Do You Have Edge? (Part One)

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BlackHat - Certified Professional
Rank: Almost Human | banana points 7,532

I know - I hate the term as much as you do, but it's real and it's damn near impossible to explain: the phenomenon investors call "edge." In its most basic form, edge is the ability of an analyst to identify, at first glance, what the key issues and concerns are in evaluating a business. Edge is being able to point to what matters, it can be the gut instinct to know what's truth and what is management bullshit, and it's the ability to ask the right questions to understand the one thing that will make or break an investment... and edge is figuring out what the rest of the street is missing.

Whether or not you think you have it yourself, it's hard to deny that some people are just able to shoot at targets nobody else can see, and they tend to get generously rewarded for it. Hell, if you ask me they're probably underpaid.

Unfortunately, the concept is so abstract and difficult to quantify that any attempts to teach it to others usually don't end well... especially when you consider most of the people who truly have "edge" probably aren't teaching it, and people that are trying to share it with others usually don't have it at all. But screw it, my job with this post is to try and do it anyway, and if you believe what I just said, then I should fail miserably. Every analyst thinks he has a unique thought process, and chances are I don't actually have one, but I'll do my best, so if you can take even one thing away from this post that helps you think like a better investor, I've done my job. This is Part One, where I'll focus on the broad strokes of figuring out what the right questions to ask are... Part Two will focus on where to ask them and who to ask them to. Have fun with this one, kids.

Comment: Looking back on this, I re-read it and worry that it's absolute shit. There's no way to quantify this stuff and any attempts to do so feel obvious for anyone in industry and maybe even most kids in college... and while I would have just scrapped the whole thing I'll post it anyway with this qualifier: There's too many "it depends" answers to this stuff for me to feel comfortable saying it's legit. Still hope it's helpful to some people though...

So you're interested in a new company... you've read the annual, recent transcripts, and any other relevant information to get you acquainted with the business. Now what?

Believe it or not, no matter how complex or ground-breaking the business is, it probably falls into a small category of ways to make money. Just about every company can be boiled down to some classification of productive asset... and I can't effectively describe the different categories of businesses as productive assets, but I'll provide a rudimentary checklist for the ones I can think of:

1) Do they generate their cash through service-based revenue streams like long-term subscriptions, non-cancellable contracts, or other highly visible periodic revenue payments? And what level of dependence do these services come at, meaning how easily can the business lose a revenue stream (switching costs)?

2) Do they manufacture products with significant supply-demand dynamics that change drastically with broader industry or economic conditions, like commodities or capital equipment?

3) Do they sell a basic good in a price-taker's environment where competition is mainly managerial and along the cost curve? Is product differentiation possible to mitigate this, such as innovation or brand equity?

4) Are they reliant on periodic large inflows from heavy investment/development products, like tech companies releasing new versions of their technology or pharmaceuticals developing new drugs?

5) Is it a hybrid of more than one of these? [Most things are]

Who Cares?

Whether or not my attempt at categorizing different businesses is even remotely accurate, the point is to understand what sustains a business and what threats are going to put sustainability in jeopardy going forward. Economically speaking, the right combination of traits from the above should make a business have a near impervious moat, while other combinations would make it an absolutely terrible, perfectly competitive business.

Anyway, like I mentioned in my previous installment on how to parse a 10-k, after we've identified what kind of income/value generator we're dealing with, we want to identify the "crown jewel" and the "growth engine." Recall that sometimes these can be the same thing, but the basic rules of economics typically force them to be separate.

Case Study...Maybe

It's not easy to explain this in generic terms so I'll use an example from here on out. Suppose we've found a company that primarily provides servers and maintains databases for its customers. The company signs 10 year service contracts that give them fixed quarterly payments (with, let's say, a variable provision for increases in costs and inflation) and in return they maintain the hardware and back up databases for customers' operations. This has been their primary business for a long time and they are a market leader. Revenues in this segment have grown 3-4% organically, as new account wins are few and far between but contracts provide for revenue growth from pre-existing customers with very high switching costs. These payments also account for 80% of the company's operating cash flow. Not hard to figure out that this is probably the company's crown jewel. If they lose this business, if it starts to comp negatively, etc. then they may be in some serious trouble.

Businesses like this that look like they've hit maturity generally have a buyback focus to generate future growth. That's all well and good if the contracts stay in place, prices keep going up, and people keep using huge data centers for their IT operations. However, that doesn't seem all that likely now does it? Right off the bat you can imagine something like that could weigh the company's shares down.

Fortunately, this potentially endangered crown jewel isn't alone, as this company has a burgeoning online data service as well. Like good managers, they realized years ago what the market is just now worrying about, and they invested heavily in the cloud on the off chance that it would one day be the "next big thing." The investment is just now paying off to the tune of 12-15% revenue growth per year. The company has leveraged their customer base on the database side and started to cross-sell them cloud-based storage and backup services as well as an outlet for outsourced IT support. While this is only 20% of OCF at this point and has plenty of volatility, it's the only promising part of the business if we want to see a substantial return.

Writing a Game Plan

So you've categorized the business, you see what they do well and what they need to do better. Unfortunately most everyone else who's been on this name for a while knows the same stuff. Research becomes an art from this point forward, and the way I'm going to generalize isn't really fair but it hopefully gets the point across. The debate among all the analysts on this name is going to be what kind of a multiple are we going to assign to the growth engine and is it enough to offset our concerns that it might fail and/or the chances that the business falls apart if the crown jewel dies. The sell side is going to spit out something +/- 10% of management because they don't want to get on anyone's bad side but they still want to have an identity, and they aren't incentivized to go out and dig into things any more than what guidance they're given. Thus, sell-side tends to be a great mouthpiece for management, but it's not going to be what gets us to something actionable...

Effective research is proprietary, and things like channel checks and scuttlebutt are often the difference between hitting the mark and being completely wrong on a name. Most of Wall Street doesn't get paid to get the right answer, just an answer that doesn't get them fired, so Part Two will cover how to think about finding the RIGHT answer...

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Comments (57)

Jun 8, 2013

Solid part 1.

Jun 8, 2013
Jun 9, 2013

as always very exciting and practical insights, Sir. Thanks a lot!

would you please elaborate:
1. Is what you are getting at is somewhat related to "The Sleuth Investor" by Mandelman? (your thoughts on the book are very welcome regardless)
2. In your opinion -- have you ever seen a solid investment pitch where analyst didn't do any primary research; that is, analyst got an edge just by going through the public fillings.
3. Are you always conducting a primary research before you make an actionable recommendation?
4. If yes, time wise, how much you spend on analyzing public data Vs. conducting a primary research?

Really excited to see what you answer on those!

Jun 10, 2013

Good read + 1

Jun 10, 2013

Am I the only reader willing to take the guts to say that this first part was relatively boring? Even BH admits it when he reviews it. I do look forward to part 2 though since it will probably touch upon the actual ways to value-add on an idea and it is so easy to be lazy about this part of the research process.

With regards to Edge, in any competitive field/industry/game this is all that matters. I used to play online poker a lot and getting an edge was the only thing that mattered (at least in the long run....). People who were successful and willing to give any tutoring away were able to charge ridiculous hourly since everyone knows how valuable it is and people at the higher levels think in terms of big bets as opposed to dollars.

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Jun 10, 2013

Good qualitative approach, BH.

The standard quantitative approach entails a linear regression on the risk-adjusted returns, i.e.:

R_you - rfr ~= Beta_you * (R_market - rfr) + alpha_you

R is raw return
rfr is the risk free rate
Beta_you is the slope of the regression
alpha_you is the intercept of the regression

The alpha component measures your edge.

Jun 10, 2013
justin88:

Good qualitative approach, BH.

The standard quantitative approach entails a linear regression on the risk-adjusted returns, i.e.:

R_you - rfr ~= Beta_you * (R_market - rfr) + alpha_you

R is raw return
rfr is the risk free rate
Beta_you is the slope of the regression
alpha_you is the intercept of the regression

The alpha component measures your edge.

Beating the market doesn't necessarily mean you have any edge.

Though I am also a fan of 'raw' returns...I hate it when PMs wrap it up.

Jun 10, 2013
justin88:

Good qualitative approach, BH.

The standard quantitative approach entails a linear regression on the risk-adjusted returns, i.e.:

R_you - rfr ~= Beta_you * (R_market - rfr) + alpha_you

R is raw return
rfr is the risk free rate
Beta_you is the slope of the regression
alpha_you is the intercept of the regression

The alpha component measures your edge.

I can't help but roll my eyes whenever I see somebody using beta as a form of measurement of risl/return. I also can't help but roll my eyes whenever I see people trying to quantify something as "soft" as a competitive edge.

No offense, just a reflex.

Jun 10, 2013
KarateBoy:
justin88:

Good qualitative approach, BH.
The standard quantitative approach entails a linear regression on the risk-adjusted returns, i.e.:
R_you - rfr ~= Beta_you * (R_market - rfr) + alpha_you
R is raw return
rfr is the risk free rate
Beta_you is the slope of the regression
alpha_you is the intercept of the regression
The alpha component measures your edge.

I can't help but roll my eyes whenever I see somebody using beta as a form of measurement of risl/return. I also can't help but roll my eyes whenever I see people trying to quantify something as "soft" as a competitive edge.

No offense, just a reflex.

There will always be people trying to quantify the unquantifiable, and it'll always be up for debate whether or not they're doing a good job

Jun 10, 2013

I think justin88 is correct here. Sure you could make tweaks related to the form of risk you are taking on relative to the market but the concept is spot on.

Jun 10, 2013
floppity:

I think justin88 is correct here. Sure you could make tweaks related to the form of risk you are taking on relative to the market but the concept is spot on.

Lol, no. It doesn't disentangle edge from dumb luck so it's basically useless for measuring 'edge'.

Jun 10, 2013

Not to mention if you're following a market neutral strategy. Just lol.

    • 1
Jun 10, 2013
Going Concern:

Not to mention if you're following a market neutral strategy. Just lol.

Then Beta -> 0. Your excess returns would be all alpha.

Obviously, you can extend the quantitative model to other factors a la Fama-French.

Feel free to provide a constructive comment instead of "lol". This isn't rocket science.

Jun 10, 2013
justin88:
Going Concern:

Not to mention if you're following a market neutral strategy. Just lol.

Then Beta -> 0. Your excess returns would be all alpha.

Obviously, you can extend the quantitative model to other factors a la Fama-French.

Feel free to provide a constructive comment instead of "lol". This isn't rocket science.

Excess return is not edge...lol. I think you might have stumbled into the wrong thread by accident. Also very mature flexing that big bad monkey poo muscle...you sure you're a hedge fund portfolio manager? lol

Jun 10, 2013
Going Concern:
justin88:

Going Concern:
Not to mention if you're following a market neutral strategy. Just lol.

Then Beta -> 0. Your excess returns would be all alpha.
Obviously, you can extend the quantitative model to other factors a la Fama-French.
Feel free to provide a constructive comment instead of "lol". This isn't rocket science.

Excess return is not edge...lol. I think you might have stumbled into the wrong thread by accident. Also very mature flexing that big bad monkey poo muscle...you sure you're a hedge fund portfolio manager? lol

It's excess risk-adjusted return.

Again, do you have a constructive comment?

Jun 10, 2013
justin88:
Going Concern:

justin88:

Going Concern:
Not to mention if you're following a market neutral strategy. Just lol.
Then Beta -> 0. Your excess returns would be all alpha.
Obviously, you can extend the quantitative model to other factors a la Fama-French.
Feel free to provide a constructive comment instead of "lol". This isn't rocket science.

Excess return is not edge...lol. I think you might have stumbled into the wrong thread by accident. Also very mature flexing that big bad monkey poo muscle...you sure you're a hedge fund portfolio manager? lol

It's excess risk-adjusted return.

Again, do you have a constructive comment?

I must admit, you're a very clever troll...risk-adjusted lol.

Jun 10, 2013
Going Concern:
floppity:

I think justin88 is correct here. Sure you could make tweaks related to the form of risk you are taking on relative to the market but the concept is spot on.

Lol, no. It doesn't disentangle edge from dumb luck so it's basically useless for measuring 'edge'.

Over long periods of time E(luck) = 0 while E(edge) != 0... at least hopefully and preferably with a positive sign.

Jun 10, 2013
floppity:

Over long periods of time E(luck) = 0 while E(edge) != 0... at least hopefully and preferably with a positive sign.

That's theoretically true for an infinite horizon, but for standard finite periods the edge-less guy could just be really lucky.

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Jun 10, 2013

Wouldnt you rather want to find a business that doesn't have some of these factors right now but will develop them over time which the market does not yet realize? That way, the business will get a higher multiple due to the improved nature of the business. Those seem like higher return opportunities than opportunities where everyone already knows how great the company is and upside is contingent on a variable piece of the business. If there's a chance that the 80% OCF side can start to deteriorate, it doesn't make that much sense to me to have that risk to bet on the 20% piece.

Jun 10, 2013

The analysts of the future will use computer science and statistics in their findings, if they aren't already. And im not talking about financial forecasts;)

alpha currency trader wanna-be

Jun 10, 2013

not to side-rail this thread further (but BH has himself said this is a bit boring, which depending on your level of knowledge it sort of is, its a nice basis for further discussion though), but wtf is with this excess return is not edge.

Of course it is, excess risk-adjusted return is edge, nothing else is. Of course there is a luck element, but that's the nature of any game involving uncertainty and randomness (even chess has some variability in outcomes, are you going to start arguing that winning in chess is not skill now?). Over a reasonable time-period your risk adjusted excess return is edge...

Jun 10, 2013
leveredarb:

not to side-rail this thread further (but BH has himself said this is a bit boring, which depending on your level of knowledge it sort of is, its a nice basis for further discussion though), but wtf is with this excess return is not edge.

Of course it is, excess risk-adjusted return is edge, nothing else is. Of course there is a luck element, but that's the nature of any game involving uncertainty and randomness (even chess has some variability in outcomes, are you going to start arguing that winning in chess is not skill now?). Over a reasonable time-period your risk adjusted excess return is edge...

That's the key element - over a reasonable time-period

Over a short period, sure, excess return could just be dumb luck. Over an extended period of time, probably not.

Jun 10, 2013
leveredarb:

not to side-rail this thread further (but BH has himself said this is a bit boring, which depending on your level of knowledge it sort of is, its a nice basis for further discussion though), but wtf is with this excess return is not edge.

Of course it is, excess risk-adjusted return is edge, nothing else is. Of course there is a luck element, but that's the nature of any game involving uncertainty and randomness (even chess has some variability in outcomes, are you going to start arguing that winning in chess is not skill now?). Over a reasonable time-period your risk adjusted excess return is edge...

No, it isn't. You could have high risk-adjusted returns because you're lucky without having any edge whatsoever. If you take an infinite number of fund managers all doing entirely random things over any finite time period, at least one of them will have massive outperformance on a excess risk-adjusted return basis, and obviously has no edge in this scenario.

Edge isn't easily quantifiable, especially not through some one line equation lol. To quantify edge you have to have a way to strip out the luck component.

Jun 10, 2013
Going Concern:
leveredarb:

not to side-rail this thread further (but BH has himself said this is a bit boring, which depending on your level of knowledge it sort of is, its a nice basis for further discussion though), but wtf is with this excess return is not edge.
Of course it is, excess risk-adjusted return is edge, nothing else is. Of course there is a luck element, but that's the nature of any game involving uncertainty and randomness (even chess has some variability in outcomes, are you going to start arguing that winning in chess is not skill now?). Over a reasonable time-period your risk adjusted excess return is edge...

No, it isn't. You could have high risk-adjusted returns because you're lucky without having any edge whatsoever. If you take an infinite number of fund managers all doing entirely random things over any finite time period, at least one of them will have massive outperformance on a excess risk-adjusted return basis, and obviously has no edge in this scenario.

Edge isn't easily quantifiable, especially not through some one line equation lol. To quantify edge you have to have a way to strip out the luck component.

well yeah duh this is the fundamental problem with quantifying it, not like you can qualitatively assess it.

Jun 10, 2013
leveredarb:
Going Concern:

leveredarb:
not to side-rail this thread further (but BH has himself said this is a bit boring, which depending on your level of knowledge it sort of is, its a nice basis for further discussion though), but wtf is with this excess return is not edge.
Of course it is, excess risk-adjusted return is edge, nothing else is. Of course there is a luck element, but that's the nature of any game involving uncertainty and randomness (even chess has some variability in outcomes, are you going to start arguing that winning in chess is not skill now?). Over a reasonable time-period your risk adjusted excess return is edge...

No, it isn't. You could have high risk-adjusted returns because you're lucky without having any edge whatsoever. If you take an infinite number of fund managers all doing entirely random things over any finite time period, at least one of them will have massive outperformance on a excess risk-adjusted return basis, and obviously has no edge in this scenario.
Edge isn't easily quantifiable, especially not through some one line equation lol. To quantify edge you have to have a way to strip out the luck component.

well yeah duh this is the fundamental problem with quantifying it, not like you can qualitatively assess it.

Not too sure where you're justified in bringing the 'duh' into play. Excess risk-adjusted return is not edge, period. It's not easily quantifiable, nor is it easy to qualitatively assess, though you can attempt to do both if you're thoughtful about it. There are people who have attempted to quantify luck, and analyzing the effectiveness of a manager's investment process is more of an art than a science.

Jun 10, 2013
Going Concern:
leveredarb:

Going Concern:

leveredarb:
not to side-rail this thread further (but BH has himself said this is a bit boring, which depending on your level of knowledge it sort of is, its a nice basis for further discussion though), but wtf is with this excess return is not edge.
Of course it is, excess risk-adjusted return is edge, nothing else is. Of course there is a luck element, but that's the nature of any game involving uncertainty and randomness (even chess has some variability in outcomes, are you going to start arguing that winning in chess is not skill now?). Over a reasonable time-period your risk adjusted excess return is edge...
No, it isn't. You could have high risk-adjusted returns because you're lucky without having any edge whatsoever. If you take an infinite number of fund managers all doing entirely random things over any finite time period, at least one of them will have massive outperformance on a excess risk-adjusted return basis, and obviously has no edge in this scenario.
Edge isn't easily quantifiable, especially not through some one line equation lol. To quantify edge you have to have a way to strip out the luck component.

well yeah duh this is the fundamental problem with quantifying it, not like you can qualitatively assess it.

Not too sure where you're justified in bringing the 'duh' into play. Excess risk-adjusted return is not edge, period. It's not easily quantifiable, nor is it easy to qualitatively assess, though you can attempt to do both if you're thoughtful about it. There are people who have attempted to quantify luck, and analyzing the effectiveness of a manager's investment process is more of an art than a science.

The answer is so obvious that it's painful, yet all of you guys are missing it. It's skill when you perform well and luck when you don't perform well. It's luck when someone else performs well and skill when someone else performs poorly.

    • 1
Jun 10, 2013
SirTradesaLot:

It's luck when someone else performs well and skill when someone else performs poorly.

haha thats what i keep telling myself anyway

Jun 10, 2013
SirTradesaLot:

The answer is so obvious that it's painful, yet all of you guys are missing it. It's skill when you perform well and luck when you don't perform well. It's luck when someone else performs well and skill when someone else performs poorly.

I can't believe I didn't see this. Thank you for opening my eyes.

Jun 10, 2013
Going Concern:
SirTradesaLot:

The answer is so obvious that it's painful, yet all of you guys are missing it. It's skill when you perform well and luck when you don't perform well. It's luck when someone else performs well and skill when someone else performs poorly.

I can't believe I didn't see this. Thank you for opening my eyes.

Just doing my part to make the world a little better place.

Jun 11, 2013
SirTradesaLot:

The answer is so obvious that it's painful, yet all of you guys are missing it. It's skill when you perform well and luck when you don't perform well. It's luck when someone else performs well and skill when someone else performs poorly.

SirTradesaLot hit the nail on the head.

Most people who do this fall victim to their own investment dogma. Theories are only as good as the results they produce. Thus a flawed theory that, for whatever reason, produces good returns is far better than a good theory that produces poor returns. Consequently, no theory at all ("investment agnosticism") is the best of all.

Jun 10, 2013

Going to go out on the limb and say our theoretical company is IBM.

Jun 10, 2013
ladubs111:

Going to go out on the limb and say our theoretical company is IBM.

Had a different company in mind, but definitely a fair guess!

Anyway, like I said I was a little disillusioned by the end of this that it ends up being impossible to really dive into specifics of what 'edge' is in a general, formulaic sense. Maybe it would be more constructive to walk through my own personal thought process on a recent idea or something? At least with Part Two I can share with you guys my scuttlebutt approach and the way I deal with management, that is fairly straightforward for me... at least compared to this.

And I'm glad this got derailed into a "let's fondle the Y-intercept" debate... for what it's worth I'm kind of on both sides because one year worth of outperformance doesn't demonstrate a sustainable edge per se, but it does show that you happened to find and/or stumble upon an edge for that given time period, whether or not that's worth anything is up for debate though.

Jun 10, 2013

you can always PM me ur email address or phone # and you could elaborate on your thought process that way.

BTW good call on OReily. Outperformed my MSFT pick last year at my old fund.

Jun 10, 2013

wait a minute... bh has a twitter???

Jun 10, 2013

so... EMC?

Best Response
Jun 10, 2013

I'm going to say that beta, for the purpose of evaluating excess returns (both of a stock and a manager), is nearly worthless. It is backwards looking and measures volatility, not risk.

I am not a great investor, and I am not too bright. But my thinking is that you are going to generate an edge by either (a) creating value or (b) finding it where others cannot. The former is fairly clear: taking an activist stake or taking a role in a restructuring, for instance. The latter is what most value investors strive to do, and, as you might expect, it's rather difficult.

You aren't going to find value through your elite modeling skills. If you could, there would be a computer crunching the Russell 3000 through a DCF 100x per minute. If you are going to take this semi-quantitative approach, your assumptions must be better than the market's. You are going to have a very hard time beating SS analysts in predicting earnings. A lot of these guys have been covering the same 10-20 companies for decades.

I personally think the individual investor has the best chance buying companies that are viewed negatively for whatever reason. Defense companies on the sequester, health insurers/pharma on Obamacare, buying a company after it whiffs on earnings due to a one-time event etc. This assumes that whatever concern in question is overblown - sometimes they aren't. But even in those cases, there is usually a company that is trading down despite being fundamentally unaffected by the event in question.

The above should be quality companies, with good management. I used to be a pure "what's the FCF yield, and is it sustainable?" guy. But for that cash to be worth anything, management has to use it to create value or give it back to shareholders. What if HPQ had been doing buybacks instead of acquisitions?

Finally, as recommended in "How to be a stock market genius", spinoffs are not a bad place to look. They are often under-priced and have experienced managers. And they usually occur for economic reasons, meaning that the two companies should perform better post-separation.

    • 2
Jun 10, 2013
West Coast rainmaker:

I'm going to say that beta, for the purpose of evaluating excess returns (both of a stock and a manager), is nearly worthless. It is backwards looking and measures volatility, not risk.

We are talking about backwards-looking measurement.

Beta is not just a measure of volatility.

Jun 11, 2013
justin88:
West Coast rainmaker:

I'm going to say that beta, for the purpose of evaluating excess returns (both of a stock and a manager), is nearly worthless. It is backwards looking and measures volatility, not risk.

We are talking about backwards-looking measurement.

Beta is not just a measure of volatility.

To be clear, beta is a measure of variance versus a benchmark. I just think it is a poor measure of risk (at least from the perspective of a fundamental oriented value investor with a longer term horizon).

    • 1
Jun 11, 2013
West Coast rainmaker:
justin88:

West Coast rainmaker:
I'm going to say that beta, for the purpose of evaluating excess returns (both of a stock and a manager), is nearly worthless. It is backwards looking and measures volatility, not risk.

We are talking about backwards-looking measurement.
Beta is not just a measure of volatility.

To be clear, beta is a measure of variance versus a benchmark. I just think it is a poor measure of risk (at least from the perspective of a fundamental oriented value investor with a longer term horizon).

I don't want to split hairs here, but...most people think of beta as just a way to measure market sensitivity, and towards that end you could use a fundamental value type benchmark and a longer time horizon if you wanted to. The point is an obvious one...just being a fundamental value investor doesn't mean on its own that you're adding any value, there is a certain risk premium attached to following a fundamental value strategy.

Jun 11, 2013
West Coast rainmaker:
justin88:

West Coast rainmaker:
I'm going to say that beta, for the purpose of evaluating excess returns (both of a stock and a manager), is nearly worthless. It is backwards looking and measures volatility, not risk.

We are talking about backwards-looking measurement.
Beta is not just a measure of volatility.

To be clear, beta is a measure of variance versus a benchmark. I just think it is a poor measure of risk (at least from the perspective of a fundamental oriented value investor with a longer term horizon).

Beta is a measure of covariance, normalized by market variance. No, it is not a perfect measure of risk. No, it should not be used as the only measure of risk. That's why I referenced Fama-French (and Im not very creative also points out Barra); it is easy to add extra risk factors. Nonetheless, market Beta is almost always the largest source of risk.

There are a lot haters in this thread who think they're too good to understand risk.

Anyway, the whole point of my original post was the Alpha part, not Beta.

Jun 18, 2013
West Coast rainmaker:

The above should be quality companies, with good management. I used to be a pure "what's the FCF yield, and is it sustainable?" guy. But for that cash to be worth anything, management has to use it to create value or give it back to shareholders. What if HPQ had been doing buybacks instead of acquisitions?

I'm relatively new to investing, and as of now I am the "what's the FCF yield and is it sustainable" kind of guy. But your what-if blew my mind. Great advice.

Jun 11, 2013

this is boring, pay your tax

SirTradesaLot said it best.

Jun 11, 2013

Barra Model > *

On a serious note, nice post BH.

Jun 11, 2013

Dumb luck seems like an edge to me. Dumb luck has made the careers of many stellar and widely praised.

I hope you didn't just discover wide moat investing: it happens to be quite popular i.e. an unknown fellow from Omaha, Ne does it quite often.

I think BlackHat read Wall Street Cheat sheet http://wallstcheatsheet.com/stocks/will-emc-contin... and was thinking of EMC Corporation (NYSE: EMC)

Jun 11, 2013
Financier4Hire:

Dumb luck seems like an edge to me. Dumb luck has made the careers of many stellar and widely praised.

I hope you didn't just discover wide moat investing: it happens to be quite popular i.e. an unknown fellow from Omaha, Ne does it quite often.

I think BlackHat read Wall Street Cheat sheet http://wallstcheatsheet.com/stocks/will-emc-contin... and was thinking of EMC Corporation (NYSE: EMC)

I would never come anywhere even remotely close to reading something called "Wall Street Cheat Sheet"

It was a simplified EQIX, for the record.

Jun 11, 2013
BlackHat:

It was a simplified EQIX, for the record.

never woulda guessed that.

Jun 12, 2013
Febreeze:
BlackHat:

It was a simplified EQIX, for the record.

never woulda guessed that.

EQIX has been a hedge fund hotel for the past year.
http://www.marketfolly.com/2012/05/philippe-laffon...

Jun 12, 2013

I just began looking at the data center space, so that's interesting... I wasn't even aware of that part of EQIX's business yet.

Jun 12, 2013

BH, have you researched Highfields thesis on DLR? I took a look, but it seems that every other Data Center does the same thing in regards to capex, so I don't think I buy his point about maintenance capex.

Jun 13, 2013
Value Sleuth:

BH, have you researched Highfields thesis on DLR? I took a look, but it seems that every other Data Center does the same thing in regards to capex, so I don't think I buy his point about maintenance capex.

I saw something on Sumzero where someone basically said they framed it the wrong way and that the maint. capex amt was not correct in their view. I'll send you PM.

Jun 14, 2013

Just out of curiosity, this may be somewhat unrelated to the nature of the post and if you choose not to answer then so be it. If as per your article here being a sell-side analyst is ultimately just a great way to be a mouthpiece for management (which I take to mean, less novel output or valuations are the result as compared to buy-side).

Then why do you recommend sell-side ER (taken from a response you gave to a question in your interview thread) as being the best and most relevant way to get HF attention? -- Granted you did have a caveat for certain buy-side shops but still.

Please correct me if I am wrong, or misunderstood you?

As always, awesome content and thanks for taking the time to write it all out so extensively.

Jun 15, 2013
dest149:

Just out of curiosity, this may be somewhat unrelated to the nature of the post and if you choose not to answer then so be it. If as per your article here being a sell-side analyst is ultimately just a great way to be a mouthpiece for management (which I take to mean, less novel output or valuations are the result as compared to buy-side).

Then why do you recommend sell-side ER (taken from a response you gave to a question in your interview thread) as being the best and most relevant way to get HF attention? -- Granted you did have a caveat for certain buy-side shops but still.

Please correct me if I am wrong, or misunderstood you?

As always, awesome content and thanks for taking the time to write it all out so extensively.

I think the dots you're connecting are a little too far apart... Don't take it to mean less novel output. Take it to mean that if you're on the sell side most of your estimates are going to come, plus or minus a small amount, from management's disclosed guidance. You still have a ton of understanding of businesses and interaction with management teams that is much more important than the spreadsheet magic a banker might have over you. It's certainly much more helpful than spreading comps in my opinion, even if you're working under an analyst who isn't all that different than consensus on his forecasts most of the time.

Put another way, even if being a sell-sider means you suck at investing (it doesn't), that doesn't preclude you from getting HF attention. Just look at how much attention bankers get.

Jun 18, 2013

Wait, by edge are we talking about inside info? Then yes I have plenty.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

Jul 11, 2013

My two cents - westcoastrainmaker framed the question of "what is an edge" much better. It would be interesting to read your take on "what are ways people find value where others can't" rather than "what does a fundamental research process look like" which is what this read like a very basic introduction to.

The former extends beyond just asking the right questions and having good instincts. "The market" isn't as omniscient as people like to think, and often being first to be among the most informed analysts within the relatively hermetic investment community on some particular topic that helps you identify an opportunity is an edge in and of itself. How do you accomplish that? Having a good process is a start, but it's not everything. For example, even as a generalist, knowing a lot about a specialized domain is another form of edge - a company you've followed forever, a particular industry niche, maybe a geography you know better than most.

Jan 2, 2017
Nov 27, 2018
Nov 30, 2018

heister:

Look at all these wannabe richies hating on an expensive salad.