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Short Term Outperformance


Gregmal
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I was having an interesting conversation with someone who had recently bought GM. I've owned GM for years. Only recently has it been paying off. On the other hand, if you bought GM in June or whenever at $33, your IRR is insane. I still love the thesis, and the inherent value, but looking at it from strictly a mathematical perspective, this sort of short term return(50% or so in 4 months) is clearly unsustainable. Thus it got me thinking. Would there be a scenario where one uses set investment parameters to dictate sell decisions based off of statistically abnormal price movements on a short term basis? This would seemingly come down to a clash between one's dedication to the long term thesis and one's faith in statistics. Outside of trading around the core of a long term holding, wouldn't it kind of being a given that one should capitalise on a short term aberration? The odds that the performance will continue and you will never see your selling price again are rather slim. On the other hand, is there anything to lose really from taking a crazy IRR and wait for a pullback, consolidation, or more compelling idea? This may also depend on whether one is trading with leverage; I do quite frequently. The example I guess I'll give is that you own stock XYZ. 4 weeks after buying it at $10, it is trading at $13. 30% in a month is crazy. Maybe you think the shares are worth $20 longer term. Or CoBF favorite SHLD. You bought the other day at 5.75 and see your shares sitting at 6.60 a few days later. Berkowitz tells you it's worth $150 though. Do you sell or hold a 15% 4 day return? Be curious to hear people's thought from a mathematical perspective as well as the obvious fundamental one.

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IRRs can be deceiving that way and lead you to stupid decisions. If you're a fund manager and want to juice performance figures that's the way to go. But I get the sense that it's not the case here. So I would recommend to make decisions based on fundamental factors and the available market opportunities.

 

So you bought XYZ at 10 and a month later it's 13. You feel really good about your monthly return. However you've figured that the stock is worth 20. There's a 35% discount to IV. Why would you leave that behind? Just because you've made 30% in one month? That makes no sense. Now it at the same time ABC is trading at 30 and you figure that it's worth 60 - a 50% discount - then it's better to sell XYZ and buy ABC (we'll ignore taxes for this).

 

I remember seeing a lecture or presentation by a finance professor at a big school in India. He was walking through one of his trades. He had a position in Hindustan Unilever. He bought a dip or it was some sort of arbitrage, I can't remember exactly. But the trade was on for a couple of months and it resulted in some crazy IRR like 40% or something. Job well done. Then he zoomed out on the chart and it showed the stock going on a crazy run. Something like 200% in a couple of years. Moral of the story, let valuation guide your investment decisions.

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I was having an interesting conversation with someone who had recently bought GM. I've owned GM for years. Only recently has it been paying off. On the other hand, if you bought GM in June or whenever at $33, your IRR is insane. I still love the thesis, and the inherent value, but looking at it from strictly a mathematical perspective, this sort of short term return(50% or so in 4 months) is clearly unsustainable. Thus it got me thinking. Would there be a scenario where one uses set investment parameters to dictate sell decisions based off of statistically abnormal price movements on a short term basis? This would seemingly come down to a clash between one's dedication to the long term thesis and one's faith in statistics. Outside of trading around the core of a long term holding, wouldn't it kind of being a given that one should capitalise on a short term aberration? The odds that the performance will continue and you will never see your selling price again are rather slim. On the other hand, is there anything to lose really from taking a crazy IRR and wait for a pullback, consolidation, or more compelling idea? This may also depend on whether one is trading with leverage; I do quite frequently. The example I guess I'll give is that you own stock XYZ. 4 weeks after buying it at $10, it is trading at $13. 30% in a month is crazy. Maybe you think the shares are worth $20 longer term. Or CoBF favorite SHLD. You bought the other day at 5.75 and see your shares sitting at 6.60 a few days later. Berkowitz tells you it's worth $150 though. Do you sell or hold a 15% 4 day return? Be curious to hear people's thought from a mathematical perspective as well as the obvious fundamental one.

 

This is a very difficult question, one that I've thought about often.  I think this is a MUCH harder decision than deciding when to buy.

 

This is doubly so when you buy deeply discounted shares in very thinly traded companies.

 

Every once in a blue moon, my whole portfolio will move substantially (up to 10%) in 1 or 2 days when a stock will move substantially higher.

 

One example that I've never had happen before was Bonal Technologies (BONL).  I bought it a few weeks earlier, and one day it moved up nicely.  The next day it ROCKETED up...all on no news.  I was looking at almost a 100% gain in about 1 month on no news.  It was an easy decision to sell.

 

In the end, I guess it depends on what you think the stock is worth and how long you  think it will take to get there.

 

I have one position that is my largest and is up 75% in a bit over a year.  When it moves, it frequently jumps higher.  I'm not selling as I think it should IMMEDIATELY trade at a 50% higher price IF it were "rationally trading" and more people knew about it.  If they have another good year, it should trade for close to 100% more. 

 

So I'm holding on.

 

It is hard to be patient when you are sitting on a gain.  But many of my worst decisions in life have been selling positions too early...

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I'll extrapolate a tad just to narrow the scope as the comments already have touched on some good points. For less liquid securities it's obviously a little bit trickier. One must also be aware of unique market conditions. Obviously Ackmans GGP trade doesn't turn out the way it does if it's sold because of a quick gain. But one had to have been aware that 2008-09 was a unique circumstance. On the other hand, something like FNMA has similar characteristics and a crazy high IV if the thesis plays out. Yet if you had taken the approach to sell FNMA after every 30% short term pop since 2011 you'd probably already have your $20 a share in gains. So as has been said, it's hugely challenging. I'd use for shit's sake, today's environment as the basis. Most securities are fairly priced. Many see big downside in the market. It also may go up more but nonetheless it's a pretty ho-hum environment. If you bought DVA at $53 a week or two ago or whatever, isn't it kind of a no brainer to take the $9 gain and free up cash?(FD: I own a small DVA position at $58, have held for a few months, and am not looking to sell but just using this as an example being it's a liquid large cap stock)

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Guest Cameron

Its a case by case basis, but in the GM example.

 

The latest auto boom has been a result of financing. Open auto loan accounts have increased 25% since 2008.

 

Sort of like the years running up to the great depression, but thats for a different post.

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yea....not sure this should be quite codified like that.

 

For instance, many board members are investors in FNMA. We've been long-term sufferers over years with the expectation of receiving par on the preferreds. If we saw the preferreds double over night (still trade at 1/2 of par) based on some decision/announcement, I think it would be a disaster to say "well, that's a great short-term return, let me sell the position" and then miss out on the second double when your thesis comes to fruition - accepting a 2x over a 4-5x. Why did we hold for years if we'd let it go for so cheaply?!?!

 

That being said, I do trade around core positions based on shorter-term movements. If something rises 20-30% in a relatively short period (a handful of months) and I don't think that much has happened to justify such a movement (i.e. my thesis or any other thesis I can understand hasn't made any progress in playing out), I might trim the position to capture the markets vicissitudes. This is done less to capture the short-term IRRs or based on some threshold calculation and is more simply a recognition of the elevated chance that the share price may return to where it was since nothing is fundamentally different from when it was 20-30% lower.

 

If something had happened to justify the rise, I'd hold steady and may even buy more at that point with annualized. IRRs be damned.

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Good stuff. Seems like many of us are doing the same thing. I often have large positions, 10-35% of portfolio and so it's easy to trim here and there. If I have a 20% position and it's up 30% in a few months but still 30% below a reasonable value and it's at cap gains rate, I may reduce to 15% position or so. Other than that, I'd say sell when in full bloom or close to it. Is it perfectly clear now that others see what you saw originally? Is it in TTM numbers now? etc.

 

I've done quite well trading around large positions, on the one hand it's hurt performance sometimes, otoh it's helped sometimes.... these seem to cancel each other out however by trading around long positions at cap gains rates I generally get nearly the same returns while maintaining a larger cash position.

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I have noticed over the years that Warren Buffett's proteges do this trimming around positions on almost any large move in price. However, no such apparent thing from Warren himself.

 

As a smaller investor, I believe that if you are exposed to a lot of undervalued companies and ideas that trimming on any unexplained move will be easier. However, if you only hold less than say 10 stocks and have nothing on your radar, what do you do with the proceeds? Add to your 2nd largest holding that hasn't moved? If not, moving it to cash while you still think that you hold a potential double or even more will be a hard choice. So psychologically, I think it makes it tougher.

 

So if it is easier with many ideas or holdings, you need to spend more time researching to obtain a diverse enough set of ideas competing for your capital.

 

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