At War With Two Heuristics
Once you've made the sale, stop selling!
I recently had lunch with a good friend in private equity where we traded notes on various get-rich-quick schemes and various portfolio companies of ours. I pitch him the stocks I like (and have mentioned in this newsletter!) in the manner a 1980s era Long Island stock salesman might. He enjoys it but it’s all arm-length to him as he’s prohibited from owning any listed businesses, and it’s all low-stakes.
He’s got his portfolio companies and their end markets reporting KPIs regularly, and he obsesses over them. All good and better than expected (his “macro priors” default to assuming the US economy is in the middle of collapse) which just reminds you of how enormous the investing world is. Without the shackles and impediments of index hugging and all that entails, it’s just a different world where a prudent opportunist can’t help but find 20%+ IRRs. Even if those opportunities *are* index constituents, correct thinking around position sizing is going to create a portfolio that behaves dramatically different than anything else out there. One way to think about leverage in the private equity world is that it’s simply a way to get 300% leverage on a small cap stock position- that could be considered a position sizing differentiator relative to an index!
Back to talking stocks: one of the major decrements to the pace of my writing and exploration of different stocks is my desire to remain objective on my best ideas. If I go around touting PetroChina it becomes part of my identity, and I can’t stay objective, and I become no better than a Twitter stock promoter. So it’s difficult for me to write on these names because it could all change on a dime. It’s what Munger called “pounding in by shouting out” and it can reinforce sloppy thinking, make one adversarial and ad hominem, it’s a terrible thing.
Unfortunately the flipside to this is that explaining my ideas (as I was to my private equity friend) is such a fantastic way to elucidate one’s ideas. I walked him through B. Riley’s history, the products and services, the owner-minded nature, the capital structure and the overall equity thesis. It really does make one cut to the heart of the matter: what’s in the market’s valuation, what does that mean for upside and downside, what might make me get it wrong in a big way? And what happens if I do get it wrong in a big way?
That last question goes back to the unprofitable tech run-up in late 2021. Getting it wrong in a big way can’t be catastrophic for me- there has to be something in the way of downside protection at the look-through asset level. Activision is worth at least $80 regardless of whether the deal goes through. PetroChina pays out a cash dividend and trades at half of book (this is a little more complicated). B Riley trades at a 30% NAV discount to trough earnings. These things are all way more complicated and management can always find a ways to steal from you, but it’s something I come back to when talking through a thesis with a shrewd friend who knows what questions to ask.
Back to the two heuristics: if teaching and instructing on a thesis is going to pound in the idea to your head that you need to stay objective about, what’s the remedy? I think that it all depends on who you’re trying to instruct. If you’re speaking to someone who understands the game with a shrewd business sense enough to question components of your thesis, it’s going to be a productive use of time. For example:
1.) Would this person call me out for specious claims or questionable assumptions in a confrontational way to cut to the heart of the matter?
2.) Does this person understand that underwriting securities involves assigning probabilities to downside-case scenarios? And that simply because an investment possesses a downside case, this does not preclude it from being a good ex-ante investment? I.e. does this person understand one gets paid to take certain risks?
3.) Does this person understand that process ultimately trumps outcomes and that an individual investment mistake or misjudgment does not make a person a bad analyst?
Forgive me in advance for any investment mistakes, I’ll make more but I’ll do my best to treat newsletter subscribers in this manner!