Issue 22
January 2021
I’m sure everyone reading this is interested in hearing my thoughts on GameStop, RobinHood, and Wall Street Bets. The biggest point I would convey is this pocket of market exuberance is gambling, not investing. If you have made a lot of money on GameStop, AMC Theaters, Nokia, or any other vestige of the late 90s economy, I would consider taking some profits off the table. If you want to “invest” in the WSB names, please only do it with assets you can afford to lose.
This is a bubble, and it will eventually pop. If it hasn’t already. Making money in the stock market is incredibly challenging and humbling. I would caution new investors to remember this great line about poker - If you have been in a poker game for a while, and you still don’t know who the patsy is, you’re the patsy. Same is true for the market. My fear is people gambling on these “hot” WSB stocks, lose money they can’t afford and are turned off from the stock market. My hope is this gets people interested in investing and thinking more about how to reach their long-term financial goals.
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More people have reached out to me about investing and my thoughts on GameStop in the last couple weeks, then probably at any point since I launched SCP. Initially I struggled to come up with a unique perspective on this whole saga. However, I think everyone who has invested can relate to the question, “when should I sell?”
For me, I have a dashboard (see below) tracking my forecasted rate of return (IRR) for positions in the portfolio and stocks on my watchlist. With my goal of generating a double-digit IRR over a 5-7 year horizon, this allows me to determine in real time when an investment is becoming more, or less, attractive.
Ideally, I would like to hold investments over this entire horizon. However, this isn’t always the case. As the IRR of an investment decreases, it reduces the potential future return. This leads to the most common decision to sell an investment, Valuation. There are two other buckets the decision to sell an investment fall into: Opportunity and Thesis.
Valuation
This is by far the most difficult reason to sell an investment. You make an investment because you think a business is undervalued. At what point does the market begin pricing in the positive things you expected to happen? There is no perfect answer to this question. My existing framework is to begin reducing the portfolio weighting of a position as my forecasted IRR (rate of return) moves into the single-digits. If it reaches the low single-digits, I will look to completely sell the position. During this period, I spend more time researching this investment in an effort to increase my confidence level I am not missing a key component of the investment thesis that is causing me to undervalue the position.
Opportunity
This is a comparative decision that is fairly quantifiable. I own Stock A and it has an IRR of 10%. Stock B is on my watchlist and has an IRR of 15%. Should I sell Stock A to buy Stock B? There is a quantitative and qualitative aspect to this decision. On the quantitative front, what is the tax impact from selling stock A? Taxes are a real expense for all of us. By factoring this into my decision making I look to optimize for the highest after-tax return. The qualitative factor is what is my comfort level with Stock B. I try to make investments within my circle of competence. If I am contemplating a stock outside my circle of competence, I would likely look for a significant IRR to compensate me for this risk.
Thesis
When I make an investment, I write out my thesis behind the decision. If at any point, I determine my thesis was incorrect, I immediately sell the investment. These types of sell decisions have proven to be extremely prescient, helping me sidestep some potential major mistakes.
If you are currently investing on your own, hopefully this framework can aid in your decision making process. Investing on your own and you have not contemplated any of these frameworks, consider reaching out to learn more about my investing process.
Bill