What makes a good long idea?
Apologies if this is a stupid question.
If I go to my PM and say
"Here is a good company (performed well historically), has strong financials (margins, profit growth, ROIC, FCF) and is trading at a steep (30-50%) discount to its peers on relevant industry multiple. The next few earnings releases are going to be positive and they will act as a catalyst to bridge this value gap"
Why is this a shit pitch? Or is it not? Any thoughts are appreciated.
Well a couple lines on the industry it operates and it’s business segments to start with before going into financials and valuation.
Then on valuation, why is it trading at a lower multiple? Can you identify why the market is pricing it that way?
How long has it been trading this way? And why will the next few earnings be positive? What is the catalyst exactly??
How is the market pricing it? How is the market predicting the earnings to be? And what do you believe the market is missing and that you are seeing that will make earnings surprise on the upside?
You gotta pinpoint your differentiator, can’t just say earnings will be positive and stock will increase.
Multiples alone aren’t a good indicator. They are definitely a starting point to filter out, but sometimes if something is trading at a deep discount, you have to be cautious of it more than excited. You gotta do a more deep dive, think like an investor, and due diligence the shit out of whatever potential question/issue may arise.
How do you identify if and how the market had priced something?
“Number one rule of Wall Street. Nobody - and I don't care if you're Warren Buffet or if you're Jimmy Buffet - nobody knows if a stock is going to go up, down, sideways or in circles. You know what a fugazi is?“
Pitching the cheap good company is usually what a long is, but in my (albeit limited) experience it’s better to pitch it with an incremental change framework. I.e, what’s changing/staying the same vs market expectations. The “good company” part is usually where you isolate the specific reasons why you’re differentiated.
I think being forward looking is also important, having an X% ROIC/margin profile is important but what’s more important is what is going to change that will cause it to revert to this, and what is the street pricing vs this.
i.e: “XYZ is a strong company in an industry growing at ABC CAGR, historic numbers = , multiple is depressed but will normalise” turns into “stocks down X% because the customers are in an inventory normalisation period, but end market demand is picking up rapidly (insert datapoints to prove this) and their customers will start restocking to meet demand in H2 (optimistic transcript fillings from customers or something) -> orders will accelerate to historic HSD in Q3 vs street extrapolating soft Q1+2 @ LSD.
-> can then make further points on other KPIs you know matter for the stock and have been strong historically, maybe there’s structural change in the industry making another higher margin product more attractive so when the industry normalises your company will accelerate margin expansion faster than consensus or something leading to an outsized EPS/EBIT(DA) beat & raise, whatever matters for the stock
also disagree with the other poster, for a 2-3 min pitch no one wants to hear about the segments/industry. They can ask that in the Q&A if the hook is good, just intro the company and the stock setup. at least, this is what my PM preferred
Ok pod boi
Likely because your thesis hinges largely on marginal buyer perception.
Long Alpha = Outcomes - Expectations. If Outcomes > Expectations = Long Alpha. If Outcomes Expectations = No alpha.
Quality of the company (high ROIC etc) matters less if it's priced as such. Some of the best shorts can be top businesses with temporary hick-ups due to the sheer magnitude of the price move, and vice versa for longs (shitco's outperforming a low set bar).
In your example specifically, the key is why it's not priced to fundamentals (could be some type of overhang).
No need to over-intellectualise it...the research should be focused on the catalyst path to fair value pricing (simple thesis = good thesis). If this just hinges on marginal buyer perception (i.e. outside the company's control) it's a weak thesis. If the company can control the the equity narrative (e.g. a biz unit pivot) then it's more interesting as it's a "trackable / analyzable" change.
How do you identify the market view, and how do you know they have/haven’t picked up on something?
You identify the market view by reading sell-side research at least that is what I do. .
You know whether they have/have not picked up on something qualitatively through reading their arguments - what are they basing their pt on? Macro improvement? Capex? New product/vertical? Etc
And quantitatively by looking at estimates for key figures (Revenue, Margins, EPS) and what multiple are they valuing the stock at.
Current price underwrites fwd. expectations, reflected in the valuation and/or forward estimates. New results one way or another reinforce tails of outcomes.
Company says we will do 4% growth for FY25. Stock is priced as a 4% grower +/- some variance based on market/sector news + sentiment. Company has historically grown 3.5%-4.5% through cycles. Today's multiple is a snapshot of longer term growth fundamentals (+ reinvestment/etc.)
Hunt for data that reinforces story one way or another. Or more simply, invest along expanding earnings growth from the trend.
Buying good companies at cheap valuations in a vacuum rarely works these days, because they are priced there for a reason (most often it is tailwinds lapsing like price from post-COVID days, demand waning, or where the end market is in the cycle). Sometimes you get lucky and market is mistaking cyclical for secular and vice versa but more often than not it is indeed the investor making that mistake.
Ideally exploiting duration in this current market should work, but this still need to occur on somewhat shorter time frame otherwise you are too early and more often than not too much can change by the time you think you will be right t+12-24m.
Not covering the more principled long only value style or more classic tiger style here, but overall the principle of determining the market's view is the same - understand your business model and figure our what a more "normalized" or "mid-cycle" earnings power is for a company.
Yeah so this is where the "art" part of the job comes in. I don't feel like there's any science behind this. The old timers in the office simply pick up the phone and speak to the specs and sellside traders who traffic in the name to see what the large shareholders and more recent marginal buyers are saying (feedback from calls, analyst meetings, etc). I think that gets you ~70-80% there of understanding what people are expecting and often that's enough before you move on.
If i've had too many cups of coffee I sometimes ping the corp broker for more formal feedback from recent blocks / placings where people have done "real" work on the name. Usually this tend to square with what IR tells me has been the key focus since they last communicated with the market.
I'm fortune enough to have good positioning data at my place so I can see how short and long positioning has changed over time, and what "investor type" have been trafficking in the name. Obviously if LO's are long and my fellow pod monkeys have been shorting in to print it tells me the pre-earnings price move might be driven by the latter and there's risk of quick profit taking in the name regardless of the fundamental outcome. So the stock might not be trading on "real" price relative to the fundamental narrative during this period.
I basically justify doing this as a shortcut to thinking: Fundamental growth = ROIC × Reinvestment rate = P x EPS. If P has been moving higher than EPS then we're rerating for a reason. What is that reason? If EPS higher then P then we're derating... why? Has quality of earnings deteriorated? Be aware tho: more often than not the sellside are trying to explain price moves for reasons unknown, just to make sense of it all and to have something to say when annoying people like yours truly ping them on Bloomberg asking "what's up with this move"? They need to justify those fee's somehow...
Where it gets interesting is where LO's and HFs are pulling in different directions, or generalists buying vs. specialists selling (or vice versa). Some sectors like Gaming could be more driven by buyside bogeys as it's heavily played by institutionals. Makes it easier to conduct surveys and pass them around the block. Occasionally this is "blind leading the blind" and taking some comfort that others have reached a similar conclusion (ironically means higher risk of unreasonable magnitude of price moves if we're all proven wrong).
Anyway, I don't need to be right every time. I just need to beat the averages. Win alot when I'm right and lose quickly and get out when I'm wrong.
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