Whitney Tilson’s email to investors discussing tails, you win; essential wisdom from America’s best-performing stocks; let your winners run; my Netflix stock story; when the stock market doesn’t need the economy.
Q2 2020 hedge fund letters, conferences and more
3) A clear implication of the tail effects that Housel and Bessembinder talk about is that you have to let your winners run.
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy Read More
How I wish I'd better understood this earlier in my career! I still get a knot in my stomach every time I think about Netflix (NFLX) because it was both my best investment – but, because I didn't let it run, also my worst mistake.
Here's an excerpt from my forthcoming book, The Rise and Fall of Kase Capital, explaining why...
Netflix Stock: Let Your Winners Run
It's so painful to know that had I only done one thing when I relaunched my fund in 2013: simply held Netflix, the stock of the decade, which I owned in size at the absolute bottom in October 2012. It would have made up for all of my other mistakes... and then some.
But instead of sitting back and profiting from correctly identifying one of the greatest moonshot stocks of all time, I focused on short-term traditional valuation metrics and began trimming (and eventually sold) the position far too soon.
I took some profits when it went up 50%. When it doubled, I trimmed some more. I kept trimming as it went higher and higher, always keeping it a 3% to 5% position. By the time I sold my last shares, it was up 600% from its lows. I was so proud of myself for this super-successful investment...
But then the stock rose an additional 600% from where I exited. I should've made more than $100 million on Netflix for myself and my investors. Instead, I made less than $10 million. Of course, that's not terrible... But it was a costly mistake that still haunts me to this day...
What was I thinking?
It wasn't that the stock had reached my estimate of its intrinsic value. In fact, my analysis revealed that, at the bottom, Netflix was trading at an unheard of 90% discount to its intrinsic value. I was buying a dollar bill for a dime!
(I based this estimate on 30 million paying streaming subscribers at the time, when the company had a $3 billion market cap. In other words, the company was valued at $100 per subscriber – at a time when 10% of Hulu, a far inferior business, was valued at $1,000 per subscriber.)
Thus, even after the stock doubled, the market was only valuing Netflix at $200 per subscriber. The business was going gangbusters, yet the stock was still a 20-cent dollar, so why was I selling?
In part, the answer is that I thought I was conservatively managing risk. But mostly it was that I let emotions get in the way of my analysis. I'd never had a stock move so far, so fast – it just felt risky and overpriced.
If there's one portfolio-management lesson I want to leave you with, it's this: You must let your winners run.
There's an old saying on Wall Street, "Pigs get fat, hogs get slaughtered," which cautions against being greedy.
If you're looking in the right places for the right kind of high-quality businesses whose stocks are attractively priced, every once in a while, you're going to invest in a stock that doesn't just double, but goes up five, 10, 50, or even 100 times.
To build a successful long-term track record, you must be greedy when opportunities like this arise! Investing in a moonshot stock like Netflix only happens maybe once a decade – or even once in a lifetime. So it's critical that you make the maximum amount of money on them.
I owned a handful of them in my nearly two-decade career, including Amazon, Apple, and Netflix.
Hanging onto them might seem easy in hindsight, but it's actually really hard. Allow me to explain why...
Imagine that you bought the stock of an incredible company that grows and grows for a decade or more. Think one of the tech giants, Costco Wholesale (COST), Visa (V), or Nike (NKE).
To make a fortune, all you have to do is hold on to it and do nothing.
But the markets are open for trading 252 days each year. Over 10 years, that's 2,520 trading days – and each day presents an opportunity for you to do something dumb: Sell the wonderful stock you own.
Let's say you're really smart and disciplined, however, and you only have one dumb day out of every thousand. In other words, you're smart 99.9% of the time.
The odds that you sell the stock at some point over those 2,520 trading days over a decade are 92%!
It's especially hard to patiently just hold on, year in and year out, if you're a professional hedge-fund manager. As one for almost two decades, I can tell you that these folks don't have the luxury of patience. Even though I had great clients who weren't putting short-term pressure on me, I still felt it. It affected my judgment and contributed to my terrible decisions to sell some of my best-performing stocks far too early.
If you aren't managing other people's money, you don't need to worry about short-term performance pressure. This is your biggest advantage over the big money on Wall Street: You can look many years into the future and, as long as your investment thesis is playing out, you can ignore stocks' inevitable short-term gyrations and let your winners run...
To be clear, I'm not saying never sell any stocks. You have to watch out for a changing story – like a 97% decline in Valeant Pharmaceuticals, for example – as well as extreme valuations – like Cisco (CSCO) at the peak of the tech stock bubble in 2000... nearly two decades later, the stock was still trading below its dot-com peak. And you need to manage the position size, as I've discussed elsewhere in this book, so you can sleep well at night.
I never had an issue identifying and buying some of the greatest companies of all time. But one of the biggest mistakes of my career is that I was rarely patient enough to hold them and let their gains compound over the long term. Remember, you only need to find a few of these multi-baggers to do well over your investing lifetime.
4) I got a kick out of this funny two-minute spoof video about the disconnect between the economy and the stock market: When the Stock Market Doesn't Need the Economy.