What is Your Edge?

What is Your Edge(s)?

Longer time horizon:

Buying something that is undervalued relative to the expected catalysts on a >6 month basis on contrast to the market which focuses on the next news release. Basically you are playing a different kind of investing game relative to most market participants. Maybe you even buy something that is overvalued relative to the latest NR but very undervalued based on what you think NR #3, #4 and #5 will show.

Conviction:

Being able to buy when price is going lower due to panic selling by the herd and you know that nothing negative has happened with the case and it will bounce back some day. Until the revaluation one has to be comfortable with looking wrong, and ever wrong:er, for potentially an extended period of time without losing conviction (and the position).

Awareness:

Being early and having done the due diligence on a story that has yet to gain traction.

Emotional discipline:

Being able to front run a period of excitement by buying when it is boring. And then being able to take low risk returns by selling a story which is at peak excitement and everyone is buying.

Portfolio/risk management:

Can be unconventionally heavy into “no brainer” risk/reward plays with margin of safety.

Can be smart enough to appreciate the mathematical risk/reward in high risk plays and are smart enough to diversify away a lot of the company risk.

Due Diligence:

You understand a story better than the market and see ways that the value could either be monetized or there are catalysts which will probably force the market to see the value you see.

Volatility:

Realizing that theoretically two identical stories could trade 10% in the opposite direction on any given day and that daily volatility is an opportunity to be taken advantage of and not see it as due diligence (panic buying the story which is up 10% and panic selling the story which is down 10%).

Quicker and Better at Appreciating New Information:

You are able to appreciate the long term implications of new information better and/or quicker than the market. Maybe a positive NR gets released and the stock jumps 10% but you realize this NR should probably hike the value of the stock closer to 50% over say the coming six months.

Calm, cool, rational Risk/Reward:

The market can be right in terms that all the risks that people are discussing are legit. At the same time most, if not all said risks, could already be priced in. The flipside is that the market could be right in terms of all the blue sky potential but said blue sky potential could already be close to, or fully, priced in.

Thoughts

Until a natural exit happens, if it happens at all, every stock is mostly a trading sardine. This, for better or for worse, means that one has to front run emotional changes. The same people who will be selling a stock because there is no material catalyst in the next >3 months is the same people who will be buying the stock when there is a material catalyst in the not too distant future. The same people who sold a stock in panic (because the market is telling them it’s suddenly a bad case) are the same people who will be buying a top (because the market is telling them that the case is suddenly the best case ever).

I think it is very important to know what you think your edge is when buying a stock. In essence knowing WHY it is undervalued and provide a good Risk/Reward opportunity. Since retail buy/sell based on emotions to a large degree it means identifying what the herd is thinking at any given time, try to see what the herd is missing, and finally how/when the herd might reward your potential foresight.

• Is it boring?
• Is it unknown?
• Has it gone down in price for no apparent reason which makes people think that risk has increased?
• Is it out of favor?
• Is it misunderstood?
• Are people focusing on the wrong things?
• etc

Preferably there will be a combination of reasons that makes a story significantly undervalued. A misunderstood, out of favor and boring story is probably a better bargain than a story that is simply boring for example. Note that one or many factors can be at play in hundreds of stories but one should always try to stick with legit companies. A boring and unknown story which is crap to begin with might stay that way forever since the story is itself is boring and should not get much attention ever.

Like they say in poker: “If you can’t spot the fish then you are the fish”.

To beat the market one must understand the market (aka the marginal buyer/seller).

Best regards,

Erik Wetterling / The Hedgeless Horseman