as an investor, I couldn’t say no. Every idea looked good. Any company trading below cash caught my eye. I read Ben Graham and Greenblatt. I scoured Buffett’s partnership letters. I tried to apply this knowledge as quickly as I could to as many ideas as I could find.

Stock screeners weren’t filters as much as they were intellectual brothels. I tried servicing my knowledge to any and every company.

There’s an element of wanting to use the knowledge you’re gaining right away. In other words, when I started investing, I didn’t know the power of delayed gratification via the knowledge I was building.

The Consequences of Being a Yes-Man

I jammed round (bullish) theses into square (realistic) scenarios. This is dangerous for two reasons. One, you start abusing a discounted cash flow model to fit your rosiest projections. This is why I’m a huge proponent of Mohnish Pabrai’s Commandment “Thou Shalt Not Use Excel”. An idea should be a no-brainer on the back of an envelope. Not on the third sheet, row AAB of an excel file.

Two, you develop a false sense of security in your own analysis. Annie Duke explains this well in her book, Thinking in Bets. She uses the example of “Nick the Greek”.

Nick the Greek had an interesting poker strategy. He always played seven-deuce. Keep in mind that a seven-deuce is the weakest mathematical hand possible. Let’s pick up from the book (emphasis mine):

“ He fixated on the relatively common belief that the element of surprise was important in poker… And because he played seven-deuce all the time, occasionally the stars would line up and he’d win. Nick the Greek, needless to say, rarely came out ahead.”

There’s a similar error that occurs when investing in low quality ideas. By saying yes to every investment idea, you’re statistically bound to have one profit. But like Nick the Greek, you won’t come out ahead. If you extrapolate the one time you got a bad idea “right” (i.e., profit), you’ll end up losing everything.

I’ve made this mistake numerous times. So much so, I wrote about a particular example last year.

Instead of red-teaming your ideas, you fall victim to confirmation bias. You’re dying to find someone that agrees with your point of view. In doing so, you feel better about your idea. This is dangerous for a couple of reasons.

First, you could miss a data point, financial statement footnote, or headwind that dismantles your entire thesis.

Second, you fail to learn from your mistakes. If all you do is seek confirmatory information, how will you get better at researching the next idea? Without someone to challenge your ideas, you’ll make the same errors and reinforce negative biases.

How I Stopped Saying “Yes”

I made two changes in my investing philosophy that cured me of my “yes-man” syndrome:

    1. I created an “Ideal Company” for my portfolio
    2. I started saying “No”

Most businesses have their ideal customer. This profile dictates how and where they market, how they craft their sales message and their company culture. For example, many retail companies have a customer profile to match the type of person they want wearing their clothes.

An “Ideal Company” description helps you refine your investment process and select only the companies that best match that criteria.

Even better, it’s completely up to you in how you define this “Ideal Company”. Make it match your investment strategy, of course. But besides that, you have total freedom. Prefer companies with no debt? Add that to the criteria. Looking for turnaround companies with share price declines >65% YTD? Add it.

That’s the beauty.

Then, once you have the “Ideal Company”, focus all your time and energy (i.e., your life capital) on finding those specific names.

I Started Saying “No”

This change has had the biggest impact on my investment process. Now, I spend less time researching bad ideas, and more time on my best ideas. Remember, “bad” and “best” are relative terms, and fit within your framework of your “Ideal Company”.

Saying no increases my portfolio hurdle rate, making it harder for new ideas to enter my book. In other words, I’m always making incremental improvements in my portfolio. At least that’s the goal.

If an idea doesn’t resonate with me after reading the Investor Presentation, 10-K or proxy statement; I pass. There’s better ideas out there for me to spend my time on.

And that’s the beauty. The market’s always throwing you pitches. You don’t have to swing if you don’t want to. Like Ted Williams, wait for a pitch in your sweet spot.

A Never-Ending Struggle

After saying all this, I still struggle with saying no. Investing isn’t a job, but a passion. I love finding ideas that challenge my intellect. Ideas that force me to think outside the box.

But that comes at a price.

Sometimes, in the search for the most obscure idea, I forget the real reason for my research. To find a great business that will compound my capital at above-average rates of return.

I don’t say no as often as I’d like. But I’m getting better. And that’s all I can ask of myself. All I want is to say no a bit more each day.

Poker & Investing: Lessons from a Professional Poker Player

A couple weeks ago I interviewed one of Macro Ops’ members, Macro Nakamoto (not his actual name). Macro is a professional poker player by trade. After finding success with the card game, Macro turned to another interest: trading and investing. 

My interview focused on Macro’s background as a poker player. Yet despite focusing on poker, the lessons and stories discussed can easily transfer to the world of investing and speculation. That’s the beauty. Whether you’re a poker player, currency trader, or value investor, we’re all making bets. That’s it.

We try to manufacture our occupation as some highly intellectual practice, but at first principles, we’re bettors. 

Specific topics include risk management, betting size, psychology of blowing up accounts, hypnotherapy, fitness and diet. My questions and comments are in bold. Macro’s comments italicized. 

Enjoy!

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Can you give me a background on how you got into poker, where you’re from, and how you got into markets. 

I started playing poker fifteen years ago. Started just as friends at home. We actually started playing for buttons — that’s how we got into it. And then it accelerated from 5 euros to 10 euros and increased a lot more over time. 

At one point we were playing pretty big and I was noticing, “okay, I’m somehow better at this than others.” I was winning more often. And that’s how I got into it. I started doing a little bit more research and yeah, studied. 

That’s how I got to online poker. 

What was it that made you better than other people you were playing with? What was your edge? 

At that time I think my main edge was patience and basic math. And most beginners don’t actually think about these things. There’s no strategy involved, no math. It’s basically gambling where you put your money in and you either win or lose. That’s not the case. 

Poker is such a complex game and there’s so much room to maneuver. Pretty much patience and basic math.

Got it, when you were in school, were you a good student? Did you have a knack for math? 

No, actually I was a terrible student. I was always pretty bad at math, actually. But poker math and academic math is completely different. Algebra and all these things have nothing to do with poker. Poker is really basic math. Probabilities and odds pretty much. So it was pretty easy for me. 

You’re winning a bunch of money. Take us through one of your biggest losses. 

I had a pretty good moment. After I realized that I was a little bit better than others, I finished my studies. I financed my studies with my poker winnings (playing online poker). When I finished my studies, I decided to turn professional for at least six months. Just to try it out and go from there. 

I saved some money — my bankroll was $15K. I pretty much ran it up to $50K and that’s when I looked into playing bigger. I wanted to make more money. And online poker is really easy to play higher games and higher stakes. Back then I was not that advanced, especially my mental game. 

What happened was I played higher and I started losing. Going on a downswing. Just having a few bad sessions. I actually went even higher and played $50/$100. You sit down with $10K. I had five buy-ins pretty much. 

I lost pretty much 2/3rds of my bankroll in a couple days. For me, I’ve never lost that much money that fast. So it was really difficult for me to accept that. I had to step back for a couple of weeks and regroup. I asked myself, “Do I really want to do this?”

I just needed a better strategy. But it was a good lesson. It taught me “OK, you’re not superhuman. You can lose.” It really helped me in the long-run. 

There’s already so many parallels between poker and investing that I can peel at. I want to dive deeper into the poker psychology when you lose your edge. What brought you back to that framework of being a consistently good poker player vs. falling off the wagon? 

That’s a good question. I think number one thing had nothing to do with poker at all. It was my mother, who always taught me to treat money well. When I was telling her the story [about losing all my money] she said, “OK, you took risk. That’s always fine. Just be smart about it. Don’t risk all” She has good understanding. She’s self employed for three decades. She just told me “be careful with risking money”

That’s how I learned about bankroll management and the fundamentals about risk. And in my opinion it’s one of the most important things in industries like finance or gambling. You need to have a good understanding of risk and totally eliminate the potential for risk of ruin [losing everything]. 

After that, that became my number one goal to never risk that I would go broke. And to this day I can say that I never went broke. And not many poker players can say that. Many of my poker friends went broke — so that’s really something that helped me. 

You’ve gone pro, you’ve done well, you blew up, you came back. When does financial markets come into the picture? When does trading come in? 

I started getting involved in finance pretty early — but I was not serious about it. I was putting money into some ETFs. Doing beta, not really interested in it. Pretty much only playing poker at that time. 

When I started realizing poker wasn’t forever — that it will go away — you just have to look at the demographics of poker. My main income source as a professional poker player is mostly older gentlemen. Baby boomers that have a lot of money. They have time to play. And at one point, in 10-15 years, this generation will not play poker that much anymore. So I just realized I have to start looking at something else. That’s when I got to finance. 

There are a lot of similar things from poker to finance. Maybe three or four years ago I started getting more interested in trading and investing. Last year I made the decision to transform into maybe a trader/investor — for the next 1-3 years of my life. 

You’ve had a short-term calling / career path. Where did you first go when you made that transition? How did you accumulate the knowledge? 

As a poker player, I learned that studying before actually playing is really important. So I started to find some sources (books, smart people to follow, Macro Ops) and find knowledgeable people I can actually learn from. The next 1-2 years is a learning phase for me. Where when it comes to trading, I won’t throw a lot of money at it right away. You have to slowly grow into it before you can say “OK now I can take bigger risks”. You need to develop some kind of intuition for the markets. And intuition comes from experience. And I don’t have enough experience yet. 

So I tell myself, “OK in the next couple years I will develop my knowledge and my intuition.” 

Were there any strategies that stuck out to you in investing/trading? Anything resonate with you? 

When I was looking into trading and different styles — short-term trading, day-trading, etc. — I realized it’s important to find an edge and reduce variance in the end. Variance is what makes you emotional. I can’t handle variance in emotions. But it’s something you want to reduce. That’s what I’ve learned over the years. You have a better win rate if you can reduce your emotions. 

I want to go in the direction of value investing. Where it goes more of a long-term outlook. Looking for an edge in the long-run and reducing emotions. 

I like that, obviously as a value investor I’m biased in your answer — but no, I definitely enjoyed that. When did you start to feel comfortable enough to go from paper account to real money? Did you have initial success or did you blow up? 

Oh I definitely blew up. I’m also involved in crypto-trading. I had a small trading account and my crypto account (two-three years ago). That’s actually how I got into trading. And I realized that trading wasn’t easy. In poker, we call it game selection. If you don’t have an edge and aren’t sure what’s going on — just step back and don’t engage. In poker if it’s a good game — players who are worse than us will sit down and play. If the game is with players that are better, there’s no reason to play that game. 

That’s when I started just trading a paper account — when it came to finance. I was actually making money on it. That’s when I decided, “OK now I can throw a little money into the real account.” My trades are still really small. I only take 50bps risk for my trades. 

What was the one skill that you learned from poker that made you think “Oh, this is going to help me. This will give me an edge.”?

I think game selection for sure. To understand when you have an edge or not. Number 2, definitely mental strength. Being able to go through drawdowns and bad days, weeks, months, etc. They happen. That’s part of the game. You’re in for the long run. That’s definitely something I think helped me the most. 

What I see many poker players struggle with is that they give up their decision making process when they have a bad day in poker. Or even a good day in poker. They change their decisions. That’s not something you should do. You should always stick to your process. 

In the long run, your win rate will go up if you stick to your process. 

What’s your favorite market to trade? 

That’s something I’m still figuring out. Right now I trade (or look into) a lot of futures. That’s something I enjoy. And also something I think I have some talent for. As well, I’m slowly but surely looking into small-caps. Currently I’m working on two portfolios. 

Number 1 is a trading portfolio. But the second one is kind-of like a long-term deep value portfolio. Where I’ll look into sectors. Let’s take energy for example. Beaten down for ten yeras now. So many companies are dirt cheap. Then looking into companies out of cheap sectors and investing into small caps for the long run in these sectors. 

That’s the reason I really enjoy your letter (Value Ventures). They’re funny and educational at the same time. They’re really good for learning. 

Let’s change course. Where should people start if they want to learn more about poker? 

What you should do is have 80/20 study to play ratio. Where most of the time you study content. There’s a lot to learn. You need to learn about game selection, hand selection I mean. Bet sizings, all these things. And apply them while playing. In my opinion that’s the best way to learn for beginners. Study deep — have a lot of study time. Then try to apply these new concepts — what you’re actually learning — on the smallest table possible. 

These games won’t be challenging. At these smaller tables, you will have an edge. Trust me. The other players at these tables don’t study. You’ll most likely win. That’s how you grow into it. The better you get, then you reduce the studying time to, let’s say, 50/50 and play more. 

I’m at a point where studying is not that helpful anymore. I have my strategies. I still learn new concepts, but at that point, I’m not trying to go any higher. I’m just trying to maintain poker skill. Now I’m down to 90% playing 10% studying. 

I love the concept of this learning and application, where it’s really this spectrum of percentages. You start off and its 80/20, and then as you get better, that spectrum shifts more towards more practice. Then every incremental minute you spend practicing is more valuable. 

I liken it to Geoff Gannon and Andrew Kuhn. Geoff Gannon said this, and I’m paraphrasing it, “There’s only so much you can learn about investing. If you read a couple base-level, foundational level book … Every incremental book you read won’t have as much of an impact as if you go to an annual report, a 10-K or an investor presentation.

In my opinion, that’s how you learn best. Because nobody likes losing money. It’s the best motivator to become better in things. when I see I’m not profitable in something — that’s how I get motivated. Losing money is not the right place to be. 

I have a few good sources I can recommend for you. 

Staying with this poker theme — what are some similarities between hands you get in poker, and how does that thinking correlate with getting dealt a bad hand in a stock (invest in a stock and company releases poor earnings). How do you react? 

That’s actually a very good analogy. Let’s take for example the US stock market right now. Yes its going up right now. Maybe it’s going to go up 1, 2, or 3 more years. But that’s for example, a high risk, low probability example. We are really at the end of a cycle. And do you really want to throw a lot of money at this scenario? Or do you decide, “OK, I’d rather invest into a low risk, high probability set up” for something like energy — which has been beaten down for years. And it’s cheap. It can’t really go down much more. But the downside potential for large-cap stocks is huge. So it’s something where it’s like, “are you choosing the aces? Do you want to play Ace-King? Or are you deciding to play 3-4 suited because it looks good?” 

Yes the return can be there. But in the long-term, most of the time you won’t have that return. 

Let’s get a bit of background outside markets, outside poker. Is there anything you do that you think gives you an edge? 

Oh yeah, for sure. I’m really big on optimization. In poker we have a concept called GTO (Game Theory Optimal). You want to look at everything as a game. You want to make the best possible decision within that game. For example, I’m really big into mental work. I meditate a lot. I do hypnotherapy. There’s a great app called BrainMind. It’s a great app — shoutout to them. 

These little things add up. Also, my diet is really important to me. I fast usually between 16-20 hours a day. I think this gives me a little edge because I’m really not getting tired anymore. My insulin sensitivity is a lot better now.

What I noticed in poker sessions, where other players struggle and breakdown — pretty much have a meltdown — these little things add up. Especially meditation and hypnotherapy. I was dealing for a long time with anxiety while playing. 

For years I had that problem. Meditation was the only thing that helped me. To let go and become better. Hypnotherapy as well. I would recommend looking into these if you don’t do it already. 

I’ve been doing daily meditation — at least ten minutes every morning before I open my laptop. 

It’s not important how long you do it. It’s a practice. If you do it five minutes, that’s fine. As long as you do it daily, you will get something out of it. You’ll grow into it. 

I’m seeing a lot of benefits in terms of not feeling rushed to open my laptop and write. During the mornings I write. Usually what I’ll do is I’ll wake up, take a cold shower and then sit down and listen to a 10-minute meditation practice. 

Then when I’m done, I don’t feel amped up, but prepared. Then when I open my laptop, the writing comes easier that day. When I skip my meditation, I have the day come at me instead of me proactively taking on the day. 

I haven’t tried hypnotherapy. I haven’t heard of many people doing that in the trading/investing world. Why did you start? What are the benefits?

I got in touch with it in Vegas two or three years ago. I go once a year to Vegas for the WSOP (World Series of Poker). I play a lot of tournaments and cash games. That’s when I struggled the most. 

Someone recommended hypnotherapy and it sounded a little bit weird at first. But he said, “Listen, just try it out. If you like meditation you’ll like this.”

I was getting the app and was blown away. What it does (hypnotherapy) — you get your body and mind into a calm state, where you can connect to your subconscious. The majority of our problems (issues) are in our subconscious. We don’t know it — but the stuff is in there. I can tell you. 

The app has five minutes to calm you down, then it’s like he’s trying to connect to your subconscious to improve your intentions. They also have ones for real day traders where it’s like “trade with confidence”. 

He tries to give you that confidence in yourself on a subconscious level. For me, it makes a huge difference. I mostly use it in poker where I know it’s going to be a long session. I want to be focused and mentally prepared. He’s basically preparing you for those situations. Be focused, be prepared for tough situations. You remember these things while playing when you’re actually in that tough situation. 

When I don’t do it — my mind goes in all directions and I don’t remember the things that are Important. It brings to you a point of focus where you remember the important things — the things that make you succeed in the long run. 

It was a huge game changer. I mostly play pot-limit Omaha. The variance is much higher because of the four cards. You get your money in so much more often. 

I have days like yesterday for example. As normal, I did my hypnotherapy in the car before playing and went into the session. Literally the first hand I get stacked, first blind down. 

What does stacked mean? 

Stacked means I’m sitting down, buying chips — that’s your stack. The first hand being stacked means someone took all your chips. 

So three hours later I was four and a half blinds down. These sessions, they happen. I don’t have many of them. But they happen. Now I have a choice to make. You have to decide — are you going to break down and go crazy? Or do you stick to your process and play your game? 

Maybe I don’t get breakeven today — but maybe I win one or two more buy-ins. But yesterday I finished breakeven — which in that situation was an absolute win. 

I see so many players struggle when they get emotional because of the results. It’s really similar in investing. When people invest into a single company, and they did the fundamental research, it’s a good company to invest, and the first month the company loses 20%. Well, now you can decide — are you actually going to break down and get emotional? Throw everything overboard and sell? Or are you going to stick with your decision and your process? Because you did your research. Now just stick to your decision. It will go back up if your decision was correct. 

People struggle letting their results influence their decision making process. 

Before I wrap it up here — I do want to get to one thing before asking last questions … One of the things I didn’t realize about poker playing is how long you guys play. Sometimes deep into the night. Poker players are almost these nocturnal creatures. 

How do you stay sharp and work on staying sharp during those late hours? 

It comes down to preparation. Eating healthy, work-outs — you need stamina, mental preparation as well. Taking breaks is really important in my opinion. Your mind is only able to focus for 90-120 minutes at a time. You need to step back and find some peace for a little bit and then you can go back. 

These are the things that I’ve learned over the years. In the early part of my poker career, I was playing 24 hour sessions. 

I’m sorry to interrupt — but take me through non-stop, 24 hour sessions. 

In the early days where I was so motivated. I had such a passion for the game. I still have that, but life balance is more important now to me. Back then it was ALL about poker. That’s the wrong thing. You need some kind of balance. Otherwise you go crazy if it’s not going well. 

I remember that. The first few times I came to Vegas, I played the whole night until the morning. I loved it back then. But, over the years you pay a fault. It really sucks you out. I don’t know how to say it better. That’s why I have to be more mindful. It’s more about quality than quantity. 

Now, for example, I don’t play anymore at night. I have a family, my wife and my dog. I want to spend time with them. That’s more important — or at least equally as important — as playing poker. So I play 6-10 hours and then I just leave. Even if the game is great, but it’s late. There are other things that I want to enjoy life. I think that’s how you ultimately become a really good poker player in the end. When you’re able to have other things around it, and it makes you a lot sharper in your game. That’s how I feel at least. 

I love that. I love that. Last question: Are there any two books that you have loved over the last year that you would gift to somebody else? 

Uhh — let me think. I read a lot of books this year. 

That’s good!

I think the best book I’ve read in a long time was Principles by Ray Dalio. I truly love him. He’s one of the greatest minds of all time. Such a humble person and his process and principles are a great way to improve everything! It helps you in every way. 

Number 2, I pretty much just finished and I think it’s a great book — and he’s a big hero nobody really talks about. Edward Snowden’s biography. I think I’m around 80% done, I read it on my kindle. And it’s a great book if you’re interested in how the government (and how life around us as citizens of our country) is actually changing. 

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Podcast Transcript: Interview with Richard Howe

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For those that don’t know, can you give everyone a background on how you got into investing? What led you to spin-offs? 

I am Boston born and raised, growing up I always loved investing. I was always one of those kids that was in the investment club in high-school and college. I was lucky, my parents were both in the business. My dad was a large-cap value portfolio manager. My mom was a bond analyst.

I pestered them non-stop with questions. I found myself very interested in investing. It was awesome to have them as a resource.

After I graduated from college, I got a job in the equity research group at Eaton Vance (Equity Research Associate). It was a great place to start my career. I was able to work with a bunch of different senior analysts. MBA types with 15+ years experience. With their CFAs.

I got to cover healthcare. I looked at some financials. I looked at software, internet. Really got to learn the business that way. Eaton Vance encouraged everyone to do their CFAs. Which was helpful.

After six years at Eaton Vance, I wanted to switch it up a little bit. Eaton was a great place to start my career, but, some secular headwinds were becoming apparent — in terms of competition from passive managers, and the index funds of the world. Eaton Vance was largely focused on large cap. So there just wasn’t as much upward mobility in terms of career.

So I started exploring other options. I ended up switching and joining Citi Private Bank. Switching gears a little bit. Focused more on private equity research. My time at Citi was awesome. One of the best parts was that I learned something new. My learning curve took off. Learned the PE industry. It was more top-down research. We researched interesting themes, and tried to find best PE manager to execute on those themes.

So that was a great experience as well. I learned a ton there and enjoyed my time there. But I really missed focusing on making individual investment decisions, and doing the fundamental public analysis work. That is kinda how I got into starting my blog. Which ended up turning into my business. Which is focused on spin-offs.

Take me through the process from moving to Citi and going on your own? 

Have you read Tim Ferriss’ 4-Hour Work Week?

Yes, I loved it. 

I was a wantrepreneur for a long time. Never took the plunge. But reading that book really opened my eyes that there’s a whole world of people out there that are starting their own small, micro businesses. A person of one, all you need is your internet and a computer. You can basically start a business.

That was kinda inspirational. When I started my blog I always kinda hoped it would turn into a business. The idea was that I would start the blog anonymously. I would publish my spin-off ideas. It would serve two purposes:

1. It would get my name out there.

2. It would help me document my investment process.

In a weird way it holds you accountable. You don’t want to sound like an idiot. Maybe it’s a little deeper than if I wasn’t publishing online. So that’s the reason I got started. I was hoping that maybe I could turn it into a business. And I wanted to document my process and get better at that.

And I couldn’t agree more with you. It was so valuable to publish your thesis online. You meet so many interesting people who are investing in the same names, or looking at the same names. You get to talk to Portfolio Managers that have no reason to talk to you if you hadn’t published something they were interested in.

It not only made me a much better investor. But it basically built my business — and enabled me to meet a lot of people, like you. We wouldn’t have met if it weren’t for the internet.

Why spin-offs in particular? 

One thing that I’ve always gravitated towards is inefficient markets. Basically, not mega-large cap stocks. My dad was a PM at a large cap value fund. I’ve had a lot of conversations with him. And at first, when he came out of business school and investing, he was like, “okay, value investing’s the way to go”. But then there became value benchmarks that you had to compete against.

Then everyone else figured out value investing generally works over the long-term. If you’re trying to do that in mega-cap stocks, it’s really hard to do it in a really diversified portfolio. It’s just hard. There are hundreds of analysts that are PhDs and MBA that are looking at these things.

In his experience, he had periods where he did really well and really poorly. One takeaway was trying to find an inefficient market. I saw that at Eaton Vance. We had a large-cap value fund that was 30-40B AUM. It had a great track record, but its hard to maintain that because everyone is gunning for you. Everyone’s looking at those stocks. Especially when you get up in size.

I’ve always gravitated towards smaller, more inefficient markets. Similar to a lot of people, I read You Can Be A Stock Market Genius, by Joel Greenblatt. That whole book was amazing. I’ve read it many times. The chapter on spin-offs was just, really eye-opening. Super interesting. And so when I read that shortly after college, that got me interested in investing in spin-offs.

The reason why spin-offs are so interesting is they’ve historically out-performed the market by 200bps to 1000bps per year, going back a long way. Spin-offs don’t always outperform, and in the past year its been a tough year for them. But in general, I still think it’s a very interesting place to be. Especially the smaller spin-offs. The work that I’ve done shows that a lot of times, you’ll see the asymmetric returns to those smaller companies. They tend to be higher risk, but you can also see the situations where the stock goes up 1,2,3x. Those are the ideas that I’m a little more drawn to.

it’s really the inefficiency. It’s finding something that not everybody is looking at. As you know, spin-offs are distributed to parent-company shareholders. If you own a stock, for instance HON, you were distributed the spin-offs of GTX and REZI (Richard is not a shareholder in either company). You didn’t make a decision to buy that name. And often times that results in forced selling pressure. Because the investors that bought the parent company to begin with, bought it because it was a large cap company. They didn’t want exposure to these smaller spin-off type companies.

And so you often see indiscriminate selling and a situation where you can be a more informed buyer than a seller. I’m always looking for situations like that. It doesn’t have to be spin-offs. I also cover other special situations. Anything where its unique — not plain vanilla idea where there’s an asymmetric opportunity.

What is your ideal spin-off? 

One thing that I’ve noticed anecdotally is that when you bring in an outside management team, you tend to have a large guidance miss. This is what happened with REZI and FTDR.

What I like to see when I’m looking at the spin-off is a company insider that is going to be the CEO or CFO of the new entity. And the reason why I look for that is because one of the big reasons why spin-offs should out-perform is that they’ve been held back by the parent company. They have to beg and scrape to ask for any investment in their business. They’re a tiny subsidiary more often than not. So there’s not much attention paid to the division. Employees and management have little autonomy. Speed of decision-making is held back.

What I’ve noticed is that when you have a spin-off where its a management team that’s more familiar with the business, they know exactly where the low-hanging fruit is. They finally have the opportunity to do something about it without needing four layers of approval.

An example of that is KTB. That’s a spin-off of VF Corp. That’s an example where the continuity of the management team is amazing. Everyone on that team was at VF before. If you listen to their last earnings call, and listen on the detail they go into. It’s pretty amazing.

That’s one thing I look for. In terms of other things I look for … I’m looking for a business that I can understand. For instance, Cyclerion (CYCN) is a recent spin-off that’s done poorly. It was a spin-off of Ironwood Pharma (IRWD). It could have been a home run. It’s based on a drug that will or will not get approved based on data that I have no edge forecasting.

Situations like that I try to avoid.

I’m looking for a company I can understand, that at the end of the day I can answer the question: Would I want to own this business at the right price?

There’s a lot of companies you wouldn’t have high conviction in owning around the business and valuation. But if it came to an attractive valuation, would I want to own this?

I’m not overly scared of debt. But one thing that I do look for is the interest rate. Bondholders are more focused on the downside than us equity holders. If the interest rate the company’s paying is over 10%, that’s a red flag. My return on equity better be very high because you could buy the debt and get 10% with more protection.

Ideally, you’re looking for a business with secular tailwinds, low capital intensity, that aren’t cyclical. Oftentimes that’s not the case with spin-offs. If a spin-off were to have all those attributes, that would be the ideal setup.

Do you think this space could get over-crowded? 

Totally. I think it totally can. I think there’s been a lot more people who have come in and focused on spin-offs. This is somewhat cyclical. In the last year spin-offs have underperformed the market. I think there’s certain waves where value stocks tend to do well, and growth stocks tend to do well. Then spin-off stocks will do well.

I do think there’s more competition in the spin-off world. From the work that I’ve done, on a median basis, spin-offs don’t outperform that much. But if you’re on an average basis they do, because a lot of the smaller companies are the outliers. And they generate these crazy outperformances that pull the average up. And so what I tend to focus on is the smaller cap companies.

Even more micro-cap companies. One company that I liked was a $300M market cap company. Even though there’s a lot of special sit funds, there’s a lot that can’t go below $300M. It’s definitely gotten more competitive. I think micro-caps in spin-offs represent a big opportunity. And the inherent nature of spin-offs make them something you want to follow. Even if they don’t outperform, there could be crazy forced selling after the spin. But I think it’d be foolish to not keep an eye on spin-offs.

I will give the caveat that all spin-offs do not out perform. You want to own the business at the right price.

Also, spin-offs publish Form 10. It gives all the background, pro-forma financials, trends over the past three years. You can get a sense of the trends, capital intensiveness, secular tailwinds or headwinds. Then if you know the business and understand its worth, you can tell when the selling is forced selling from indexing.

The best way to do it is to dollar-cost-averaging … start buying a little bit at a time.

If you had to go to one place on the Form 10, where would you go? And how important are management incentives? 

If you read Greenblatt’s book, he thinks incentives are the most important thing. You do see these days, more often than not, you can go to the executive compensation section of the Form 10. And you can usually find how many shares are reserved for executive compensation and incentive compensation.

I’d say, if it’s a small company, you could have 10-15% of shares outstanding reserved for incentive compensation. That’s obviously a huge incentive for management to not only not pump up the stock price, but eventually create real value — because they’ll become rich if they do.

When you see the larger spin-offs, usually 5% of shares will be reserved. Or even maybe less. It’ll add up to a real dollar amount, though. $100M of dollars of stock.

In terms of the Form 10 … I usually scan the financials. I want to figure out basic questions:

1. Is revenue growing? Is it declining?

2. Is this business capital-intensive? What’s the return on capital?

I use the Greenblatt method: Add up net PP&E and divide by net working capital. And then your numerator is your EBIT.

Often I’ll search for the world “valuation”. For one reason or another, there’s a minority sale. And for one reason or another they valued that business during the minority sale. This let you glean into what outside investors thought the business was worth. Other than that, I’d say don’t get overwhelmed with the Form 10. Just read through it. As you’re reading, write down questions as they come up.

Some of those questions will get answered as you continue to read. If I don’t answer those questions, I’ll set up a call with management or IR to walk me through those questions.

Don’t get intimidated by them. They’re dense documents. A lot of it is fluff.

Get a sense of the financials, read managements explanation of trends and get a general feel for the business. See how many shares are reserved for shareholder compensation. It’s an iterative process.

Do you look at international spin-offs? 

I focus right now on US spin-offs. But I’m hoping that as I build out my team, I focus on international spin-offs. The opportunity is the same, and probably fewer people cover international spin-offs.

How do you primarily source spin-off ideas? 

I have a bunch of Google Alerts, probably eight. Once a week, there’s a Bloomberg that I have access to and I’ll search for recently announced spin-offs. If there’s anything that I have missed, usually people shoot me ideas. It’s primarily news alerts. You can go to an SEC site that has all the Form 10s that have been published.

How much of your idea generation comes from social outlets? 

First of all, I know you’d agree — Twitter has been awesome. Not just for ideas, but for searching what’s going on with a stock. Also, when I’m ramping up on a stock, you can search for who else is interested in the stock and if they’ve published anything.

I don’t know if I’ve gotten any ideas that I’ve sourced from social networks. But it’s enhanced my research process and my ability to find information quickly on things that I’m interested in.

I’d say my subscribers send me ideas — not all the time — but my most recent idea was one that a subscriber shared with me. There are a lot of ideas we’ll share back and forth — special situations. But my latest recommendation, I’m a shareholder (Recro Pharma).

The idea was that they’re spinning off their drug development business. What was going to be left behind was their CDMO business. Basically its an excellent business, 50% EBITDA margins. It’s on pace to grow revenue 30%. They’ve beaten expectations the past two quarters. There’s been crazy consolidation in the space.

In the Form 10, REPH lists 6 CDMO peers, and 4 of them have been acquired. I just dug into that one and I was like “this looks super compelling”. That was a recommendation, the remaining company. But I couldn’t agree more in terms of Twitter’s usefulness. And then just interacting with other people who are looking at the same ideas.

What other ideas are you currently looking at? What ideas are you most excited about?

Two that I’ve mentioned:

1. Recro Pharma (REPH)

I think the thesis there is it’s a great business, sticky business. The manufacturing of the drug is written into the label of the drug. So to change the manufacturing, the drug company would have to refile the label with the FDA. There’s a lot of growth.

The one thing to be aware of, they’re very concentrated. 80% of their revenue came from Novartis or Teva. They are diversifying a lot. It’s just a small company.

It’s just a great business — not very capital-intensive. It’s a defensive business. People are still going to take their medicine in a recession.

It’s rare to find a business that’s growing quickly, there’s a secular trend where pharma companies are outsourcing to third-parties. There’s margin expansion. And it’s trading at 13x this years EBITDA, and maybe 9x next years EBITDA.

2. Kontoor Brands (KTB)

That was an ideal spin-off. I wanted to own it at the right price. Did my work, think it’s worth about $40. It started selling off like crazy. First month it sold off, bottomed close to $25. I think I recommended it at $29.40. I was early, but I was able to buy more as it continued to fall. And then the cool thing is, if you read the Form 10, they were going to pay a $2.40 dividend. So that’s a 9% dividend yield at the bottom.

Revenue only fell 10% in the GFC. The dividend yield is still 6%. Just listen to the call, there are tons of low hanging fruit. It just goes to show that the brands, Wrangler and Lee, weren’t as high growth as Timberlands or Vans or North Face.

The sense you get from KTB, VF was harvesting the cash flow the business generated, and not reinvested in the business. And that’s changing. Management’s super smart. All VF veterans. Really well-regarded corporate culture. They’ve identified a lot of ways to grow revenue, with really simple things.

Lee Brand is a pretty big brand in China. It’s one of the leading lifestyle brands in China. But Wrangler hasn’t launched yet in China. Wrangler and Lee were managed separately when they were a part of VF. They didn’t take the time to launch Wrangler in China. So that seems like a super easy thing to accelerate growth.

They’re underindexed internationally. They’re only 26% and peers are closer to 46%. They’re also expanding into other accessories and other products. Using the Wrangler and Lee brand, but not necessarily in jeans. But in T-shirts. Some jean companies sell 500 t-shirts for every 1 pair of jeans. Wrangler sells 1 t-shirt for every 5 pairs of jeans. So there’s a big opportunity there that doesn’t take rocket science to roll out more t-shirts, or expand distributions there, or launch in China.

My price target was originally $40 — which was kinda conservative. I think it’s now worth closer to $50. Pretty decent upside. It’s trading around $38 now. You get a 6% yield. Even though it’s run a bit, it’s still pretty compelling.

I am a shareholder.

3. Madison Square Garden (MSG)

I am a shareholder of this one too … full disclosure.

The thesis has always been that the individual pieces are worth more than the sum of the parts. Well, the spin-off has been announced. When the spin-off was announced two summers ago, the stock rallied 30%. It almost peaked at 330. If you look today its at 273.

Basically the spin-off is a quarter away. You can do dumb math and figure out that the value of the Rangers and the Knicks, and the cash on the balance sheet is worth more than the Enterprise Value of the company.

It looks ridiculously cheap that’s less than a month away. The other interesting dynamic is there’s been a lot of speculation that PE is interested in buying the sports companies. SilverLake already owns 10% MSG. There’s a lot of interest in sports franchises from institutional investors.

The original spin-off was structured so the sports business would spin-off. That was changed. They’re now spinning off their entertainment business which includes cash a billion, MSG arena, as well as its entertainment business. My understanding is that because it’s a tax-free business, and because MSG owns the Rangers and the Knicks franchises for so long, that whole company could get acquired without any sort of tax liability.

A big knock on the SOTP valuation was that Dolan would have to pay a big tax fee if they sold off the sports. My understanding is that there wouldn’t be a tax liability. For that reason, you should see the discount close significantly. Even if it stays open, Dolan has admitted that if the stock is trading at a big discount to its clear value, I have a fiduciary obligation to close that gap. He also owns 20% of the common stock outstanding.

I think that one’s interesting. There’s been a lot published. But it feels like an idea hiding in plain sight. It’s finally here, but it’s still trading at a big discount.

I just love the sports franchise businesses. You’re probably aware of this, the cable companies, and some of the legacy media companies are in trouble. Nobody’s watching legacy, linear TV anymore. But if you’re an advertiser and you want to get in front of a large, engaged audience, you go to live sports or live news.

That’s why there’s such appeal for sports rights. And that’s why the value of these sports franchises continues to go up.

The other interesting aspect is the number of professional sports franchises is fairly fixed, but there’s more billionaires. Every once in a while you get a new team every 10 years. But there’s more billionaires to buy the assets, but the same number of assets. So you get the supply/demand imbalance.

The other thing is sports businesses tend to be recession proof. NBA and NHL revenue didn’t go down during the GFC.

If everyone is assuming it’s going to happen, is it still a great idea? 

You got to think a level ahead. And that definitely could be the case. From my perspective, there’s been all this buzz around people interested in the sports business. Whether its SilverLake or other PE managers. Dolan’s getting nonstop hell for the Knicks being so bad for so long.

There’s clear valuation marks for how much the Rangers and the Knicks are worth, through Forbes. Forbes values the Knicks at $4B and the Rangers at $1.6B. So that’s $5.6B. Typically when you sell a sports franchise, it transacts at a 38% premium to the last Forbes valuation.

So those valuations are conservative. Even if you assume the Forbes valuation, the stock is so ridiculously cheap. I think that once it happens, and once this clean split happens, it’s going to be pretty hard to ignore how cheap the sports franchises are.

I think another reason why this is interesting is because no-one’s interested in owning the entertainment business. Dolan’s gonna spend $2B building this sphere. Why would I want to own this stock now?

But what I’ve found, and KAR Services was a good example. They spun-off IAA, which was a business that does auctions. Primary customers are insurance companies. You wreck your car, insurance company insures the car. Instead of getting it fixed, they’ll write you a check for the pre-accident value of your car. Then they’ll auction off your car through IAA.

That business is an awesome business. Great business. People get into accidents in any market. 30% EBITDA margin business, revenue growing 8%. People are more distracted now driving — more and more accidents. You also have cars with so much tech. A larger percentage of cars that get into accidents are deemed total losses. It’s so expensive to fix them.

So you have all these secular tailwinds for IAA. And if you looked at that business ahead of time, even though its remaining business was an auction business for used cars. Even if you assumed the remaining business was worth 9x EBITDA and IAA was worth 13-14x EBITDA — it’s still a huge discount to Copart.

So that gives me confidence that people might not buy until the spin-off happens. I’m still confident in the upside, but you’re totally right. But even if I’m not right, the downside is pretty limited.

One of the cool things about investing in spin-offs, and I’m going on a tangent, is you get to invest in really eclectic ideas and assets. It’s cool where people who are getting into investing, or if you have kids, it’s a great way to teach someone that’s younger. If you buy a share of MSG entertainment, you can say you’re a part owner of the building or the team. 

The other thing that’s so cool is that you’re a generalist by default as a spin-off investor. That’s also tough because you might not know something that a sector specialist doesn’t.

What is your valuation process? 

In an ideal world, you have clean financials, you can do a DCF. You can look at publicly traded comps that are good comps for the business you’re looking at. And you can also look at similar transactions. With REPH, you can do all of those. That’s the ideal way that I want to value a company.

I’d say the biggest thing that I look for is relative value. When a spin-off is trading, I want to know what its peers are trading at, and trying to get a sense of whether or not this is a good comparable company. Whether the spin-off deserves to trade at a discount or not. That’s the metric I lean on most heavily, EV/EBITDA.

But if I can, transactions or DCFs.

There can be other situations, Nuvectra. Recommended it, went up a bunch, and then went bankrupt. When that spin-off came out, it had an approved medical device, and a pipeline, and was selling for $40M with $60M in cash on the balance sheet. With that one, I’m not going to do the DCF, but more a function of indiscriminate selling. Down 60% and below cash on the balance sheet with an approved product and heavy investment to build out the platform.

You have to be flexible. In an ideal scenario: DCF, comparable companies and transactions.

What’s been the most fulfilling thing since going from corporate world to owning your own business? 

It’s been an amazing process. I’ve loved it. These are obvious things. But when you work at a big institution, everything you do or write has to be documented. Every decision has to be run up the tree. Everything checked by internal and external council, then compliance.

It gets tough to do work. You’re focused on jumping through hoops. It’s so freeing being able to make my own decisions super quickly, and implement them tomorrow.

If I have a new stock idea or a marketing idea, I can get it up and running. Or if I want to expand (like odd-lot share repurchases, etc.) I can change. I can make that decision. I can add that to my service without need committee approval.

I also have two small kids. I have a four-year old girl and a one-and-a-half year old boy. When I was working at Citi, I saw my girl on the weekends. I’d get home at 7-8 and she was asleep. You don’t realize you’re missing anything until my boy comes along and I see him several times a day. We get to hang out so much and I get to know him so much better.

It’s having the flexibility and control of your schedule.

What gets you exited when you wake up in the morning? 

One nice thing about working for myself is that I have time for the gym. But in terms of work stuff, the thing that gets me super excited is when I have another idea that I think is really interesting. I want to complete my diligence on. I love those situations. It doesn’t happen every day, obviously, but it gets me fired up.

I also love when I do a ton of work on a spin-off and waiting for the indiscriminate selling to happen. That happened with KTB. It doesn’t happen all the time, but those are the really fun days.

New ideas are the most exciting.

How To Take Advantage of Tax-Loss Selling

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Tax-loss selling (or harvesting) sounds complicated. But in reality, it’s simple. You sell your biggest losers to shield the gains you’ve made in the rest of your account. It’s not only retail investors with adept accountants that do this. Financial advisors, hedge fund managers and institutions all join in on the game.

Yet this tax strategy comes at a cost. Investors that focus on tax efficiency could sell at the very moment they should buy. So the cheap stocks get cheaper.

As value investors, this strategy becomes our advantage. We can position ourselves to buy from forced, not thoughtful, sellers.

This isn’t a post about the efficacy of tax-loss harvesting. That’s venturing well beyond my circle of competence. This piece is about understanding why it happens, when it happens and how we can take advantage of it.

When Does It Happen?

Many investors think about tax-loss harvesting around Thanksgiving and Christmas. The official deadline is usually around the last week of December (26th – 31st).

There are some investors that fill their tax-loss quota early in the year. Yet in most cases, procrastination wins. Investors rush to sell their losses towards the end of December only to find lower prices and no bids. There’s not a buyer in sight.

Doing some second-level thinking, this problem makes sense. After all, we’re the ones trying to take advantage of their selling. Investors that focus on absolute returns — like ourselves — know why these investors want to sell.

So we wait.

We don’t buy. Not yet.

This exacerbates the selling pressure as tax-minded sellers dump at any price.

Why Does It Happen?

Tax-loss harvesting happens for a couple reasons. One obvious reason is to shield any gains from investments or ordinary income. The second reason — which isn’t as sexy — is the need for advisors / fund managers to window-dress their portfolio.

Financial advisors face career risk with every quarterly / annual meeting. In other words, one bad quarter is all it takes for a client to move assets and find another stock picker. Because of this, many advisors ‘upgrade’ their portfolios right before their year-end review.

There’s a couple ways advisors upgrade their portfolio. They either sell their client’s biggest losers, exit turnaround projects or remove small cap companies. I’m not saying this is the right thing to do. But it happens. I’ve seen this first hand at my previous work. Michael Burry commented on this idea in one of his investor letters, saying (emphasis mine):

“Indeed, as the quarter came to a close, the stock came under renewed selling pressure, presumably as other investment funds worked to ‘window dress’ their portfolios for public viewing. Some element of early tax-loss selling may have played a role.”

Whether for tax purposes or a career risk, end of year selling presents opportunities for a specific group of stocks. Which we’ll chat about next.

What Kinds of Stocks Does it Impact

We know why it happens, and we know who’s doing the selling. Now we need to know what stocks get hit the hardest.

Scavenging the 52-week all-time low lists is a good start. These are stocks that tend to be down 40, 50, 60 even 80% on the year. In other words, most investors who bought these stocks are probably in the red. They’ll want to sell before the end of December.

You can also find thematic movements in tax-loss harvesting. 2019, for instance, should feature a lot of oil and gas names. Trends like this make things tantalizing from a deep value investor’s perspective. You combine a beaten down industry with forced sellers and it’s bottom-feeding time.

Regardless of the theme, any stock that’s down over 50% is a good candidate for more tax-related selling pressure.

How To Take Advantage of Tax Selling

This may sound counterintuitive, but the best thing to do during this time is wait. Sit on your hands. I know, it’s hard. But,like Livermore said, sitting tight is how you make the real money.

I form a list of 10-20 stocks that I think are primed for tax-selling / window dressing. Then I put those names in a watchlist. I’ll dive deeper into the names to make sure they aren’t zeroes (at least to the best of my ability). Then, I’ll wait for consolidation in the price charts.

Here’s what I’m looking for when going through my tax-loss buying candidates:

    1. Little to no debt. It’s hard to go bankrupt when you don’t have debt.
    2. Potential catalyst for earnings or revenue growth.
    3. Insider ownership

We don’t want to catch falling knives. Doing so will lead to a bleeding portfolio. This is where charts come in handy. They tell us whether downward momentum has been exhausted. Once consolidation occurs,  I’ll buy around the low price support or after a breakout from the range.

This strategy relies on mean-reversion. I’m not looking for the best businesses. I’m looking for the ugly business that’s oversold and overlooked.

Some Ideas Going Into 2019 Tax-Selling Season

With our knowledge of tax-loss harvesting in place and our strategy defined; we’re ready to take on ideas. Here’s a few names I’m thinking about adding to my tax-loss harvesting watchlist:

1. Medifast (MED)

Medifast (MED) is a health and wellness company dedicated to helping others lose weight. The stock is down 40% YTD, making it a great candidate for tax-loss selling pressure. Yet does it deserve the current cheap price? Let’s take a look under the hood.

The company trades at 16x earnings and 9x EBITDA. They have zero debt and an activist investor who recently took a 15% stake in the business. MED hits many of the characteristics we want in tax-loss victims. A cheap price, no debt and incentivized management.

Meanwhile, famous value investor Bill Miller took a position in MED during Q3. Here’s Miller’s thesis (emphasis mine):

“The stock peaked about a year ago at $260 per share and has fallen to around $99 weighed down by competitive concerns after troubles at WW (formerly Weight Watchers) and Nutrisystem, along with some headline-grabbing short reports and concerns about an ERP (enterprise resource planning software) implementation. At the current level, the company trades for just 14.5x earnings with 20%+ topline growth going forward and a 3% dividend yield. If it reaches its 2021 target, it’s trading for only 10x earnings out a couple of years. We believe Medifast has the potential to double.”

2. Kirkland’s (KIRK)

Kirkland’s (KIRK) is a specialty retailer of home decor and gifts primarily focused in the United States. I know, retailer. I told you we were dumpster diving, didn’t I?

There’s plenty of reasons KIRK’s a candidate for our tax-loss seller’s watchlist. First, the stock is down 87% YTD. Shares are rather liquid (trading 390K/day), so anyone looking for that locked-in tax-loss harvest should get it. Second, the company’s a $16M nano-cap stock. Any advisor caught with an 87% loser AND a nano-cap stock would be in hot water.

Now let’s get to the good. The company has zero debt. In fact, they trade at roughly net-cash. KIRK has $1.04/share in net cash and its last quoted market price was $1.19. It’s also trading at an 88% discount to book value.

Here’s where things get interesting. KIRK generated $15M in EBITDA last year. That’s nearly its entire market cap in EBITDA. The company’s losing money but has bought back 1M shares over the last 6 months.

3. TripAdvisor (TRIP)

TripAdvisor (TRIP) operates a portfolio of online travel brands and consists of two main business segments: Hotel and Non-Hotel. Its website, TripAdvisor.com, is home to over 600M reviews on what to eat, where to go and things to do in various locations.

TRIP’s grown revenues, cash flow and paid down all short-term debt. Yet despite these achievements, the stock’s down 48% YTD. In fact, share prices haven’t been this low since 2012. TRIP generated $736M in revenue in 2012. Last year they did $1.6B. But the stock price remains the same.

The company trades for a mere 12x free cash flow (8% yield) and 9x EBITDA.

4. GameStop, Inc. (GME)

GameStop, Inc. (GME) is a hot-button value (trap) name. We know Burry’s actively pushing for massive share buybacks. The stock’s up over 30% since Burry’s letter to GME management. But the game isn’t over. Here’s Burry’s bull thesis over the next 2-3 years:

“We expect GameStop’s business will perk up a bit during 2020 and 2021 as the new console cycle, with associated software updates and introductions, finally gets underway. But what is happening now in the stock is about more than late-cycle doldrums or even the streaming paradigm – shareholders do not have faith in current management, and have not been inspired by new leadership policies.”

If you’re curious about this idea, an interesting play could be buying OTM call options on GME. Let’s take a look at the farthest-dated options and prices for the $7 strike price:

    • April 16, 2021 for $1.53/contract
    • July 16, 2021 for $1.70/contract
    • January 21, 2022 for $2.05/contract

Concluding Thoughts

Forced selling from tax-loss harvesting creates a fertile ground to dig for dirt cheap companies. Like most deep value areas, tread with caution. Most of these companies are falling knives. Wait for consolidation, look for little-to-no debt, and position accordingly.

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