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The Courage Of Our Convictions

  • May 24, 2022

A few years before AT&T (T) decided to spin-off its Warner Bros. division and merge it with Discovery to create Warner Bros. Discovery (WBD) in a tax efficient transaction called a Reverse Morris Trust transaction, Discovery was languishing as an attractive value stock without a catalyst. John Malone, who served on Discovery’s Board of Directors purchased $75 million worth of the stock in an insider purchase and said the following about the company in a CNBC interview,

“I believe that they will solve this issue and that they are dramatically undervalued right now. When I put my screen up and I look at companies based upon market cap versus levered free cash flow, they were the cheapest thing on the screen. And I said wait a minute, they are growing in a world where everyone else in shrinking, they own all their content, they are generating a ton of cash, they have an investment grade balance sheet, why are they, why are they cheap.”

The stock continued to decline further after Mr. Malone’s purchase and I started a position when the pandemic driven drop in the market provided a great buying opportunity at prices in the low $20s that were nearly 40% below Mr. Malone’s $28.03 purchase. And then a strange thing happened in early 2021. The stock went parabolic and eventually peaked over $77 per share. If you had done the work on the company, you realized that something didn’t seem right despite stories that Discovery’s streaming division was driving the performance.

I decided to exit my position for a decent profit and didn’t let the fact that it continued higher bother me. It eventually emerged that the huge spike was driven by manipulation of the stock by Bill Hwang’s Archegos Capital Management and the sudden collapse of the firm left several investment banks with $10 billion in losses. Credit Suisse was attempting to unload blocks of Discovery stock in April 2021 to recoup some of its losses from the Archegos debacle.

The decision to both enter and exit the position in Discovery was driven by an idea discovery process, work that I did on the company and then exiting the position when it felt like the stock had gone from being undervalued to overvalued. Unfortunately most investment decisions don’t quite work out that way. You are constantly trying to figure out if you have all the information needed to make a decision, attempting to arrive at the right interpretation of the data you gathered and realizing that you have to act on imperfect information at times to avoid analysis paralysis. The investment process is messy because your counter party is a market driven by emotion in the short-term. The fact that the market is also driven by future expectations means that you have to have some idea of how the future might unfold or what is coming around the curve.

Having the courage of your convictions to act in the face to uncertainty is crucial. That courage can come from,

  • personal experiences having invested across market cycles
  • learning from past mistakes or
  • experientially by learning from books or the mistakes of others.

While learning experientially is less costly, it is also harder to internalize the lessons of others. There were times during this technology bubble where I scaled back positions in companies like Atlassian (TEAM), Twilio (TWLO), Twitter (TWTR), Workday (WDAY) and Zoom (ZM) by taking profits along the way but was not as aggressive at selling them down as I should have been. I was unfortunately swayed by conversations I had with other market participants that had not seen a classic bubble and had bought into the prevailing growth narrative.

One of the reasons I seek out the opinion of other market participants is to guard against hubris. Getting several investments right or figuring out how a market cycle plays out could lead to overconfidence and hubris. This yin-yang of having the courage of your convictions to act and at the same time avoiding the trap of overconfidence makes the investment process both interesting and challenging. A mechanism I use to seek out other opinions is to pose a question like “What is the bear case for X?” on Twitter. I recently posted this question for Crocs (CROX) and the breath and depth of responses I received from the FinTwit community was very helpful. It also highlighted how folks can come to completely different conclusions given the same data.

Cultivating your community of experienced investors can help you avoid the hubris trap. They don’t have to like minded and divergence of opinion is actually valuable. This is one of the reasons I have been writing for more than 15 years and distributing my content across platforms. The interactions with other investors in one of the things I enjoy about the process and it helps me remain a life long learner.

Voluntary Disclosure: I hold long positions in Atlassian (TEAM), Twilio (TWLO), Twitter (TWTR), Workday (WDAY) and Zoom (ZM).