Whitney Tilson in an email to ValueWalk discusses his short 3D Systems Corporation (NYSE:DDD) postion, long magicJack VocalTec Ltd (NASDAQ: CALL) stake, and his annual returns.
The Kase Fund finished 2013 with a gain of 16.6% and is off to a strong start this year, up slightly on the year vs. -2.5% for the S&P 500 (through today’s close).
Attached is my 2013 annual letter, in which I discuss lessons learned and adjustments made (especially on the short side), how I’m casting a wider net, and my 10 largest long positions.
2) Attached is a brand-new, in-depth report I wrote on one of my latest positions, Internet-phone-service provider magicJack (CALL), which I believe could be “my next Netflix, Inc. (NASDAQ:NFLX), a stock with multi-bagger upside potential.” It was sent out on Friday to Value Investor Insight subscribers, and the stock jumped more than 18% today.
Going forward, my articles and commentary on various stocks, both long and short, will be made available first to VII subscribers.
I’ve attached one more example of what we’ll be sending first to our subscribers going forward: my comments on 3D Systems. I think last week’s blowup is the beginning of the endof the 3D printing bubble (I’m short five stocks across the sector, the largest of which is DDD).
Adjustments to my short strategy
That said, there’s certainly room for improvement, and I have been making the following adjustments:
1) Smaller positions. Until late last year, I was managing the fund’s short book similarly to its long book in terms of the number of positions – about a dozen exceptionally-high-conviction positions – but roughly half the size. Thus, the average long position was around 5-6% whereas the average short was in the 2-3% range.
I’ve learned the hard way the perils of sizing too many short positions above 2%. Every five or ten years, the market goes through periods like the current one in which overvalued stocks can become even more overvalued, rising 50-100% or more. This causes a lot of pain and sometimes forces me to cover some positions to manage risk.
I am now sizing new short positions around 1% and only rarely let a short exceed 2%, which I expect will enable our fund to better weather the market’s periodic bouts of foolishness. This means, of course, that the fund’s short book will be comprised of more positions, but I believe I can manage this, especially in light of today’s incredibly target-rich environment.
2) Better match the fund’s long and short positions. A meaningful percentage of the fund’s long exposure over the past year has been in large-cap stocks like Berkshire Hathaway and AIG, whereas the short positions have tended to be in smaller, more volatile, heavily shorted, battleground stocks. These stocks tend to be the most overvalued and have the potential to fall the furthest – often, I believe, 100% – but they can also rise the most during periods of excess liquidity and complacency. (It hasn’t been a complete mismatch, as the fund’s long book has
some similarly volatile stocks like Netflix and Deckers, which have performed beautifully; I sold the latter last week after it nearly doubled over the past year.)
I am seeking to better balance the fund’s long and short positions by having a wider mix of stocks on the short side. Among my three favorite types of shorts – fads, frauds and failures –
I’ve had too many of the first two and not enough of the latter: dying businesses that some call
“reverse compounders.” A good example of such a company is our largest short position today, St. Joe, about which I’ve written extensively about in past letters.
3) Be more patient. I’ve been reasonably successful over the years in being able to identify hugely overvalued stocks, but have been less successful in getting the timing right. I find that I can frequently correctly foresee what’s going to happen a year or two in the future, but am often amazed at how the market – especially this market – ignores huge red flags at certain companies and runs their stocks up further in the short term. I’ve certainly gained a greater appreciation for the power of short-term stock price momentum and am going to make more of an effort to be patient, stay out of the way of freight trains on the way up, and make money shorting these types of stocks on the way down.
For example, I cut our fund’s short position in World Acceptance (discussed at length in my Q2 letter)from a bit over 2% to 1.3% today. I haven’tlost any degree of conviction in myinvestment thesis, but I recognize that it might take some time, perhaps even years, for regulators to act to rein in this company. In the meantime, exploiting the vast majority of its customers is, sadly, a heck of a good business, so I expect the company will continue to grow – and its share price will continue to rise – in the near term. Thus, I plan to patiently wait with a small position until there’s clear evidence that regulators are taking action, at which time I will look to size up the position. Sure, I’ll miss the peak and the stock might be down 10-20% before I act with conviction, but I think the downside here is 70-100%.
During the year, I discussed the following short positions, all of which are still in the fund (in descending order of size, with links to further discussion): K12 ( Q3 letterand here), Green Mountain ( Q3 letter), InterOil ( December letter) and Lumber Liquidators ( December letter).