Multibaggers and portfolio management

[bargainhunter]

Let's say you are running a concentrated portfolio and have the fortune to see your largest position (a microcap) go up 3x or 5x. Suddenly it makes up more than half your portfolio -- a position size you usually would not be comfortable with. However, even at the higher price it is still your best idea -- and you see a lot more long term upside in the stock.

 

What do you do? Sell down part of the position and reallocate into ideas I have less conviction in? Let your winner run and become a larger and larger portion of the portfolio? Thoughts welcome!

[Hielko]

I think it would be unlikely that a stock that goes up 5x gets (significantly) cheaper at the same time. If it goes up 5x and your estimate of intrinsic value also goes up 5x it would make sense to maintain the original (smaller) portfolio allocation. Only when the stock goes up 5x but your estimate of intrinsic value goes up 10x or 25x it makes sense to maintain the large position.

[TwoCitiesCapital]

I generally agree to trim. I've long since learned that my best ideas are not always my best performers and I try to take advantage of situations where certain positions underperform and outperform.

 

I generally have another similar position in the portfolio with a similar type of exposure that I roll money back and forth between. For instance, I own both Santander and Sberbank - two banks with large amounts of emerging market exposure located in troubled economies. Sberank has been on a tear recently while Santander has languished (Sberbank up 70% over the last 12 months and Santander down nearly 40% over the same period). Both companies have tough operating environments, but Sberbank has rallied with oil while Santander is still held down by Brazilian and Spanish exposures. So I recently sold 15% of Sberbank and rolled it into Santander to capture that performance differential and will do it again in the next few months if the trend continues.

 

Similarly, I rolled some positions out of Altius (coal/iron/gold/potash/copper/etc. royalty exposure) into PDER (coal/gas/oil/timber exposure) after Altius rallied 50+% while PDER is only 10% off it's lows.

 

 

[frommi]

Its always easy to fool yourself or make mistakes, so even if you think that intrinsic value has gone up more than the price i would take some money off. Like TwoCitiesCapital wrote the best performers are not necessarily your best ideas. Look at what happened to VRX or XPLT.

[merkhet]

Let's say you are running a concentrated portfolio and have the fortune to see your largest position (a microcap) go up 3x or 5x. Suddenly it makes up more than half your portfolio -- a position size you usually would not be comfortable with. However, even at the higher price it is still your best idea -- and you see a lot more long term upside in the stock.

 

What do you do? Sell down part of the position and reallocate into ideas I have less conviction in? Let your winner run and become a larger and larger portion of the portfolio? Thoughts welcome!

 

If it's a wonderful company with a significant runway, why would you sell? You've indicated it's still your best idea, right? So unless you get a better idea, there seems to be no reason to sell.

[Hielko]

Let's say you are running a concentrated portfolio and have the fortune to see your largest position (a microcap) go up 3x or 5x. Suddenly it makes up more than half your portfolio -- a position size you usually would not be comfortable with. However, even at the higher price it is still your best idea -- and you see a lot more long term upside in the stock.

 

What do you do? Sell down part of the position and reallocate into ideas I have less conviction in? Let your winner run and become a larger and larger portion of the portfolio? Thoughts welcome!

 

If it's a wonderful company with a significant runway, why would you sell? You've indicated it's still your best idea, right? So unless you get a better idea, there seems to be no reason to sell.

i think that is too simplistic. Why not buy such a big position from the start if it's someone's best idea? Or why not buy even more?

[bargainhunter]

I generally agree to trim. I've long since learned that my best ideas are not always my best performers and I try to take advantage of situations where certain positions underperform and outperform.

 

I generally have another similar position in the portfolio with a similar type of exposure that I roll money back and forth between. For instance, I own both Santander and Sberbank - two banks with large amounts of emerging market exposure located in troubled economies. Sberank has been on a tear recently while Santander has languished (Sberbank up 70% over the last 12 months and Santander down nearly 40% over the same period). Both companies have tough operating environments, but Sberbank has rallied with oil while Santander is still held down by Brazilian and Spanish exposures. So I recently sold 15% of Sberbank and rolled it into Santander to capture that performance differential and will do it again in the next few months if the trend continues.

 

Similarly, I rolled some positions out of Altius (coal/iron/gold/potash/copper/etc. royalty exposure) into PDER (coal/gas/oil/timber exposure) after Altius rallied 50+% while PDER is only 10% off it's lows.

 

Thanks TwoCities. You make a good point -- in the past my "best ideas" too have not always been the best performers. That argues for a bit of humility. A question on the rolling back and forth you describe above. Would you do this regardless of the tax consequences? What if the unrealized gains were still short term?

[merkhet]

Let's say you are running a concentrated portfolio and have the fortune to see your largest position (a microcap) go up 3x or 5x. Suddenly it makes up more than half your portfolio -- a position size you usually would not be comfortable with. However, even at the higher price it is still your best idea -- and you see a lot more long term upside in the stock.

 

What do you do? Sell down part of the position and reallocate into ideas I have less conviction in? Let your winner run and become a larger and larger portion of the portfolio? Thoughts welcome!

 

If it's a wonderful company with a significant runway, why would you sell? You've indicated it's still your best idea, right? So unless you get a better idea, there seems to be no reason to sell.

i think that is too simplistic. Why not buy such a big position from the start if it's someone's best idea? Or why not buy even more?

 

I'm not naturally against on either of the two questions you've posed.

 

It's hard to argue in the abstract here, because we don't know what company we are talking about. However, if it's a safe company, with a lot of growth ahead of it, and a fantastic management, you should be buying a lot of it.

 

A lot of this also has to do with your personal hit rate as well. If you're hitting 90% of your best ideas out of the park, then have a big position. If you're hitting 51%, then maybe not.

 

As a purely hypothetical example, if you get a chance to buy Interactive Brokers @ 1x TTM earnings, and it's not because there's something existentially wrong with the company, then the fact that it is up to 5x TTM earnings is not a reason to sell. Even if it's 50% of your portfolio by that point. And buying more is probably not a stupid move either.

[glorysk87]

In my opinion, even if it's your best idea by a long shot, it's simply prudent risk management to trim the position down to a reasonable size.

 

Take ValueAct for example.  VRX was their "best" idea for years. It exceeded 20% of their portfolio numerous times, and due to their risk management protocol, they always trimmed the position back to a reasonable size.  It's 100% because of that action that their fund didn't blow up.  If they had maintained the position size or even increased it, they'd be 100% screwed today.

[Picasso]

In my opinion, even if it's your best idea by a long shot, it's simply prudent risk management to trim the position down to a reasonable size.

 

Take ValueAct for example.  VRX was their "best" idea for years. It exceeded 20% of their portfolio numerous times, and due to their risk management protocol, they always trimmed the position back to a reasonable size.  It's 100% because of that action that their fund didn't blow up.  If they had maintained the position size or even increased it, they'd be 100% screwed today.

 

This is a good point.  I'm always amazed at how I'll look at some holding as a "best" idea, only to look at it several months later and find something out of left field crushed the thesis.

 

But knowing when to hold a big winner is sort of what defines a good investor from a bad one.  You should have a good sense of your probabilities and whether your thinking of "this is good long-term" is clouded by the fact that it's done well for you recently.  If the stock went down 50%, how would your sentiment towards the business change?

[Hielko]

As a purely hypothetical example, if you get a chance to buy Interactive Brokers @ 1x TTM earnings, and it's not because there's something existentially wrong with the company, then the fact that it is up to 5x TTM earnings is not a reason to sell. Even if it's 50% of your portfolio by that point. And buying more is probably not a stupid move either.

Sure it is. Buying IBKR at 1x TTM earnings is a lot more attractive than at 5x TTM earnings, and as such your allocation to the first option should be way higher than your allocation to the second option. And if you buy at 1x and it then goes to 5x your allocation actually goes up, instead of going down while the risk/reward of the position got worse.

[cubsfan]

Humility is so important in decisions like this on large positions.

 

If you think you know everything important about your largest position, you better not be kidding yourself

about what you don't know or can't control.

[AzCactus]

In my opinion, even if it's your best idea by a long shot, it's simply prudent risk management to trim the position down to a reasonable size.

 

Take ValueAct for example.  VRX was their "best" idea for years. It exceeded 20% of their portfolio numerous times, and due to their risk management protocol, they always trimmed the position back to a reasonable size.  It's 100% because of that action that their fund didn't blow up.  If they had maintained the position size or even increased it, they'd be 100% screwed today.

 

Not trying to split hairs but it looks like they only trimmed once---at least according to dataroma.  To be fair it was a 22% trimming but that means that 78% wasn't trimmed.

 

 

[Guest longinvestor]

Humility is so important in decisions like this on large positions.

 

If you think you know everything important about your largest position, you better not be kidding yourself

about what you don't know or can't control.

 

+1

 

It is also presumptuous that one has a drawer full of the next X ideas that you know everything important about. And ready to deploy at the exact time that your top idea has flowered, fruited and is about to wilt. (so you think)

[merkhet]

As a purely hypothetical example, if you get a chance to buy Interactive Brokers @ 1x TTM earnings, and it's not because there's something existentially wrong with the company, then the fact that it is up to 5x TTM earnings is not a reason to sell. Even if it's 50% of your portfolio by that point. And buying more is probably not a stupid move either.

Sure it is. Buying IBKR at 1x TTM earnings is a lot more attractive than at 5x TTM earnings, and as such your allocation to the first option should be way higher than your allocation to the second option. And if you buy at 1x and it then goes to 5x your allocation actually goes up, instead of going down while the risk/reward of the position got worse.

 

I don't think your comment is appreciably different than my comment.

 

We both agree that buying IBKR @ 1x TTM earnings is a good idea.

We both agree that buying IBKR @ 5x TTM earnings is less good an idea than buying @ 1x TTM earnings.

 

Where we disagree is whether continuing to add @ 5x TTM earnings is a terrible idea. And that depends on (A) the opportunity cost of your capital in the future, somewhat unknowable, and (B) the opportunity cost of your capital at the present, which is largely knowable. However, if you've decided that the opportunity cost of (A) & (B) are both lower than adding at 5x TTM earnings, then adding is not a terrible idea.

 

Look, don't get me wrong. You do need some amount of diversification to guard against the left field stuff that @cubsfan is talking about. However, "it got big" is not that great a reason to trim, in my opinion. As another hypothetical, what if it got big and it got cheaper? Would you still trim? I would say no -- but reasonable minds can differ on this.

 

As for the VRX comparison, maybe the issue is not to put a large allocation towards a rollup with questionable accounting run by an alleged alcoholic? I'm sure the immediate response is that this is an ex ante opinion, but there were many board members who passed on the company because the financials did not match up to the claims. (I'm not sure any of us knew about the alleged drinking problem though. Maybe @longhaul, as he's done a ton of work on Valeant.)

 

As a side note, on the ValueAct part, I have it on good authority that Ubben trimmed his position because it was trading a bit expensive and it hit the portfolio limit. That is not the situation presented by the OP, unless I missed it. OP indicates his company is still cheap.

 

In any case, we're a bit far afield of the initial question. Largely, it'll come down to the specific company.

[TwoCitiesCapital]

I generally agree to trim. I've long since learned that my best ideas are not always my best performers and I try to take advantage of situations where certain positions underperform and outperform.

 

I generally have another similar position in the portfolio with a similar type of exposure that I roll money back and forth between. For instance, I own both Santander and Sberbank - two banks with large amounts of emerging market exposure located in troubled economies. Sberank has been on a tear recently while Santander has languished (Sberbank up 70% over the last 12 months and Santander down nearly 40% over the same period). Both companies have tough operating environments, but Sberbank has rallied with oil while Santander is still held down by Brazilian and Spanish exposures. So I recently sold 15% of Sberbank and rolled it into Santander to capture that performance differential and will do it again in the next few months if the trend continues.

 

Similarly, I rolled some positions out of Altius (coal/iron/gold/potash/copper/etc. royalty exposure) into PDER (coal/gas/oil/timber exposure) after Altius rallied 50+% while PDER is only 10% off it's lows.

 

Thanks TwoCities. You make a good point -- in the past my "best ideas" too have not always been the best performers. That argues for a bit of humility. A question on the rolling back and forth you describe above. Would you do this regardless of the tax consequences? What if the unrealized gains were still short term?

 

Tax implications always play a part in the the decision as do my forward looking expectations for each company. Without short-term losses to offset from another source, I'd generally wait for a 12 month holding period to re-allocate barring some massive appreciation that you think might only be temporary. This is certainly a better strategy for tax-deferred/tax-free options like IRAs and 401(k)s. I do it in my individual account too, but with larger performance differentials required to initiate the trading to taxable gains.

 

Ultimately, this strategy is a result of me being humbled in the past. At one end of the scale, you should put 100% of your money if it's your best idea. On the other end of the scale, you should put 0.01% in it because you recognize that you're likely to be wrong and want to diversify the risk. I still lean towards the former with concentrated positions up to 10% of my portfolio, but I actively trade "around" those positions adding after substantial drops and taking profits after substantial rallies to help hedge against the fact that I've been wrong a lot in the past and will likely continue to be wrong on some things going forward.

 

The ultimate goal is to increase my portfolio's forward % of total market free cash flow and/or equity. As a stocks multiple expands, it decreases it's relative value in this perspective and makes it'a ripe contender for trimming in favor of other stocks where I can now buy a greater % of equity/FCF with the same dollars.

 

[Jurgis]

I agree with Merkhet that it depends.  ;) Hard to decide in abstract.

 

Somewhat abstracty:

 

- If it's a Buffetty hold-forever great management, great moat company, then hold forever. Especially if it's still cheap.

 

- If it's a dinky microcap/nanocap that was a cheap because of mediocre business and mediocre management, but just became "great management growth story can't do wrong" and is cheap based on new thesis, sell. Most of these roundtrip IMO.

 

In other cases, think long and hard.

 

Although personally, I'd probably diversify (diworsify) from 50% allocation even if the position was god Buffett himself.

[vinod1]

I agree with Merkhet that it depends.  ;) Hard to decide in abstract.

 

Somewhat abstracty:

 

- If it's a Buffetty hold-forever great management, great moat company, then hold forever. Especially if it's still cheap.

 

- If it's a dinky microcap/nanocap that was a cheap because of mediocre business and mediocre management, but just became "great management growth story can't do wrong" and is cheap based on new thesis, sell. Most of these roundtrip IMO.

 

In other cases, think long and hard.

 

Although personally, I'd probably diversify (diworsify) from 50% allocation even if the position was god Buffett himself.

 

+1

 

I would go further and say that anything that is not a Buffett type strong-moat long term IV compounder should be the 2nd category. Make it binary. Either is it a Buffett type or it is not. Nothing in between.

 

These 2nd category stocks should have smaller position limits. Even if you think it is trading at 0.1x earnings, there is a possibility that (1) you are wrong (2) some other factor can impact the business and reduce its IV before it reaches your estimate of IV.

 

If we look at biases that effect even seasoned value investors, it is overconfidence, confirmation bias, and anchoring. One way to make sure these dont kill you, is to put limits on position sizes.

 

Look at the mirror, if it is not Buffett staring back, do not act like one.

 

Vinod

[glorysk87]

This is a good point.  I'm always amazed at how I'll look at some holding as a "best" idea, only to look at it several months later and find something out of left field crushed the thesis.

 

But knowing when to hold a big winner is sort of what defines a good investor from a bad one.  You should have a good sense of your probabilities and whether your thinking of "this is good long-term" is clouded by the fact that it's done well for you recently.  If the stock went down 50%, how would your sentiment towards the business change?

 

I agree, in sentiment.  A good investor knows when to make a concentrated bet and let the thesis fully play out.  But in my opinion, a good investor should always discount the fact that maybe, just maybe, there's an extraneous factor that he didn't know of or maybe overlooked that could sink the thesis. Because no one is omniscient.  That being the case, even the highest conviction idea should be trimmed down if it gets to be an overwhelmingly large position in your portfolio.  The worst case here is that the name continues to fly and you miss out on the returns. But even in this worst case, you receive a huge amount of cash that you can deploy into a different (2nd best) idea that can diversify your portfolio. In the best case, the unanticipated downside case plays out and you avoid permanently losing capital.

 

Obviously everyone has their own opinion on this. But in my mind, there's no investment idea good enough to justify allowing it to get large enough to sink your entire portfolio/fund. That's hubris in my mind (eg. Ackman)

[scorpioncapital]

"We both agree that buying IBKR @ 1x TTM earnings is a good idea."

 

I don't agree with this. In fact, I think it's worse than buying it at 5x or 10x TTM because it's not a linear function but some sort of bell curve, beyond a certain point there is like a 99.9% chance of a seriously bad situation. So 5x-10x may be just cheap market or a mid-range bad problem. 1x is like bankruptcy or all clients lose their money. I'd reason in this case 10x is  better than 1x.

[merkhet]

"We both agree that buying IBKR @ 1x TTM earnings is a good idea."

 

I don't agree with this. In fact, I think it's worse than buying it at 5x or 10x TTM because it's not a linear function but some sort of bell curve, beyond a certain point there is like a 99.9% chance of a seriously bad situation. So 5x-10x may be just cheap market or a mid-range bad problem. 1x is like bankruptcy or all clients lose their money. I'd reason in this case 10x is  better than 1x.

 

In general, sure, but this was a hypothetical under specific assumptions. It was laid out a few posts above the quoted post. The assumption was specifically no existential threat. I only laid it out that way to avoid having a discussion about the "right" price for IBKR, which I thought would further detract from the discussion. Pretty much everyone can agree that 1x TTM & 5x TTM earnings is cheap for that company with the assumption that there is no existential threat.

[Picasso]

There's always the "maybe, just maybe" that something can kill the thesis.  2008 could have killed Berkshire if things played out just a little bit differently.  A global financial crisis putting us back into the stone ages wasn't something a buyer of BRK in 2006 could have anticipated.  But I think you just have to accept that it's a possibility of getting wiped out on an investment no matter how good you are.  Just like it's possible to get on the wrong plane that flies into some mountain at the hands of a suicidal pilot.  As soon as you're mid flight, you're really "all in" on your idea that your probabilities of landing safely are pretty good.  It doesn't mean you never fly because you don't know that answer at 100%.  Investors are constantly exposes to non-diversifiable risks in day-to-day activities all the time.  But for some reason people feel it more when it comes to handling money.

 

There's probably only a very small handful of stocks (one out of thousands) that are truly buy and hold forever.  In regards to the OP, if you have to ask the question of whether you should diversify the position or not; he/she should probably diversify.  In reality the question doesn't need to be asked at all if it's that much of a no brainer for the long-term.

 

It also depends on the composition of the portfolio.  I find that 80% of my returns will come from 10% of my ideas, and cutting those 10% early is damaging to long-term returns.  So you sort of have to know how these multibagger positions play into your overall process in order to have a working strategy.  Just lots of probabilities you have to properly manage.

[bonkers]

I have had several multibaggers, but no quick ones, so each one has taken several years to play out. In none of the cases has the IV increased faster (after first year or two) than the stock price. So I consider the original question a very rare case.

 

If the position has been originally of appropriate size, there has been no reason to add. As some other positions in the portfolio have also done ok (albeit with lower returns), they have thus "slowed down" the relative growth of my best positions. But in the end, I have ended up trimming most big winners - some of them several times over the years - before finally selling out.

 

I have often felt sorry for trimming too soon, but I still think it is sound risk management. Same with selling out, but this might be biased due to the length and extent of recent bull market. I might think differently if we'd just had the 1930s or 1970s. As always, I should have kept some of the positions (or parts thereof) to this day, and I would have done better.

 

Buffett and Munger are pretty rare in how much concentration they could take: 25 %, even 40 %, Buffett has mentioned up to 75 %. Not going to Soros, even these guys have not promoted going to 100 %. I think there is always the left field, and some opportunity cost.

 

However, as some people noted, also my current thinking is that it's most of all the safety of the business (assuming you've analyzed it properly) - not valuation (e.g. simplistic "P/E x5") - that determines the upper limit for position sizing. Valuation is only secondary, as it is even at best an overly simplified projection of the outcome. If you give me a highly levered oil exploration company run by a drunk at P/E x1, I will not put 100 % of my money in it. In fact, I would not put even 10 %.

 

So the real question is not what has happened to valuation, but what has happened to the business. If the risk has materially declined (rare for established companies, where risk is pretty constant, or might even increase over time), then you might even add (assuming little change in valuation). But always have a limit: Even Buffett capped Amex (safe, great, and cheap) at 40 %.

 

Then there is always the psychological limit: No matter what your business analysis and valuation say, if you can't sleep at night, you should trim or sell.

 

As a final note, especially if you also manage (large proportion of) other people's money, you need to have stricter limits than what e.g. Kelly would propose. With my own money I might be willing to adopt larger position sizes, less trimming (i.e. riding theses all the way to the end), and higher portfolio volatility. With others' life savings not.

[scorpioncapital]

bonkers, was there any consideration of company size for attempting to guesstimate the multibagger potential? E.g. sub 500m, sub 1 billion or something larger like sub 10-20b?

In my mind I can imagine even a 20-30b as a multi-bagger, but I can't for the life of me imagine Berkshire as such, unless we define it as little as double or triple instead of 5x or 10x (and even there my imagination is at the limit). Of course one may be more comfortable to put a larger amount of capital in it.