AdamReviews.com – A Novice Investor's Notebook

There have been plenty of advice on when to buy stocks, deciding what stocks to buy. One can look at fundamentals, business of the company, momentum, insights, fair value with plenty margin of safety and so on. However, not much has been said on when to sell. One that’s probably most remembered is the following:

“Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling” – Peter Lynch

This thought come to mind when I was moving into my new rental apartment. The worst part of renting is that you may not fit your old furniture in the new place, hence the need of selling and buying.

In this occasion, I am a buyer. I needed to furnish my new apartment, I know I will be moving out in a few years, so I don’t want to buy new or fancy furniture that won’t fit my next place.

I browsed on second-hand items marketplace for furniture in great condition that are >50% off retail, sometimes delivered to your door steps, assembled. Yes, I am a big fan of IKEA furniture, but I’m not a fan of having to assemble them myself, or paying >20% of the furniture price for professional assembly service.

While hunting for these furniture, it struck me:

1. Sellers are most responsive when the item is recently posted, and that the seller indicates that he/she needs to sell it by certain date
2. Sellers are most willing to negotiate the price down when the seller is obligated to sell (He/she moving out of the country or moving out of a place in very short time, so these items are must sell)

Note the word, obligated – or to certain extent, must sell due to the constraint that are in place. In most cases, this is due to rental expiring or having to move out of town. Sellers of these kinds have very high intention of selling, and willing to bring the price down to ridiculous levels (sometimes >90% off the retail)

I put some thoughts about this experience and realized that, while there are plenty of debate about when to sell a stock, one can look at the inverse and it becomes more deterministic, i.e, how to NOT have to sell a stock:

1. You don’t want to put yourself in a situation that you MUST sell (margin calls, having needed emergency money, having to meet redemption)
2. You don’t want to put yourself in a situation that makes you have high intention of selling – which is going to make you very responsive to Mr. Market
   • You don’t want to buy speculative issues that at some point, you need to sell as it doesn’t really fit your portfolio
   • You don’t want to buy issues that you are not comfortable holding for a long time (i.e, you feel itchy to sell)

This rhymes with one of the book I read, which says statistically, it is better to buy all in one go, and sell piece by piece. In other words, DCA when selling, not when buying. By definition, the situations I described above prohibits you from DCA-ing when selling.

Obviously, it is easier said than done, or one may say that this is very obvious. I found myself a good hunter for bargain, but not necessarily smart about putting myself in a position not to have sell a stock.

During a late-night random chat, a wise person in our group raised an important point, which I thought is applicable not only to the situation it is describing but also generally in our lives, and in investing.

“Good warlords win most battles he fight. Great warlords fight the battles he is certain to win”

It a simple sentence, almost sounds like a riddle but it has deep or even almost profound meaning.

In our lives, battles are almost certain, we are not talking about fights, it could be competition, it could be an important meeting, it could be an interview.

“Seize every opportunity” – they say

Most of us these days are taught to take all the opportunities that are presented, no matter how big of the chance we can seize it. Inevitably and by definition, this leads to, sometimes, failure. This also stretches our physical and mental resources on opportunities, that might not even be worth taking, despite the success chance being high (or low) – at this point doesn’t matter anymore as the outcome is not worth fighting for.

In other words, when presented with opportunity, we forget to ask two important questions:

1. How good is the positive outcome?
2. How likely I can achieve the positive outcome?

Instead, we march on when we see an enemy coming. In today’s society, people are crazy about seizing every opportunities that they are presented with, that they get into stress, constant grinding, regular drug prescriptions, some even lose their lives because of it. The society rewards and glamorize hard work, being the hardest worker in the room, that often translates to “OT” instagram stories and “plz fix” pictures from clubs or motorbikes. Advances in medicine translates to drugs that can make people endure grueling work hours, stress, overcome depression (temporarily), in pursuit of machine-like endurance to physical and mental limitation

This sentence, also have very stark resemblance with what Warren Buffett says on the game of baseball or the punch card.

“The stock market is a no-called-strike game. You don’t have to swing at everything–you can wait for your pitch. The problem when you are a money manager is that your fans keep yelling, ‘Swing, you bum!’“

“You only have an opinion on a few things. In fact, I’ve told students if when they got out of school, they got a punch card with 20 punches on it, and that’s all the investment decisions they got to make in their entire life, they would get very rich because they would think very hard about each one.”

In investing, just like picking our battles in life, learning from the great warlords, we don’t have to seize every opportunity. We only “fight” when we know we are going to win.

Turns out, while human civilization have greatly improved from the time back in the day where people would be fighting with swords and traitors get beheaded, (and you can also get beheaded for just being innocent peasants), to iPhone, and satelite internet, space exploration, robo taxis and genome editing, the general rule of seizing opportunities have been the same. It’s the society that have changed, for the worse.

Be great warlords.

Warren Buffett famously said (not an exact quote):

Rule #1: Don’t lose money. Rule #2: Don’t forget Rule #1.

I only recently came to understand the wisdom behind these rules, a realization that came with changes in my own life circumstances.

Previously, I had a six-figure salary, with a steady monthly income from a stable, large corporation that was unlikely to go under anytime soon. Now, my situation has drastically changed; my monthly income is no longer guaranteed.

My approach to investing has shifted significantly. In the past, I considered an investment with a potential 50% return and an equal chance of a 50% loss to be viable. Today, I would only consider investments that offer the potential for 3-5x returns in the long term, with a minimal risk of losing up to 10% of the invested amount.

On social media platforms like TikTok or Instagram, we often see “finfluencers” promoting various strategies. However, these recommendations may not align with everyone’s personal circumstances or natural inclinations.

Imagine living paycheck to paycheck with less than $10,000 in assets under management (AUM). You might be tempted to gamble it all on an opportunity that could either quintuple your money or result in a total loss, simply because you could potentially recover from the loss within a few months.

This mindset changes drastically with $100,000 in savings. After working hard to accumulate this amount, you’re less willing to take high risks. Losing even a portion of this amount feels significant, especially if it would take you 12-24 months to save that much again. However, when money is still flowing, you are inclined to think that – it’s okay to lose X because I know I can pay back X in 1-2 months.

Another perspective to consider is this: With $100,000, a 10% gain yields $10,000. However, if you lose $50,000, a 10% return on the remaining $50,000 only adds $5,000. To recover from a 50% loss, you need to double your remaining funds. If doubling your money were easy, everyone would be wealthy—clearly, it’s not.

As an investor, you must assume that there’s no regular cash flow coming in. Investing is your primary focus, and the money you have is all you can work with. Therefore, it’s crucial to avoid losses and not rely on the idea of making up for them in the near future. A commitment of 12-24 months is substantial and should be taken into account when assessing risk.

Consider this: with $100,000, a 10% return yields $10,000. However, if you lose $50,000, you’d need to double your remaining money just to get back to where you started. Doubling your money is far from easy, or everyone would be wealthy by now.

As a full-time investor, your greatest asset is time. You have the time to analyze, research, and identify opportunities. It’s easier to find investments with a 90-10 chance of a 3x return or a 10% loss than those with a 50-50 chance of either a 50% gain or loss. Fewer opportunities meet the former criteria, and finding them requires thorough research, including reading 10-Ks, 10-Qs, and earnings transcripts.

Another advantage of being an investor is the flexibility in holding assets. You can sell at any time—whether it’s tomorrow, immediately after purchase, or hold for several years—assuming you can cover your living expenses. This is different from professional money managers who might be forced out of their positions if their investments underperform relative to benchmarks within a year.

As Jack Ma once said: “Today is hard, tomorrow will be worse, but the day after tomorrow will be sunshine. Most people die tomorrow evening.”

I came to a realization as I was reading Altria’s most recent quarterly earnings report and call transcript: Altria is such a wonderful company, I thought.

While my understanding of what it does is limited, as I have yet to read its annual report, I have some idea of its operations. It sells cigarettes and is venturing into the vape or so-called smokeless products. In a nutshell, they are selling nicotine in various shapes and forms.

I thought to myself, what a beautiful business: it generates a lot of profit and cash flow and returns a relatively good amount of its capital to shareholders. You have a product that contains a chemical known to develop addiction, but at the same time, it is legal. It is frowned upon in society, but it’s legal, and I have many friends who smoke packs of them every day. Yes, I think I am a second-hand smoker. A lot of fund managers are likely to avoid it as well, as I don’t think it falls on the favorable side of the ESG spectrum.

Then it struck me: good businesses are not those that give me a 20-30% return overnight but those that compound for a very, very long time. For a business to be able to compound for a long time, it must have a sustainable business model with a large moat. By definition, the sustainable business model needs to incorporate some aspects of ESG (Environmental, Social, and Governance) principles in order to be able to realize its economic sustainability. It needs to be sustainable for the environment, society, and its corporate governance.

I think ESG matters, just like a lot of other things, and just like a lot of other things, people tend to go overboard with them. With ESG, it’s gotten to a point where companies implement ridiculous policies just to show that they’re ESG or DEI (Diversity, Equity, and Inclusion) compliant, often just raising eyebrows and, on some occasions, being detrimental to their business.

When I was still working in IT at a financial services firm, our CIO sent out an email about how to be inclusive in the terms we use, which included avoiding terms like whitelisting/blacklisting, master/slave, and man-days. It was also unspoken but happened that people were requested to hire a specific gender, racial group, or person with a disability to fulfill the “DEI” quota. That is just ridiculous. It went so far that during an interview session for new hires, there was a row of women university students sitting in the waiting room. One of them asked me during the interview, “Are we hired for diversity because all of the applicants are women?” which is uncommon in the IT field.

To conclude, this is to remind myself that ESG matters, not because you need to tick a box, but because it directs you to the economic sustainability of the business. Great businesses are those that can compound value to shareholders for a long time.

I felt that it was just on time for this one. I have heard about Liberty Media previously, though I have never looked into it in more detail. I got interested in LSXMK/SIRI and started deep diving into it to find out that this could be a good opportunity.

The Opportunity:

Tracking stock trading at a discount to the underlying, which is going through a (relatively certain) merger with the underlying, converging the two stocks tracking the same entity into one, with potential gain due to:

• The underlying may have been shorted, hence the price is artificially depressed.
• Thus, there is a higher chance that the tracking stock may then converge to the underlying price, which is trading at a 40%+ premium.
• The pending merger caused the underlying stock to halt stock buybacks, which have supported their price in the past.
• Potential index inclusion post-merger.
• The underlying stock represents a very good business (monopoly) with more tailwinds than headwinds going forward.
• The underlying business is well-positioned as an acquisition target by tech platforms looking to acquire a loyal subscriber base and directly tap 30M+ customers.

About the Opportunity

Liberty Media owns about 80%+ of SIRI. Unlike Berkshire Hathaway, it has made its holdings in the form of tracking stock that anyone can purchase. In this particular example, Liberty’s holding of Sirius XM is traded under the tickers LSXMA, LSXMB, and LSXMK. This has become an interesting opportunity because, unlike their other holdings, in December 2023, Liberty Media and Sirius XM announced that they would merge the two into a combined “New Sirius XM” trading under the current Sirius XM ticker. It is also announced that the conversion rate will be about 8.4 SIRI per LSXMx stock.

As of the time of this writing, the tracking stock is trading at a relatively high 30%+ discount to the underlying stock. You might also see it the other way: that the underlying is trading at a 40%+ premium. We don’t know at what price the new entity will trade. The company plans to vote on 23 Aug 2024, and if everything goes smoothly, as we expect it will, the new entity will start trading on 9 Sep 2024.

The Arbitrage Opportunity:

The arbitrage opportunity is to buy tracking stock and short the underlying stock, pocketing a risk-free profit. However, the underlying stock has been trading in a more volatile manner, with shortable stocks not available and borrowing costs that could fluctuate and become very high.

The Long SIRI Opportunity:

To look into half of the arbitrage opportunity—that is, long tracking stock—we need to understand what the underlying company is about, as we may need to hold it longer term.

But, What Is Sirius XM?

Sirius XM, in a nutshell, operates a monopoly in satellite radio service in the US. It is a merger of Sirius and XM from pre-2010, and Liberty Media came in to provide debt to them. It has since grown its subscriber base rapidly until recently, where the number of subscribers is tapering and going down. The business is very good with roughly 50% ROIC; however, its net book value is negative due to the high load of debt it has. The company itself has been using its free cash flow to pay dividends and conduct share buybacks. Therefore, the debt here acts more like leverage than necessity.

Headwinds and Tailwinds

• The company’s subscriber count growth is tapering off. While we think the company will be able to grow the subscriber count, our base case is that the subscriber count will stay stagnant, due to the increment of new subscribers being offset by those who are churning.
• The company is currently going through a capex cycle to renew its satellites, which, once completed, can result in low maintenance capex, resulting in higher free cash flow, ultimately enhancing shareholder return.
• The company has very high debt compared to its assets, but as mentioned, more as leverage instead of necessity. It is planning to utilize its FCF to pay down the debt. Another tailwind to this is the Fed rate hike cycle is ending and going into the reduction cycle.
• The company has a monopoly in satellite radio, which, while facing competition from the likes of Spotify and YouTube, has its own niche audience, mainly those who commute within areas with poor coverage of internet service.
• As a bonus, there could be potential for a Sirius XM acquisition, supported by Liberty Media and Sirius XM simplifying the structure, unlike in the case of other Liberty holdings.

Concluding Thoughts

I have gone long SIRI through LSXMK, which hopefully provides me access to a stock with some tailwinds (artificially depressed due to execution of arbitrage opportunity, temporarily suspended buyback, potential index inclusion) that represents a business that has more tailwinds than (manageable) headwinds at a hopefully instantly collapsing discount.

It’s amazing how things have changed over the years. In 2019, while I was traveling to a few countries, I got tired of traveling each year at year-end and told myself, “This is getting tiring.”

Lo and behold, the four years that followed were nothing short of crazy. Starting with COVID-19, which I discovered earlier than others in the world thanks to my proximity at the time to the point where the outbreak was first discovered, followed by one of the most rapid stock market crashes I’ve ever experienced in my life, and then one of the most rapid stock market rebounds ever driven by the decisive action taken by the Fed to lower the interest rate to 0%.

Since then, we had SPACs, and even SPAC Jesus going on live TV, followed by Crypto, from Bitcoin, to Ethereum, to Dogecoin, to Shiba Inu coin, followed by NFTs. Don’t forget, everyone was buying TSLA stocks back then.

The Fed then embarked on (at least) the most rapid increase of interest rates in my life, raising the rate from 0% to 5.25%, and suddenly all that madness started disappearing. I rarely hear about SPACs or NFTs anymore. Bitcoin dropped to $18k and has since bounced back up. The only use case of Bitcoin that I can think of is for evading taxes, but I won’t go there.

Then in 2022, we had GenAI.

Coming from a computer science background, I’ve heard about AI and how it has evolved from its early days as applied statistics, to artificial intelligence, machine learning, deep learning, and now Generative Artificial Intelligence. It’s quite neat; you have a tool that can basically provide you with answers as if you’re talking to some assistants in a non-programmatic way, unlike Siri – which feels pre-programmed.

At first, no one knew what it was capable of, but in the 1-2 years that followed, it was, again, nothing short of crazy.

Every tech company seems to be building its own model. VC funding goes towards AI projects. If you have a real business and are raising from VCs, the question you will get asked is, “Where’s the AI? Our IC won’t be approving it if there’s no AI angle.” AI businesses are raising tons of money at incredibly high valuations.

I always wonder what they put in the business plan. It’s probably: “I need $100 million on a $500 million valuation (because you typically give 20%) to train the model that I am building, and I need lots of NVIDIA chips and compute power for that.”

NVIDIA stock soared, followed by other stocks which has AI direct and more recently, second/third/n-th order effect, from the chip manufacturer, to the server builder, server rack provider, to even the energy provider for the data centers. Companies start mentioning AI in their quarterly report, from software provider, to probably restaurant operators, apparel companies, retailers. The stronger reason is not because they are actually benefitting from it directly (or even indirectly) in a meaningful new way since GenAI, but it is because their stock price will get punished if they don’t mention it.

Recent writings by Goldman Sachs and comments from top company leaders have shed some more light on this matter. Skeptics start asking about the ROI on these capital expenditures related to GenAI. While that remains questionable and time will tell, top company leaders start mentioning their true intention. They invest in this because the risk of under-investing in it is higher than over-investing. Which is another way of saying, I also don’t know the ROI, but if I don’t, then I have a risk of going down.

That doesn’t sound like a good thing to bet our own money on, does it?

This exact reason has driven NVIDIA to be one of the most valuable companies in the world. A simple way for me to determine whether it belongs there or not is:

Do you use it every day?

I use Apple iPhone, communicate on WhatsApp and Instagram, use Google search engine, MSFT Windows and Excel spreadsheets, watch Netflix, buy things on Amazon (and recently subscribed to Amazon Prime), and billions of others do. I believe billions of people in this world have never even seen an NVIDIA chip, yet they buy the stocks. This is very similar to where TSLA was back in 2020-2021 when people thought that everyone was going to drive multiple Tesla cars and have their homes powered by the Powerwall, and so on. Yet, nowadays, a lot of companies are going back to building gasoline cars.

I belong to the camp that truly believes that AI is going to change how we live for the better, like other inventions such as electric cars, mobile phones, the internet, gasoline cars, electricity, and oil. At the height of the internet bubble, you had hundreds of companies doing internet-something, and I don’t see them existing anymore now. Back in the day, you had hundreds of car companies; nowadays, you have only a few that are still standing.

I don’t think it is wise to bet against the excess, but for sure it feels excessive, and anything excessive will normalize.

Time will tell.

Link to the Goldman Sachs Report: https://www.goldmansachs.com/intelligence/pages/gs-research/gen-ai-too-much-spend-too-little-benefit/report.pdf

Link to the Berkshire Hathaway Shareholder Meeting 2021: https://finance.yahoo.com/video/2021-berkshire-hathaway-annual-shareholders-142101852.html

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