VALUE: After Hours (S08 E03): Letting Winners Run: The Difference Between 20% Gains and 1,000% Returns

During their recent episode, Taylor, Carlisle, and Ian Cassel discussed Letting Winners Run: The Difference Between 20% Gains and 1,000% Returns. Here’s an excerpt from the episode:

Ian: Yeah, there’s two tribes on the winning side. The one was called raiders. Basically, raiders are the people that just sell their position very quickly after a 10% or 20% gain. I think a majority of the folks that he invested in– Not a majority, but a decent percentage where he would coin as these raiders, they never let winners run. They were quick to take the easy 10% or 20%. The other side of that–

Tobias: That’s the more favorable side?

Ian: No, no, that’s a bad side.

Tobias: Yeah. Okay.

Ian: The more favorable side is the connoisseurs. These are the folks that develop deep conviction. They were very boring individuals, because they’re always in the same stocks, and they were able to hold on to things for 1,000%, plus returns over time. And that’s really where the real money was made. His argument against the raider mentality is you just don’t make enough money to make up for the losses you take along the way when you’re only getting 10% or 20% here and there.

Tobias: I think that’s one of the things that I noticed when I test– Graham’s got the net-net rule where he talks about you sell after two years or a 50% gain. And the 50% gain definitely hurts returns, because that particular group of companies are characterized by– [crosstalk] Yeah. But lots of them don’t work. That’s a really good example of a lot of them don’t work. But you get a handful of big winners and you need the winners to 10x or 20x to pay for the rest of the portfolio, that’s not really working.

Ian: Yeah. I think–

Jake: Friend of the show Kevin Zatloukal wrote a paper on this that it’s a horseshoe looking shape of, you have VC one side that’s very power law driven. A few of the startups make all the money, and then actually your outcomes on deep value bucket is also like that very power law. Like, there’s just a couple of names in the portfolio that drive all the outperformance, and the rest are like duds or break even. You would think these things are so opposite of each other, and yet they have the same characteristic of return profiles.

Tobias: Yeah.

Ian: Yeah. So, his main takeaway was just that all the successful managers, they have a philosophy around letting winners run. I think one of the other takeaways, and I’ve written about this before, is I’m okay trimming. I trim stocks all the time. I have a firm fast rule is, yes, I do sell when things get overvalued and sell a decent chunk of something, but I try not to sell all of it, because usually you’ll miss out on the 5% that actually that right tail continues. So, I think it’s okay to trim, just don’t sell all of the winners.

Tobias: I’ve done tests where I just turn off my sell rules and just hold them forever. One of the problems that you get with that is you get to the end and you have a handful– It’s not so much a problem, because we’re always– The study finishes in the present day, and whatever’s working in the present day is a big chunk of the portfolio. But then you have this question right at that point, well, now I’ve got something that’s 15% of the portfolio that’s up 1,000%.

Jake: I thought it was more than a lot of them. There was like–

Tobias: Yeah, across the entire portfolio, 15%, I think, is about the biggest I’ve ever seen starting at a pretty small– Like, that’s starting at a 1% or 2% or 3% position.

Jake: Okay.

Tobias: But even 15%, you’ve got a decision at that point. Do you want to go forward with a 15% position or trim that one back or what are you doing? So, now you’re really beholden to whatever that big position does. That’s something that’s right at the end of it. It’s had a really great run. Like, everything’s worked and the multiple’s way up, and everybody loves it. You look like a genius, because it’s the biggest thing in your portfolio, but now you’ve got to make a decision.

Jake: Right. Now, you got rich. Do you want to stay rich? [chuckles]

Tobias: And the other side is funny, too, because it looks to me like it’s completely random. I go through the portfolios when they’re bought, and I’m like, “Well, I like these ones because they’re names that I recognize and it’s some of the stuff I’ve just never heard of before.” It’s the stuff I’ve never heard of before. That’s like a 15x or 20x over 20 years.

Ian: Yeah. Well, to that point, Toby, to what you’re mentioning, I think of– An area that I’ve definitely evolved is this belief that high conviction means high concentration, which means high at-cost positions. Now, I tend to take smaller at-cost positions, especially in microcap where it’s probably good anyway to see the management team can execute for a few more quarters, because the main difference between microcap and large caps is just the shelf lives are shorter, the moves can be more fleeting, they can last– They’re usually two to four to six quarters. It’s not 10 years. We all want it to be 10 years, but that’s just not reality. You try to live in reality, not what you hope the world would be that you could coffee can these things.

I’ve reconstructed my beliefs around that, and the number of positions, and the at-cost position sizing, and things like that to reflect that. I still love large positions, don’t get me wrong. But I find that like the bigger the at-cost position, the harder it is to do the right thing. When I start it smaller and let the position earn its right to that larger position size, it’s easier to sleep at night. I would love to have a 20% position. We have that earned the right to get there, but it wasn’t from me trying to prove the market it’s wrong– [crosstalk]

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