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Will Thrower: Deep Value Opportunities in Japan & Australia (Ep. 47)

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Will Thrower is one of the most under-followed investors on Twitter. In fact, his Twitter profile is like the companies he hunts for: undervalued with long runways for growth. Our conversation took us from chicken farms in China to equity trading offices in London.
How Will got started in markets is such a fascinating story. It was one blog post, picked up by Bloomberg, that led to a job as an equity analyst.
We spend over an hour discussing how Will finds ideas, the opportunity set in Japan and Australia, and why US investors should think twice before passing over an International business because, “A US competitor can do the same thing.”
Here’s the time-stamp for our chat: 
  • [0:00] The Chicken Farm
  • [5:30] What led you to become an equity researcher?
  • [20:30] The Beenos Thesis (3328.T)
  • [33:20] Questions that You Want Management to Answer.
  • [35:20] An Ideal Investment
  • [40:40] Nano Cap Investments and Competitive Advantages 
  • [54:00] Positioning Sizing
  • [1:01:10] Advance Nano Tek (ASX: $ANO)
  • [1:16:00] More from Will Thrower
  • [1:19:22] Closing Questions
This was one of the more esoteric conversations I’ve had on the podcast. Will is intellectually bright, honest and has a thirst for learning. He’s also a good investor. Two of the companies he wrote on his blog have gone on to generate monster returns. Beenos (3328.JP) is up over 30% since he wrote about it. And Base (4477.JP) is up nearly 40% since late August. 
If you enjoyed our conversation and want to learn more about Will Thrower, check out the following resources:
Display ballet dancer because Darvas was a ballet dancer

How Nicholas Darvas Made $2M In The Stock Market, A Book Review

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“I shot upright in my chair. My 50-cent BRILUND stock was quoted at $1.90. I sold it at once and made a profit of close to $8,000 … I decided I had been missing a good thing all my life. I made up my mind to go into the stock market. I have never gone back on this decision. But little did I know what problems I would encounter in this unknown jungle.”

We all remember our “first”. You know, that one profit that hooked us into the stock market. Nicholas Darvas was no exception. At 23, Darvas began his career as a dancer. Touring the world light on his feet.

But when Darvas wasn’t dancing, he was reading. In fact, Darvas consumed over 200 books during his down time on tour. Some say he read up to eight hours a day. He studied markets, speculation and how those before him raked millions from the market.

Darvas ventured into Wall Street, armed with 200+ books of knowledge in his head. What resulted was a rollercoaster of wins and losses. Triumphs and defeats. A near decade’s effort that culminated in over $2M profits in an 18-month span.

Darvas’ journey from loser to winner reads like a movie. With painful lessons, simple insights and dogmatic application to what worked. Luckily, he wrote it all down for us in his book How I Made $2,000,000 In The Stock Market.

This book review will highlight three things:

1. Darvas’ early losses and lessons learned

2. The Darvas Box Theory: The Strategy That Made Darvas A Multi-Millionaire

3. Why You Should Distance Yourself From The Market

Darvas was mainly a swing trader. But the lessons in this book are useful for even the most long-term focused investor. As such, I use the words interchangeably.

Are you ready to learn how to make millions?

Darvas’ Early Days: The Antithesis of A Good Trader

Take a second and think about what makes a great trader … Got some ideas? Good. Darvas did the opposite of all those things.

He doesn’t hide it either. Within the first six pages of the book Darvas hints at two major issues with his early trading strategy:

    • Buying based on “hot tips”
    • Turning losing trades into “pet stocks”

Never Trust A Hot Tip

Buying stocks off “hot tips” from friends, neighbors or FinTwit accounts is a bad idea. It’s also not a new idea. Darvas notes on page 5:

“I listened eagerly to what they had to say and religiously followed their tips. Whatever I was told to buy, I bought. It took me a long time to discover that this is one method that never works … All I knew was what the last head-waiter in the last nightclub I had performed in had told me was good.”

Tip-based investing never works because you can’t buy a person’s conviction in an idea.  If you don’t do the work yourself you’ll never have the confidence to hold on when you’re right.

Even worse, if the stock goes down, who do you look to for confirmation? That friend.

Lesson: Do your own work. It’s okay to get a head start from a friend/someone you trust. But do your own work to develop your own conviction before buying.

Date, Don’t Marry Your Stocks

Warren Buffett’s ideal holding period is forever. Ideal is the key word. Never fall in love with a stock or a company, no matter the circumstances. Darvas learned this painful lesson early in the book. Here’s a quote from page 8 (emphasis mine):

“For some of them [stocks] I acquired a special liking. This came about for different reasons. Sometimes it was because they were given to me by a good friend of mine — other times, because I had started by making money with them. This led me to prefer these stocks more than others, and before I knew what I was doing I had started to keep ‘pets’”.

This paragraph reveals something all traders struggle with: confirmation bias. And the temptation is worse in the social media age. God forbid you write a long, detailed write-up on a recent investment only to find out you’re wrong. What do you do then? Can you cut your loss and admit defeat?

It’s tough.

Darvas continues with the pet stock analogy and shows how much damage this mentality can cause to a portfolio (emphasis mine):

“I thought of them as something belonging to me, like members of my family. I praised their virtues day and night. I talked about them as one talks about his children. It did not bother me that no one else could see any special virtue in my pet stocks to distinguish them from any other stocks. This state of mind lasted until i realized that my pet stocks were causing me my heaviest losses.”

Stocks are hard. On one hand, you need the conviction to hold an idea as it executes, despite what the general market thinks about the company. But at the same time you have to be willing to accept that you’re wrong and cut your losses.

Cut too soon and you can abandon a potential big winner. But failure to cut at the first sign of danger might blow up your entire portfolio.

This is especially true for value-oriented investors. If a stock you own falls in price, the first reaction is to buy more. After all, if you loved it at $X you’ll really love it at ($X – % decline)! You’ll conjure reasons for the decline that have nothing to do with the fundamentals of the business.

And sometimes you’re right. But other times the fundamentals have deteriorated. And now instead of cutting a loser you’re nursing a pet stock.

Lesson: You need a system to judge whether you should buy, hold or sell your stocks. Whether you’re a swing trader or long-term investor. You need a system. Preferably something quantifiable. That way there’s less room for ifs, ands or butts.

Darvas’ First System: The Seven Rules

Before Darvas’ Box Theory there were the Seven Rules. These rules shaped Darvas’ latter portions of his early trading days.

Here were his rules:

    1. You should not follow advisory services. They are not infallible, either in Canada or on Wall Street.
    2. You should be cautious with brokers’ advice. They can be wrong.
    3. You should ignore Wall Street sayings, no matter how ancient and revered.
    4. You should not trade “over the counter” — only in listed stocks where there is always a buyer when you want to sell.
    5. You should not listen to rumors, no matter how well-founded they may appear.
    6. The fundamental approach worked better than gambling. Study it.
    7. You should hold on to one rising stock for a longer period than juggle with a dozen stocks for a short period at a time.

What do all these rumors have in common? One thing: cut out the noise and focus on what matters: the stock and its fundamentals.

Darvas loved this strategy. Finally, he thought, a way to cut the Wall Street noise and focus on the business. Analyze the balance sheets, income statements and cash flows. Determine what a company should trade for, and buy it at a discount.

After all, if it’s hard numbers, the market will eventually agree with you. Or so Darvas thought.

Quantitative Metrics Aren’t Enough & Why You Should Match Style With Personality

It’s at this point in the book where we experience Darvas’ first major loss. He found Jones & Laughlin after culling through a list of “B-rated” stocks in a hot industry. To his excitement, this “no brainer” was for the taking.

What made this stock a no-brainer?

    • Strong industry
    • Strong B rating
    • 6% Dividend Yield
    • P/E was better than any stock in the group

There’s not much about the actual fundamentals of the business in the analysis above. All we know is that it pays 6% and has a lower P/E versus its peers.

Yet to a gambler in markets (like Darvas), this analysis proved unbreakable. Here’s his thoughts (emphasis mine):

“A tremendous enthusiasm came over me. This undoubtedly was the golden key. I felt fortune within my grasp like a ripe apple. This was the stock to make me wealthy. This was the gilt-edged scientific certainty, a newer and greater BRILUND. It was sure to jump 20 to 30 points any moment.”

Run the other way if you read the words “sure” or “certainty” in an investment write-up. Darvas leveraged his “sure” bet to the hills. He mortgaged his home, took a loan out on his insurance policy and got an advance on his paycheck.

He then dumped all of that into Jones & Laughlin. Darvas recounts the memory, saying, “The 23rd of September, 1955, I bought 1,000 shares of Jones & Laughlin at 52 ¼ on margin, which at that time was 70%. The cost was $52,652.30 and I had to deposit $36,856.61 in cash. To raise this amount I had put up all my possessions as a guarantee.”

You know where this is going.

Three days after Darvas’ purchase, the stock began to freefall. This is where Darvas went wrong. He bought on fundamentals but used price action to confirm/deny the validity of his investment thesis.

That’s not to say that one way is better than another. There’s countless traders that make money focusing only on price action. Just as the world’s best long-term investors (Buffett, for example) don’t pay any attention to price action.

Darvas didn’t have a strategy. He was helpless and treading water in no-man’s land. Listen to his excruciating relationship with Jones & Laughlin (emphasis mine):

“I saw it fall and yet I refused to face reality. I was paralyzed. I simply did not know what to do. Should I sell? How could I? In my projection, based on my exhaustive studies, Jones & Laughlin was worth at least $75/share. It was just a temporary setback, I said to myself. There is no reason for the drop. It is a good sound stock; it will come back. I must hold on. And I held on and I held on.”

That’s when Darvas realized he needed a strategy that matched his personality. He tried the fundamental approach and it didn’t work (emphasis mine):

What, I asked myself, was the value of examining company reports, studying the industry outlook, the ratings, the price-earnings ratios? The stock that saved me from disaster was one about which I knew nothing. I picked it for one reason only — it seemed to be rising.

It’s at this point Darvas developed his Box Theory. From pure fundamentals to pure technical analysis.

Darvas’ Method: The Box Method

I might lose all the value investors that have read until this point. Darvas’ success took off when he switched to pure technical analysis: price and volume.

Darvas noted in Chapter 4 (emphasis mine), “This experience did more than anything to convince me that the purely technical approach to the market was sound. It meant that if I studied price action and volume, discarding all other factors, I could get positive results.

His studies led him to the cornerstone of his trading strategy:

“Stocks did not fly like balloons in any direction. As if attracted by a magnet, they had a defined upward or downward trend which, once established, tended to continue. Within this trend stocks moved in a series of frames, or what I began to call ‘boxes’.

The boxes. That was the secret. Darvas waited for periods of compressed volatility.

In essence, that’s what a box is. A fierce war between buyers and sellers. Each burdened by the psychological effects of their previous decisions.

Then when the market tips its hand as to the direction of the next magnetic trend, you buy (or sell) in the direction of that new trend.

Here’s Darvas’ explanation of The Box Method (emphasis mine):

“This is how I applied my theory: When the boxes of a stock in which I was interested stood, like a pyramid, on top of each other, and my stock was in the highest box, I started to watch it. It could bounce between the top and the bottom of the box and I was perfectly satisfied. Once I had decided on the dimensions of the box, the stock could do what it liked, but only within that frame. In fact, if it did not bounce up and down inside that box I was worried.”

Examples of The Box on Price Charts

In short, he waited for stocks to form box patterns on a price chart. Here’s a few examples of what Darvas would call a “box”:

CELH moved between its $3 and $7 box for nearly three years before breaking out of the box into new highs.

TOBII bounced between its $24-$28 box before breaking out and moving higher before forming another box at $34-$38 (disclosure: I own shares of TOBII).

Currently, HEAR is in the middle of its $16-$21 box.

These are only three examples of stocks forming boxes on daily, weekly and monthly price charts. Mr. Market presents these opportunities every single day, 365 days of the year.

How To Buy and Sell in The Box Method

Darvas’ buy and sell instructions were simple:

    • Buy when the stock broke out of its box
    • Sell for a loss when the stock moved back into its previous box

The other, more difficult decision, involved selling a stock at a profit. Darvas already knew the danger of taking quick profits. Here’s how he defined his profit-taking strategy (emphasis mine):

“I decided that since I could not train myself not to get scared every time, it was better to adopt another method. This was to hold on to a rising stock but, at the same time, keep raising my stop-loss order parallel with its rise.

I would keep it at such a distance that a meaningless swing in the price would not touch it off. If, however, the stock really turned around and began to drop, I would be sold out immediately.”

This is the hardest and least scientific part of the strategy. How do you know when your stop-loss is close enough? How can you tell if it’s too far?

Honest answer: there is no right answer. Find what works for you.

What we see by the end of Chapter 4 is a man with a defined strategy. The polar opposite approach to the beginning of the book. Let’s listen to Darvas’ newfound confidence (emphasis mine):

“I knew that I had to adopt a cold, unemotional attitude toward stocks; that I must not fall in love with them when they rose and I must not get angry when they fell; that there are no such animals as good or bad stocks. There are only rising and falling stocks — and I should hold the rising ones and sell those that fall.”

Power in Simplicity

Darvas’ actual trading method is very simple:

1. Find a box pattern on a price chart

2. Buy the stock if it breaks out above its box

3. Sell the stock if it falls back into its previous box

But before he finished the book, Darvas added one element to his technical strategy: fundamentals.

Darvas’ Final Form: Technicals + Fundamentals

After perfecting his technical approach, Darvas added one last element to his stock selection criteria: improving earning power or anticipation of it.

Darvas became a Techno-Fundamentalist. We’re big fans of this approach at Macro Ops and employ it in our own stock selection criteria. Here’s his reason for adding fundamentals (emphasis mine):

“I would select stocks on their technical actions in the market, but I would only buy them when I could give improving earning power as my fundamental reason for doing so.”

In other words, Darvas didn’t buy a stock on the chart pattern alone. He needed a fundamental confirmation from improved earnings.

Darvas also took the long-term view when picking stocks. It sounds counter-intuitive, right? Looking out 20 years into the future for swing trades that may last weeks or months. But that’s what Darvas did (emphasis mine):

“I looked out for those stocks which were tied up with the future and where I could expect that revolutionary new products would sharply improve the company’s earnings.”

Said another way, Darvas wanted to invest in forward-looking industries. Industries with long runways and strong tailwinds behind them.

So now we can add two more rules to our simple formula above:

4. Buy a stock with improving earnings or expected improvements

5. Buy stocks in strong industries with long-term tailwinds

But as Jesse Livermore says, “It’s not the buying or the selling that makes you money. It’s the waiting.

The real genius in Darvas’ book is his ability to make millions touring the world as a dancer. It’s his occupation that helped Darvas make (and keep) his millions. In fact, most reviews of this book completely forget this crucial detail.

Let’s examine a few reasons why.

Darvas’ Greatest Weapon: Distance From Wall Street

“Being thousands of miles away from Wall Street, I succeeded in disassociating myself emotionally from every stock I held.”

Darvas, like Buffett or Templeton, knew the power of distance. Buffett barricaded himself in Omaha. John Templeton took frequent beach walks and moved to the Bahamas to escape Wall Street’s snare. As a dancer, Darvas spent most of his life away from Wall Street.

Yet Darvas wasn’t immune to the sweet song of New York. With his newfound trading success, Darvas set up shop at a Wall Street brokerage firm. What followed was a complete unraveling of a perfectly good trading plan (emphasis mine):

“As I began trading day to day from the board room, I gradually abandoned my detachment and started to join them. I opened my ears to the confusing combination of facts, opinions and gossip. I read the market letters. I also started to answer questions like, ‘What do you think of the market?’ or ‘What do you know that’s cheap?’ All this had a deadly effect on me.

The closer you are to the markets the higher your odds of following the herd. This makes sense. We’re social creatures. It’s how we survived. Yet following the herd is what gets you killed in financial markets. That’s the moment you start buying at the top and selling at the low. Darvas reveals first-hand the dangers of herd mentality:

“Instead of being a lone wolf, I became a confused, excited lamb milling around with others, waiting to be clipped. It was impossible for me to say ‘no’ when everybody around me was saying ‘yes’. I got scared when they got scared/ I became hopeful when they were hopeful.”

Lesson: Stay as far away from Wall Street as possible. Move to the Bahamas if you must.

The Last Word: A Life Changing Book

Darvas’ book changed my life.

It made me realize it is possible to make life-altering profits in financial markets. Moreover, Darvas took readers on a journey through the highs and lows of speculation and trading. We witnessed his early losses. Celebrated his victorious improvements. And cringed when he almost lost it all at the end.

But the most important part of Darvas’ book is that his strategy works. It worked in the 1950s and it works today. The stocks change names and the participants come and go. But business fundamentals stay true. And basic human psychology doesn’t change.

I can’t wait to read this again.

Winners Evolve..

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This will make you sit up in your chair (emphasis mine):

In the 1990’s Harvard Business School’s Amy Edmondson performed some research to try to understand some of the qualities that make up a well-run hospital. She was not prepared, however, for one of the results her research produced. After surveying the nurses at eight different institutions, one of the things her study found was that in those hospitals where nurses reported the very best leadership team, along with great relationships with their co-workers, the number of medical errors reported was ten times higher!

What could possibly explain this outcome?

…In hospitals where the nurses felt safe and highly regarded, both by their peers and by their managers, the reason they reported more errors was that they felt more psychologically “safe.” Nurses in these more cohesive, well-led units made comments such as “mistakes are natural and normal to document,” and “mistakes are serious because of the toxicity of the drugs, so you are never afraid to tell the nurse manager.”

By contrast, in those environments where mistakes were not forgiven and miscreants were punished, nurses were more likely to report that “The environment is unforgiving, heads will roll.” In other words, it was highly likely that just as many mistakes — if not more — were made in these institutions, but not reported. Instead of learning from their mistakes, these hospitals were hiding from them.

– Don P, Peppers & Rogers Group, Does Your Company Make Enough Mistakes?

That opener is so eye-opening it is worth repeating:

“in those hospitals where nurses reported the very best leadership team, along with great relationships with their co-workers, the number of medical errors reported was ten times higher!”

Think about what this implies:

    • the sheer number of hospital errors that DON’T get reported
    • the number of errors that even top hospitals make (a lot)
    • the number of errors that marginal to poorly run hospitals make (surely a lot more)
    • the number of hidden or non-reported errors that are missed completely

An observed reporting spread of 10-to-1 suggests the hospital error base rate is remarkably high. If there are remarkably high error rates in the confines of hospitals — where medical processes are exhaustively detailed and regimented — think how much more capacity there is for error in the relatively undocumented world of discretionary trading and investing.

And if top hospitals report an order of magnitude more errors than second or third-rate peers… while surely having a lower absolute number of errors (because top-performing institutions are better run)… think of the overwhelming number of errors sloppy performers must make… and by simple logical extension, the vast quantity of errors marginal traders and investors must be making over and over again, every single day.

(The collective presence of investor error fuels real trading opportunity, by the way, for the same reason errors at the poker table are profit opportunities for the skilled. Difference being, in a poker game you typically only have one opponent on the other side of a big hand. In a big trade you can have myriad investors, who have collectively all made the same mistake, pooling profits in your pocket by way of their positioning.)

“Heads Will Roll”

This fuels a delicious irony: If Edmondson’s findings translate to traders, one of the strongest indicators of performance quality is the frequency with which one admits and reports weaknesses or mistakes rather than hides them. This is 180 degrees from the attitude of “I never make mistakes ever.”

When interviewing a prospective money manager, then, what you want to hear is: “We’ve messed up plenty of times but learned a lot, and continue to learn.” If instead you get some variant of “We’ve always been perfect and will continue to be perfect,” walk away fast.

Why is it, then, that top performers are more willing to admit mistakes? Perhaps because lesser performers operate out of fear:

    • fear that bosses will judge them harshly
    • fear that clients or investors will judge harshly (or even pull funding)
    • an inaccurate self-judging compass (the perception that all mistakes are bad)
    • an ego-preserving data distortion field (fear of ego being bruised or even shattered)

Unfortunately, bad bosses and bad clients actually justify such fear in all too many cases. The notion that “heads will roll” is the result of subconscious signals delivered and received. Within organizations, bad leaders really do “shoot messengers”… confuse useful feedback with negative performance… fail to distinguish between luck and skill… fail to cultivate small improvements… R&D expansion into adjacent areas… better results monitoring… and so on.

In the investment world, bad clients are even worse: Rewarding slickly polished presentations from “empty suits”… chasing performance over a cliff… being emotionally averse to inevitable flat periods… disregarding the value of risk control… preferring artificial smoothness to organic robusticity… etcetera ad infinitum.

(The answer to the “heads will roll” problem is tongue-in-cheek but effective: Avoid bad bosses and clients! If someone with a functional lack of understanding and/or an obtuse point of view has the ability to impact your future in a negative way, change your situation to remove that person’s impact — or at least minimize it — as soon as you can…)

Mistakes vs Weaknesses

For mechanical traders, and discretionary traders who long ago check-listed their basic processes, it is also important to distinguish between “mistakes” and “weaknesses” — and to recognize that reporting and studying a “weakness” can have the same beneficial impact as a mistake.

Take the practice of honoring one’s risk points, for example, or always following a daily homework routine. For traders with a certain level of experience and professionalism, these standards are virtually never deviated from. For a seasoned and disciplined trader, mistakes defined as “a deviation from established best practices” might happen once in a quarter, or even less frequently than that (e.g. less than 2% percent of the time).

Even still though, weaknesses can be treated as a form of mistake — and every process that crosses a minimum complexity threshold – like most any trading or investing methodology — has potential weaknesses embedded that can be observed, reported on and contemplated: Flaws in the structure of the process… potential adjustments to variable component weightings… adjustments to the step-by-step pre- and post-analysis process… the shoring up of knowledge gaps or re-tooling of assumptions… and so on.

An Emphasis on Culture

At Macro Ops we are keenly aware of mistakes — and “weaknesses,” which apply even when processes are down cold — and as a result have a very strong emphasis on culture.

Institutional culture is real and powerful. You cultivate it, establish it, and strengthen it via what you do and how you do it, day after day. Think of the winning habits, processes and mindsets a successful person relies on until they are “second nature.” Then expand those mental models, ways of thinking and doing and interpreting, across a team, an organization, an entity of multiple individuals, where values and step-by-step actions, “ways of doing things” are passed on to anyone new who comes through the door. That’s culture.

As the size of our research team grows — and we are hiring in 2021 by the way! — an emphasis on growing and maintaining the MO culture becomes ever more important. This is not just because culture contributes massively to consistent outperformance (though it certainly does)… but because the quality of your culture determines the rate at which you evolve.

And the rate at which you evolve goes back to errors, weaknesses and mistakes…

EVOLUTION, MORPHEUS, EVOLUTION

Think of the following logic chain:

    • Error Data (Mistakes + Weaknesses) = Constructive Feedback
    • Constructive Feedback = Opportunity to Analyze and Refine
    • Analyzing and Refining = Incremental Improvement
    • Incremental Improvement = Micro-Evolution
    • Micro-Evolution over extended time cycles = Macro-Evolution
    • Macro-Evolution = Smarter, Faster, Deeper, Stronger
    • Smarter, Faster, Deeper, Stronger = DOMINATE

To approach from another angle:

    • Natural evolution = serendipitous impact of randomly distributed trial and error
    • Accelerated evolution = guided impact of shaped and observed trial and error
    • Trial and error = experimentation, hypothesis, “useful failures” etc
    • Which cycles back around to errors, weaknesses etc as “Constructive Feedback”

The trading organizations that deliberately nurture a “culture of embracing mistakes” will receive a much higher volume of constructive feedback… and will further be better positioned to respond and hypothesize… in turn allowing them to “analyze and refine” at a faster rate… allowing them to improve and evolve at a faster rate than their peers.

In trading and investing, this is huge.

But individuals can apply these ideas too. You don’t need a team to create a culture (though it certainly helps). You can embrace mistakes on your own by asking questions like:

    • Am I a vigilant observer of my trading and investing process?
    • Do I diligently record my errors and mistakes?
    • Do I seek out and contemplate potential weaknesses?
    • Do I probe and test for weaknesses as a matter of habit…
    • …not to bring myself down, but to make my process stronger?
    • Do I constantly seek to analyze, refine and evolve as a matter of survival?
    • Do I give myself permission to acknowledge weaknesses and still feel like a winner?

Cheerful vs Zero Tolerance

Keep in mind, too, that there is an important balance here. Being a winner means walking the line between tolerating mistakes — responding to them cheerfully and constructively — and ruthlessly stamping them out with a “zero tolerance” attitude.

At Macro Ops, our general mode of operation is a response of positive urgency to fresh mistakes we uncover. When the observation bell goes off, we “halt the assembly line” and ask questions like:

    • What was the origin of this mistake (or observed weakness)?
    • Did it come from a gap in process, misread of information, judgment error etc?
    • Was it something subtle and nuanced, or big and obvious?
    • Does it fall under research, execution, strategic allocation, or something else?
    • How do we extract maximum tuition from this?
    • Should a specific step-by-step aspect of the process be modified?
    • Should a conceptual or philosophical principle be explored (or re-explored)?
    • How can we best evolve and strengthen from this?
    • How do we use this to become more awesome?

We can’t claim originality in this. The most successful organizations in the world, be they trading-focused or something completely different, all have some variant of the same mindset.

For instance: The following quotes are from Ray Dalio, the founder of Bridgewater (one of the most successful hedge funds of all time):

More than anything else, what differentiates people who live up to their potential from those who don’t is a willingness to look at themselves and others objectively.

I believe the biggest problem humanity faces is an ego sensitivity to finding out whether one is right or wrong and identifying what one’s strengths and weaknesses are.

Your ability to see the changing landscape and adapt is more a function of your perceptive abilities and reasoning abilities than your ability to learn and process quickly.

Recognize that you will certainly make mistakes; so will those around you and those who work for you. And what matters is how you deal with them. If you treat mistakes as learning opportunities that can yield rapid improvement if handled well, you will be excited by them.

If you don’t mind being wrong on the way to being right, you will learn a lot.

Of course, there is also a certain class of mistakes we have “zero tolerance” for — things like:

    • Neglecting risk or failing to follow a risk management protocol
    • Blatantly neglecting an established process step
    • Any type of “phoning it in” or extended delivery of subpar effort
    • Being “mentally hard of hearing” — not paying attention to repeated instruction
    • Making the same mistake repeatedly (failing to learn from repeated trials)

In other words, some mistakes are understandable and even exciting — as Ray Dalio puts it — because their presence indicates forward evolution and opportunity for advancement on the capability frontier.

But other mistakes — the ones that go back to well-covered areas, well-developed process, or issues of moral code and doing one’s best work — represent serious internal issues and thus receive a brutally harsh response. (We aren’t afraid to lose our tempers.)

The Circle of Competence

In evaluating mistakes, you can picture acceptable vs unacceptable in the context of a circle — a “circle of competence.”

Mistakes on the circumference of the growth circle are acceptable, and even desirable… if they represent intelligent efforts at expanding competence. The only way you make the circle bigger is by evolving your capabilities… and you do this via thoughtful trial and error, risk-adjusted tinkering and refining, allocations to R&D, and so on.

Mistakes deep within the circle are unacceptable, however, because they represent failure in areas already covered… or failure in areas that should be covered… or worse yet, a failure of internal structure as relating to things like capacity for hard work, commitment to accuracy, moral commitment to excellence, and so on.

Furthermore there are at least two competence circles that matter: The circle for the individual team member, and the circle for the organization as a whole. Efforts to expand the organization as a whole — via contributions to team knowledge or net capability — are appreciated and rewarded. There are many “good failures” in respect to this endeavor, because the potential ROI (return on investment) is so long-term beneficial. (This is a good acid test of leadership by the way. Does the leadership “get” this? Do they embrace it as a directive?)

On the individual team member side, competence circles should match up with experience levels and expectations. A senior trader or analyst with 10+ years of experience will be expected to have a much larger competence circle than, say, a fresh analyst with lots of talent but only a modicum of seasoning. For this reason a certain type of mistake or weakness may be acceptable in one team member but not in another, again relative to situational differences.

Altogether this unites to create an enlightened (in our opinion) and goal-oriented approach to evaluating mistakes and weaknesses: We want to maximize top performance, minimize “unforced errors” and low-grade process failures, and cultivate a healthy expansion of competence for both individual team members and the organization as a whole. Mistakes made in alignment with this goal are not only tolerated but appreciated — “winners evolve” is our short and sweet motto, and it applies across the board. Mistakes of the unacceptable kind, if made too frequently, result in a friendly parting of the ways (so as to avoid team resentment and “Full Metal Jacket” treatment).

Confidently Humble

In many ways, being a successful trader is a paradox. You must develop a deep sense of confidence in your methodology and talent, yet remain ever humble and flexible. You have to trust yourself, but also know when to intelligently doubt yourself — and have no fear of doing so. You need a profound unshakeable faith in who you are and what you can do… yet at the same time maintaining the attitude of the humble student, the raw beginner, the white belt always ready to learn.

Getting this mix right is also the key to personal evolution and incremental improvement, because evolution itself is such an iterative, trial-and-error driven process (and thus a reflective / contemplative process).  It’s not enough to get your hands dirty and fall on your face every so often. Having fallen, you must have the presence of mind to put your ego aside… objectively examine your weakness or mistake… and then put in the elbow grease of analyzing, and intelligently responding to, the data born of your stumble.

None of this is rocket science. But it is harder than it sounds… harder even than rocket science in some aspects… and thus represents a golden opportunity, because so few can do it! The need for ego preservation is a massive block to trading in so many ways — even among people who appear “humble” on the outside, yet cannot apply a “culture of embracing mistakes” on the internal level.

Evolving Alongside Us

While a humble attitude is key, we aren’t big on “false” humility here (pretending to be modest for show). In certain areas we kick-ass and we know it. One such area is in Macro Op’s ability to relentlessly cultivate our own evolution and growth while sharing with others simultaneously.

We are obsessed with a handful of questions, like:

    • How do you become a great trader?
    • How do you become the best trader you can possibly be?
    • How do you scale out a trading methodology to AUM hundreds of millions…
    • …or even to AUM in the billions?
    • How do you get trading performance into the top 1% echelon…
    • While living the best life and having a blast as you do so?

These questions are not answered quickly or simply. They are expansive, multi-faceted areas of exploratory research, with the latent fecundity and diversity of a lush tropical rainforest. The answers are thus revealed in phases and stages over time, via passionate dedication, by way of the iterative process — observing things, trying things, learning from mistakes and weaknesses as new waters are tested, new concepts developed and executed on, old concepts refined and revised for increased clarity and power, and so on.

The “sharing with others” aspect is why we write (and tweet). We are prolific in our content output not just because we enjoy the process of writing, but because thinking and writing are one and the same to a significant degree… and because we get so much benefit from sharing our own evolution — our joys and triumphs, insights and discoveries — with an enthusiastic and motivated community.

This is really what the Macro Ops Collective is all about. In creating the Collective we wanted to figure out:

    • How can we accelerate our own evolution as traders?
    • How can we accelerate the long-term goal of ten-figure AUM?
    • How can we add depth and clarity to our trading processes?
    • How can we share all this with others as we move forward?
    • How can we become the best traders we can be… and help others do the same?
    • How can we build a community and have fun as icing on the best life cake?

The answer that we hit on — evolved via trial and error of course — is found in the materials that go out to the Collective each week. We are having an awesome time with this experiment, and offer anyone who wants the chance to become a part of it.

We have already had repeated testimonials to the effect that we are not just changing perspectives, but changing lives — all in the course of making our own dreams real and saying “Hey, come along with us! Ride alongside or even contribute if you feel like it! We’re having a blast!”

If any of this rings true to you. Then stop wasting time and sign up today for our Collective. Life is too short and markets are too tough to go at it alone. Leverage our research, our education, and our community to become the best trader/investor that you possibly can. Evolve with us and attack markets with a group of ruthless profiteers… and have a hell of a time doing it.

Click here to sign up for the Collective. Enrollment closes tonight at midnight.

Looking forward to seeing you in the group!

How To Write A Great Investment Thesis w/ Morgan Housel

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Morgan Housel is a man that needs no introduction. He’s a NY Times Bestseller, prolific writer for Collaborative Fund and great conversationalist. I’m still amazed I was able to swindle him into joining the podcast this week. As a writer, I’ve wanted to chat with him and pick his brain about his writing process, how he thinks about new topics and the power of reading.

Morgan and I spend an hour discussing investment philosophy, the power of writing and what makes a great investment thesis. This was arguably my favorite and most challenging podcast to plan. I struggled with the question, “What do I ask the man that’s been asked every question under the sun?”

Well, here’s how it turned out:

  • [0:00] Who is Morgan Housel?
  • [1:32] Most Challenging Parts of Writing a Book.
  • [7:45] Investing Psychology
  • [14:10] Topics that Haven’t Been Written About in WW2 and in Finance.
  • [19:50] Becoming a Writer
  • [28:00] How to Write an Investment Thesis?
  • [30:00] Examples of Good Investment Theses: Dandelion Energy & Beyond Meat
  • [34:00] The Reasons Behind Complex Business Models
  • [39:00] How to Look for Ideas.
  • [45:00] Writing is a Thinking Process.
  • [48:00] How Has Writing Changed Your Life?
  • [50:00] Closing Questions: What Writer Would You Like to Write Your Biography?

This episode is a testament to scratching my own itch. Asking questions because I wanted to know the answer, not because I thought it would make for a great podcast. I hope you enjoy this episode as much as I did.

Thanks again to Morgan for coming on the show. If you want to learn more about Morgan, check out the following links:

***Disclaimer: Nothing you hear on this podcast is in any way, shape or form to be construed as investment advice. The guest on this podcast may hold positions in any/all names mentioned during the podcast. This is not investment advice and investors should always conduct personal due diligence before investing in any security. Past performance of any funds mentioned are not indicative of future returns.***

It’s Not The Goal But The Man…

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What is the biggest life mistake you can make? Short of getting yourself killed, what is the one thing you want to avoid doing?

There are lots of ways to answer that question. But on a philosophical level, I would argue the biggest mistake you can make is this: Not being true to yourself.

Almost all other mistakes can be learned from, bounced back from, or otherwise overcome. (Even blowing up a trading account has its tuition merits.)

But not being true to yourself — that’s the “big mistake” that forever robs you… permanently weakens you… atrophies your soul.

Below is something you should read. It’s a letter from Hunter S. Thompson — yep, that Hunter S. Thompson, of “Fear and Loathing in Las Vegas” fame — written to his friend Hume Logan in 1958.

The topic is “what to do with your life.

To give advice to a man who asks what to do with his life implies something very close to egomania. To presume to point a man to the right and ultimate goal — to point with a trembling finger in the RIGHT direction is something only a fool would take upon himself.

 “To be, or not to be: that is the question: Whether ’tis nobler in the mind to suffer the slings and arrows of outrageous fortune, or to take arms against a sea of troubles…”

And indeed, that IS the question: whether to float with the tide, or to swim for a goal. It is a choice we must all make consciously or unconsciously at one time in our lives. So few people understand this! Think of any decision you’ve ever made which had a bearing on your future: I may be wrong, but I don’t see how it could have been anything but a choice however indirect — between the two things I’ve mentioned: the floating or the swimming.

The answer — and, in a sense, the tragedy of life — is that we seek to understand the goal and not the man. We set up a goal which demands of us certain things: and we do these things. We adjust to the demands of a concept which CANNOT be valid. When you were young, let us say that you wanted to be a fireman. I feel reasonably safe in saying that you no longer want to be a fireman. Why? Because your perspective has changed. It’s not the fireman who has changed, but you.

Every man is the sum total of his reactions to experience. As your experiences differ and multiply, you become a different man, and hence your perspective changes. This goes on and on. Every reaction is a learning process; every significant experience alters your perspective.

So it would seem foolish, would it not, to adjust our lives to the demands of a goal we see from a different angle every day? How could we ever hope to accomplish anything other than galloping neurosis?

The answer, then, must not deal with goals at all, or not with tangible goals, anyway. It would take reams of paper to develop this subject to fulfillment. God only knows how many books have been written on “the meaning of man” and that sort of thing, and god only knows how many people have pondered the subject. (I use the term “god only knows” purely as an expression.) There’s very little sense in my trying to give it up to you in the proverbial nutshell, because I’m the first to admit my absolute lack of qualifications for reducing the meaning of life to one or two paragraphs.

To put our faith in tangible goals would seem to be, at best, unwise. So we do not strive to be firemen, we do not strive to be bankers, nor policemen, nor doctors. WE STRIVE TO BE OURSELVES.

But don’t misunderstand me. I don’t mean that we can’t BE firemen, bankers, or doctors—but that we must make the goal conform to the individual, rather than make the individual conform to the goal. In every man, heredity and environment have combined to produce a creature of certain abilities and desires—including a deeply ingrained need to function in such a way that his life will be MEANINGFUL. A man has to BE something; he has to matter.

As I see it then, the formula runs something like this: a man must choose a path which will let his ABILITIES function at maximum efficiency toward the gratification of his DESIRES. In doing this, he is fulfilling a need (giving himself identity by functioning in a set pattern toward a set goal) he avoids frustrating his potential (choosing a path which puts no limit on his self-development), and he avoids the terror of seeing his goal wilt or lose its charm as he draws closer to it (rather than bending himself to meet the demands of that which he seeks, he has bent his goal to conform to his own abilities and desires).

In short, he has not dedicated his life to reaching a pre-defined goal, but he has rather chosen a way of life he KNOWS he will enjoy. The goal is absolutely secondary: it is the functioning toward the goal which is important. And it seems almost ridiculous to say that a man MUST function in a pattern of his own choosing; for to let another man define your own goals is to give up one of the most meaningful aspects of life — the definitive act of will which makes a man an individual.

A man who procrastinates in his CHOOSING will inevitably have his choice made for him by circumstance. So if you now number yourself among the disenchanted, then you have no choice but to accept things as they are, or to seriously seek something else. But beware of looking for goals: look for a way of life. Decide how you want to live and then see what you can do to make a living WITHIN that way of life. But you say, “I don’t know where to look; I don’t know what to look for.”

And there’s the crux. Is it worth giving up what I have to look for something better? I don’t know—is it? Who can make that decision but you? But even by DECIDING TO LOOK, you go a long way toward making the choice.

I’m not trying to send you out “on the road” in search of Valhalla, but merely pointing out that it is not necessary to accept the choices handed down to you by life as you know it. There is more to it than that — no one HAS to do something he doesn’t want to do for the rest of his life.

Your challenge, if you are willing to accept it, is to live the most fulfilling life possible, the most meaningful life possible. Goals and plans are just a flexible means to that end.

But who determines what “fulfilling” means? Who determines what “meaningful” means?

You and only you.

Being true to yourself means following the compass of your heart… having the guts to go where it leads… and doing everything you can to enable the destiny you choose.

The alternative? Forever wondering what might have been.

Reminder: The doors to our Collective, our institutional-grade research, and training service are open until Sunday at midnite. If you’re interested in checking us out then just click the link below and sign up. I’m looking forward to having you in the group! And, as always, don’t hesitate to shoot me any comments/questions.

Join The Collective

Stay safe out there and keep your head on a swivel.

How To 20x Your Money Without Upping Your Risk

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Hope everybody is having a good week so far… Gotta love these markets as they are anything but boring! Today I wanted to show you a section from our introductory guide to our DOTM Strategy (DOTM stands for Deep Out of The Money options) that’s typically reserved for members of our Collective.

I’m sharing this because we’re in the process of executing a number of DOTM trades this week and I plan to share one of these trades with y’all. So you’re going to need to know the basics of what this strategy is and why it works or else you’d be lost in the sauce. Also, I’m pretty damn excited about the convexity in these setups and figure I’d share the love.

Anywho… getting back to the matter at hand. The below is just a short section from our intro to DOTM guidebook. In the Collective we have a host of materials (reports, case studies, and video courses) where we really dive into the topic. If after reading this, you feel like this is something you’d like to add to your toolkit, then check out our group. We’re running an enrollment period for the Collective that goes till the end of this week. You can click this link to sign up. As always, let me know if you’ve got any Qs… Enjoy!

What is the “DOTM” strategy?

DOTM is short for deep-out-of-the-money. This strategy involves buying cheap calls on bullish stocks. If the stock price makes a strong move higher in a short amount of time, these call options can appreciate in value by many multiples. It’s not out of the ordinary for some of these call options to appreciate 30-50x.

Here’s an example to illustrate the power of DOTM calls.

Back in August of 2017 we issued a buy alert for Interactive Brokers in our MIR report (link here).

At the time IBKR traded at $40.54.

The December DOTM call options struck at $47 were trading for just $0.20.

Had you gone out and bought plain IBKR stock at $40.54 you would of done pretty well by the end of the year. By December 15th, IBKR was trading for $60.40. A 49% gain in a few months.

But take a look at the price of the 47 DOTM calls.

Those were trading for $13.00 That’s a 6400% return in a few month. $1,000 invested in this DOTM option would turn into $65,000 in four months time….

That’s a serious difference in return.

What is considered a deep out-of-the-money call?

A deep out of the money call is an option with a strike price that is far away (25%+) from the current price of the underlying. If you’re familiar with option greeks — DOTM calls are those with a 15 delta or less.

You can see in the example below that IBKR is trading for $64.46. The DOTM calls are the ones with a strike price far away from that value. The red rectangle shows that these are the calls struck at $85 and $90.

Also notice that these calls are much cheaper than the ones closer to the current stock price. The 90 call in this example trades for $.80. The 65 call trades for $5.60 — 7 times more expensive. Buying DOTM calls can be a very lucrative strategy because if we’re right about a stock trending higher these inexpensive calls give you incredible positive asymmetry versus buying ones closer to the money.

Options have a ton of expiries, how far out should you buy?

Selecting the correct tenor (time till expiration) is one of the hardest parts about option trading. We’ve spent years experimenting with different tenors for buying and selling options. After thousands of trades, and lots of time spent researching this, it’s clear to us that the best options for the DOTM strategy are those with 6-18 months left until expiry. Billionaire trader Jim Leitner agrees:

If the option maturity is long enough, trend can take us far enough away from the strike that it’s okay to overpay. ~ Jim Leitner

Short-dated options (1-90 days to expiry) don’t allow enough time for the underlying stock to capitalize on the power of its price trend. Buying these short-dated calls is a losers game because time is not on your side.

The long-dated calls on the other hand allow ample time for a stock to make its full move.

Another benefit of buying long-dated options is the convenience. We can open the trade and then let it sit for half a year or more before worrying about rolling exposure. This makes execution much easier.

Why buy the DOTM calls instead of the stock?

Options take away that whole aspect of having to worry about precise risk management. It’s like paying for someone else to be your risk manager. Meanwhile, I know I am long XYZ for the next six months. Even if the option goes down a lot in the beginning to the point that the option is worth nothing, I will still own it and you never know what can happen. ~ Jim Leitner

Buying a call option defines your risk. The most you can lose on a DOTM call is the amount of premium that you pay. This makes risk management easy. We can know our risk with absolute certainty before placing a trade.

You also avoid the hassle of setting and honoring stops.

A standard stock trade with a stop can be frustrating. It’s common for a quality stock to hit your stop from random volatility and then resume its uptrend without you in it.

By using a call option you don’t have to worry about controlling your risk with stops. The DOTM call does it for you. In a sense, you’re outsourcing the risk management process to the option.

Using DOTM calls also allows you to greatly leverage your capital and amplify returns.

Since 1 call option represents 100 shares of stock you can take on much more exposure for less cash. Let’s run through a quick example.

Let’s say IBKR is trading for $64.46 and our target DOTM call option is trading for $.80

Purchasing 100 shares of this stock would cost $6,446. Replicating the same exposure in the DOTM call option would only require $80 — a fraction of the cost.

We could buy exposure to 10x more shares in the DOTM option for only $800 — still less cash than 100 shares of stock.

The cash savings we get from using the DOTM call option can be used for other trades or put into short-dated government securities to earn an additional return.

What are the downsides of using DOTM calls over stock?

Every trading vehicle has its downsides and DOTM calls are no exception. DOTM call holders are not entitled to dividends. If the company pays a dividend, only stock owners will receive that distribution.

DOTM call holders can also lose 100% despite a mild rally in the underlying stock. If the stock chops around and finishes lower than the strike price of the DOTM call it will expire worthless.

In the example below, IBKR traveled up 28.38% by the time the DOTM option expired. But because the strike on the DOTM call was at $90 (above the current price of the stock) the option expires worthless.

In this situation the stock owner would have a 28.38% gain while the DOTM call holder would have a 100% loss.

Can this strategy be executed on any stock that has a bullish outlook?

No, not all stocks have liquid DOTM call options with 6 months or more until expiry.

Market makers only list options on underlyings that have a lot of public interest. These companies will usually have a market cap of $10 billion or higher.

What’s the ideal trade/investment case for this strategy?

Every play has its own nuances but here are the three primary things we like to see before placing a DOTM trade.

    • Stock has strong positive price momentum (ie, bullish trend)
    • Stock has a great fundamental narrative supporting the strong trend
    • Option volatility is moderately priced (20-50% implied volatility reading)


How do you size a DOTM options trade?

Sizing depends on the individual’s risk tolerance. In the Macro Ops portfolio we usually put anywhere between 0.5%-1.00% of our portfolio into one DOTM option.

Why does this strategy work, what is the theory behind it?

The Black-Scholes model assumes that all stocks have an equal chance of going higher as they do lower. The math behind Black-Scholes implies that trends don’t exist and that day to day fluctuations are random.

Take a look at the probability distribution for April calls on Apple stock, below. The pink shaded area represents the likelihood that Apple falls into that particular price range by expiration. You can see that it’s a fairly symmetrical bell curve. The amount of shading on the right is about the same as the amount to the left. Also note that the market implied forward price is right near the price that Apple was trading at the time of this snapshot (October 30th, 2017).

Now let’s say we believe Apple actually has positive price and fundamental momentum. We believe trends exist and that Apple will continue its uptrend over time. If our assumption is true, the probability of the stock moving higher than it is today is much greater than what the above distribution implies.

The correct distribution should instead look something like this.

The red shading represents the probability of Apple reaching those prices if we assume that the current trend persists. The difference between the red and the purple areas are what we call edge.

The market is implying a low probability of higher prices while we think the likelihood is significantly higher. We can buy the DOTM calls in this situation and show a profit over time.

Also notice that the “custom” forward price is higher than the market implied price. The option market always assumes no trend — and in this hypothetical example, we think otherwise.

It’s important to understand that these edges, i.e. the discrepancy between the red area and the purple area, are more likely to occur in options with more than 6 months left to expiry. Long-term momentum is a factor that the options market regularly ignores.

Who on Earth is selling these cheap call options to us?

Whenever you’re trading derivatives it’s important to understand the psychology and reasons behind the other side of your trade. Derivative trading is a zero-sum game. One side needs to lose for the other side to win.

So who’s willing to sell us DOTM calls that have the potential to 50x?

Option market makers.

A market maker’s goal is to collect the bid ask spread on an option’s price. They aren’t in the business of guessing what the final value of the option will be. They don’t want risk associated with movements in the underlying stock.

To protect against this risk they do something called “delta hedging.” Delta hedging offsets the directional risk of an option. When market makers sell DOTM call options they delta hedge them by buying stock. As the underlying stock trends higher and higher they buy more and more stock to offset directional risk.

At the end of the trade they are left with a really large loss on their short call but at the same time a really large gain on their long stock hedge. The two P&Ls cancel each other out and the market maker is left with the tiny gain from the original bid/ask spread.

The real “losers” in this trade are the market participants selling their stock to the market maker who’s delta hedging. These sellers of stock missed out on a nice bull trend.

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Keep your eyes peeled for a follow-up to this piece. It should hit your inbox tomorrow. I’m going to share a case study on how we manage these DOTM positions as things can get pretty wild when you’ve 20x’d or more your initial risk. So it’s critical to have a hardcoded plan on when to take profits beforehand.

Hope you enjoyed the read. And don’t forget to take a minute and check out our Collective. It’s been called the best damn market research service around… Click this link to find out more!

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$NTDOY, $TWTR and The Hard Break w/ Aaron Edelheit

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Aaron Edelheit is the CEO of Mindset Capital and author of the book, The Hard Break: The Case for a 24/6 Lifestyle. He also runs the newsletter, Mindsetvalue. Aaron’s a tried-and-true value investor searching the globe for undervalued businesses.

We spend the early portion of the podcast discussing Aaron’s early investment philosophy, his real estate endeavors and how he grew his small partnership into $25M.

From there, we talk biggest winners/losers over his investing career and why he wrote The Hard Break. 

Finally, we spend the bulk of the conversation diving deep into Nintendo ($NTDOY) and Twitter ($TWTR). Aaron lays out the NTDOY bull case, the bear case and exciting new technologies on the horizon for NTDOY. Aaron also dives into TWTR’s bull thesis, the bear thesis and what investors should know about the company’s future. 

Finally, we spend the remaining time discussing international investment ideas and where Aaron’s looking for value (hint: its Japan).

Big thanks again to Aaron for coming on the show. He was a fantastic guest and I can’t wait to have him back on for another episode!

Here’s the time-stamp:  

  • [0:00] Who is Aaron and how did you get started in investing?
  • [6:33] What was your style for growing a small sum into 25 million?
  • [7:00] Biggest Winners: ATL Ultrasound
  • [12:00] Biggest Losers? Doesn’t matter how people sound or how they look, you really need to be very skepticism.
  • [17:15] The dangers of overworking and Aaron’s Book “The Hard Break: The Case For The 24/6 Lifestyle”
  • [35:00] Nintendo: A 2013 MSFT?
  • [56:00] Risks for Nintendo
  • [1:01:00] Value investor’s case for Twitter
  • [1:22:00] Besides Nintendo and Twitter where can value be found? (Energy and Lincoln Educational Services)
  • [1:32:00] International Investments: Japan
  • [1:40:00] Closing Thoughts and Questions
If you want to learn more about Aaron Edelheit, check out these links: 
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$SE, $GRVY and Digital Transformation w/ Mads Christiansen

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Mads Christiansen is a private investor specializing in digital transformation, e-gaming and technology. He freely shares his thoughts and ideas on Twitter and also runs a YouTube channel (both you can find in links below). Mads got his investing capital from his job as a medical practitioner. While working, he parked his money in passive index funds.

As his itch for investing grew, he found himself drawn to e-sports, gaming and digital transformation companies,. These are companies with long secular tailwinds at their backs. To Mads, if you start your fishing trip in the best ponds, you’ll end up catching a few big winners. And that’s exactly what he’s done. A couple of Mads’ big winners include Sea, Ltd. (SE) and Gravity (GRVY).

Mads and I chat about poker, investing, bet size, portfolio management and specific investment ideas. Check out the time-stamp below:

  • [0:00] Who is Mads Christiansen?
  • [4:30] Specialization vs Generalization
  • [8:00] How to develop the specialization skill?
  • [11:00] How to not suffer from FOMO?
  • [13:00] Poker and Investing: $MELI Case
  • [20:00] Gaming and eSports
  • [24:30] Challenges in Analyzing the Gaming Industry
  • [27:30] eSports
  • [30:30] Mads’ Portfolio Picks: $SE and $GRVY
  • [35:00] Valuing $SE
  • [41:00] $GRVY
  • [47:00] Portfolio Construction
  • [49:50] Customer Attention and the importance of it for a Value Investor.
  • [56:00] New Opportunities
  • [57:00] Closing Thoughts
  • [1:00:40] Closing Questions

If you liked our conversation, consider following more of Mads’ thoughts:

Thanks again to Mads for coming on the podcast! I look forward to reading more of his ideas and watching his portfolio reviews.

***Disclaimer: Nothing you hear on this podcast is in any way, shape or form to be construed as investment advice. The guest on this podcast may hold positions in any/all names mentioned during the podcast. This is not investment advice and investors should always conduct personal due diligence before investing in any security. Past performance of any funds mentioned are not indicative of future returns.***

$UBER Deep Dive w/ Abdullah, Mostly Borrowed Ideas

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Abdullah runs the Mostly Borrowed Ideas newsletter and Twitter account. He’s one of the sharpest value investors on Twitter and I look forward to his emails every month.

Abdullah got his start as an equity analyst and realized he wanted to create his own newsletter and achieve financial freedom. The ability to work anywhere and do what he loves. You can hear his passion in the way he talks about business models, valuation and investing.

We spend the early part of the show discussing Abdullah’s background and general investment philosophy. After that, we dive deep into Abdullah’s latest research report: Uber (U).

There’s a lot of information in this podcast, so you might want to listen twice. Abdullah walks through the bullish thesis, Uber’s specific risk points/competitive challenges and valuation. What I loved about Abdullah’s research is that he ended the report not bullish on the company.

Pay close attention to his thoughts on valuation and how he backs into it using an Expectations Investing approach.

Time-Stamp:

  • [3:23] Intro Questions
  • [9:13] Why did you start a newsletter?
  • [16:34] Uber Deep Dive
  • [22:04] Why People Use Uber
  • [28:06] The Troubling Economics of Uber
  • [39:26] Driver & Customer Incentive Structures
  • [42:18] Uber Eats Unit Economics
  • [53:15] The Consumer Disincentive for Uber Eats
  • [63:12] Performance-Based RSU’s
  • [69:34] Closing Questions

Where To Find Mostly Borrowed Ideas

If you want to learn more about Abdullah and his newsletter, check out the following links:

This episode is brought to you by TIKR. Join the free beta today at TIKR.com/hive. They’re constantly releasing new updates that make the platform better including a new Business Owner Mode that hides share count, market cap and enterprise value. I couldn’t be more excited to partner with TIKR.

***Disclaimer: Nothing you hear on this podcast is in any way, shape or form to be construed as investment advice. The guest on this podcast may hold positions in any/all names mentioned during the podcast. This is not investment advice and investors should always conduct personal due diligence before investing in any security. Past performance of any funds mentioned are not indicative of future returns.***

Avoid Value Traps With One Simple Scoring System

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How do you avoid buying value traps? How do you avoid thinking Mr. Market isn’t as smart as he really is? Ask this simple question: Why is this stock being sold at this price?

Markets are generally efficient the majority of the time. This isn’t breaking news. Yet as value investors, we sometimes try to see the market as a weaker opponent. We step into the arena thinking Mr. Market doesn’t really know what he’s doing. And when we’re wrong, we call it a “value trap”.

Again, in a select number of cases that’s true. The short-term voting machine quote triggers in your brain right about now. Yet we think this happens more often than it does.

Can you blame us? We read The Intelligent Investor, run a low P/E screen and viola! We find hundreds of stocks completely ignored by Mr. Market. Ripe for the plucking.

Therein lies the danger. Investors that don’t ask the right question fall victim to value traps again and again.

How To Avoid Value Traps 101

In early June I recorded a podcast with Brad Hathaway. Brad’s the managing partner of Far View Capital. Far View is a hedge fund focused on special situations and long-term value investing.

One of the most important topics we discussed was the idea of asking the right question. Brad understood that there’s usually a reason why a stock is selling at such a cheap price. He understands that Mr. Market is generally right most of the time.

So how does an investor like Brad avoid value traps? He asks the question: Why is this stock being sold at this price?

Here’s a snippet from our podcast (emphasis mine):

“As an early investor it’s easy to get caught up in the ‘here’s why I’m right, here’s how much money I can make.’ But looking ahead of time to say ‘if I’m wrong, here’s why.’ This really forces you to look for those factors ahead of time. If you can define it in a period when you’re not emotionally invested. It’s much easier to make that decision to sell at a loss when that decision comes to pass.”

Step 1: Use The Answers As Your Hurdle

Asking the question “why is this stock being sold at this price?” places you in the proper mindset before investing your capital. The answers to this question become the metrics you track to confirm or deny your original thesis.

Let’s use an example. Say I find a stock trading at 3x P/E with a decent balance sheet and small (but positive) cash flows. Before I place a single dollar in the stock, I ask myself, “why is this stock being sold at this price?

My answers may include:

    • Management dilutes shareholders
    • It’s a low margin business
    • The industry has little runway over the next 5-10 years
    • SG&A is growing over time while GM shrinks

Each of those answers now becomes a barometer to judge our bull thesis. If we see shrinking EBIT margins our bullish thesis might include a reversal of that trend and higher EBIT margins. Or if the industry has little growth, our thesis might depend on the company expanding into other verticals.

The answers become the hurdle.

The higher the hurdle, the less attractive the idea. The less attractive the idea, the higher the odds you shouldn’t invest.

Step 2: Use The Occam’s Razor Rating 

One of the best mental models out there for analyzing an investment thesis is Occam’s Razor. In short, when given two opposing hypotheses, theories, or explanations the simpler one always prevails.

The keyword is simpler. When we ask “why is this stock being sold at this price” we want reasons that are simple, easy to understand and easy to fix. The harder the solutions, the harder the turnaround. The more likely that stock will stay cheap.

We can actually codify this with every turnaround investment we analyze via our Occam’s Razor Rating.

Occam’s Razor Rating allows you to hard-code your confidence in an investment thesis. It works for turnarounds, fast-growers and special situations.

Here’s how it works. Each hurdle we assign to a thesis gets a rating between -3 and +3. A -3 rating means you have zero confidence in the company’s ability to overcome that hurdle. A +3 rating means you think the company will easily clear that obstacle.

Then you add up the total scores from each hurdle to get your Occam’s Razor Rating. The higher the number, the higher your confidence in the bull case.

Avoid Value Traps Example 

Let’s return to our above example. We’ve already identified four hurdles:

    • Management dilutes shareholders
    • It’s a low margin business
    • The industry has little runway over the next 5-10 years
    • SG&A is growing over time while GM shrinks

We can run those through our ORR system to get an exact score of what we’re thinking in that moment.

Here’s what it looks like:

Downsides of ORR Scoring

Yes, there’s a lot of subjectivity to this scoring system. But that’s a feature, not a bug! The whole point of the ORR system is to see how you think about specific company hurdles in the moment. This allows you to track and compare your initial thoughts to what actually happened.

The more companies you score using ORR, the more data you’ll have on what hurdles companies struggle with the most. If you score 10 companies and notice all scoring +3 on reducing SG&A spend, that should increase your confidence the next time you see that hurdle.

Try it out for yourself! Let me know what you think. Keep a repository of all ORR scoring. You’ll never know the insight that data might provide.