Real quick. To the one person who unsubscribed after my “Dick Shrink” post (link in Appendix) for being too vulgar: go fuck yourself. I never liked you.
Now back to our regularly scheduled programming.
Once upon a time, …
… a portfolio manager that I looked up to pinged me out of the blue. We hadn’t caught up in a few months so we spent the first few minutes doing the usual:
“What’s new?”
“Things are well. And you?”
“All good here too. Thanks for asking!”
“No problem. haha”
“haha”
Afterwards, he asked me for my top stock idea. Lil’ ol’ me sent it over to him without a second thought. It was a company that had 45% upside with 10% downside. Nothing else during that time flagged close to a 4.5x risk-reward with a clear event path: the main lever that everything hinged on was regulatory approval of an asset sitting on their balance sheet that can now be commercialized.
Anyway, after I sent it to him, he completely ghosted me. I didn’t think twice about it until I later came to realize that this portfolio manager straight up jacked my stock write-up, replaced my name on the cover sheet with his and placed it into his “Best Idea” presentation that he was using to market to prospective investors for his new fund. In other words, a guy that I idolized plagiarized off of me.
Being young and dumb, I took it as a compliment that he liked the idea enough to steal it. But the softer, more sensitive part of me said, “I mean, at least say bye or something. ”
You know how I know there is a god out there? Because what happened to this portfolio manager afterwards.
My regulatory approval thesis came from covering the stock for years beforehand without placing a single trade. I would listen to every earnings call, update my model, speak to management regularly, and track every development. Once management started to tease, in a private meeting, that they would try to monetize that neglected asset, my thesis started to develop. It’s like they were sitting on an oil patch and all they needed was the right approval to begin minting their billions. I bounced it off of other analysts who covered the stock as well and we all started to coalesce around a similar risk-reward.
Behind ahead of a regulatory thesis requires boots on the ground so you can develop conviction. You not only have to come up with the thesis but monitoring can require talking to management, frequently talking to key committee members who would make the ultimate decision, and competitors who may also pursue a similar approval path.
When I gave the PM my stock idea, he didn’t develop his own conviction. When you steal someone’s idea, you have the contents of the idea but you can’t steal the belief in that idea and, as a result, you won’t know when to double down or get out of it, leaving yourself vulnerable to emotional ups and downs.
Conviction, ultimately, is a fluctuating metric. It goes up and down and sideways depending on certain conversations or certain events taking place. You may be bulled up this week and then an analyst tells you that the CFO avoided every question on the asset in a meeting, making you incrementally bearish. And then you sense an optimistic tone from someone on the designated committee or how some random 30-year old staffer cutely says, “well, I don’t know” with a smile to a bunch of analysts at a lunch. You can accordingly see everyone’s Bloomberg up processing buy and sell orders.
Ultimately, the stock went up more than I thought and almost hit 60% upside on rumors that they might get the approval. Cool. I sold out of it.
However, the plagiarizing PM did not. He wasn’t satisfied with the 60% and he doubled down as it was rising. What happened then? They didn’t get regulatory approval. The stock crashed. He booked a loss and had to explain to his prospective investors why he was wrong.
If you’re going to steal someone’s idea and borrow their conviction, you run the risk of not knowing how to navigate the stock. Do your own work so you can develop your own conviction or delegate the task of stock-picking to the ones who are doing the work.
In this very blog, I’ve shared stock pricks with associated stock ranges. However, I’m also constantly changing my conviction levels depending on ever-changing datapoints. I may be bullish today and bearish tomorrow depending on which datapoint I’m currently digesting.
Conviction Score
One way to develop conviction in an idea is to assign a conviction score. Within each of the six variables listed below, you assign a number between 1 to 3 (3 being the highest). The higher the cumulative score, the higher your conviction. That score then can inform how high you rank this particular stock within your portfolio. Note that the composition of your conviction score is just as important as your overall score though.
1) Earnings Estimates
How differentiated are your earnings’ estimates compared to consensus estimates?
Which line item are you exactly different (the further down the income statement you go, the less conviction you should have)?
What do you know about earnings that consensus hasn’t factored in?
2) Valuation
How differentiated is your valuation multiple compared to current levels?
What will cause it to get to your valuation level?
Do comparable companies trade higher or lower?
3) Quality of Thesis
Does your thesis have any holes in logic?
Does your thesis require constant monitoring (like it did with the regulatory approval thesis)?
Is there anything external that your thesis depends on (e.g. oil prices, inflation, change in human nature, etc.)
4) Risk-Reward
What is the upside and downside arguments of the thesis?
Are your bull and bear prices realistic and sufficiently backed up?
Is the stock in a range-bound regime currently?
5) Investor Sentiment
Are other investors skewing a certain direction that may not align with your thesis?
Is this stock a cult-favorite that is impossible to short or vice-versa (e.g. Peloton in 2021)?
Is the stock heavily concentrated with high-velocity multi-manager money that may dump shares quickly or is it within stickier, slower money?
6) Event Path / Catalyst Path
Is there a particular event that could drive the stock in a certain direction (e.g. product announcement, earnings, investor conference)?
What is the event risk-reward for the next meaningful event?
Would it be better to take cover ahead of the catalyst and get involved after it clears?
Main Points
You can’t inherit conviction so do your own work or delegate the task to the ones that do
One way to do your own work is to assign a conviction score that depends on the following variables:
Earnings Estimates
Valuation
Quality of Thesis
Risk-Reward
Investor Sentiment
Catalyst Path
Appendix
Dick Shrink
While I was drafting this post, I put “[title shrink]” as the title so people walking by don’t think I’m writing 10 minutes worth of words on some medical issue. We’re actually talking about inventory shrink at Dick’s Sporting Goods but now you, as the reader, have to deal with a post titled “dick shrink” and rushing down so people can’t see you inquiri…