It’s interesting to see Prof. Aswath Damodaram ‘s article as to why he’s selling Apple. He bought in early 1997. According to Google, and assuming he bought on 10-Jan-1997, he would have made a gain of 11554%. There are no decimal points missing in that figure. The stock has split twice since his purchase, and it is unclear to what extend Google corrects for this. Whatever, he’s still clearly going to be in the money.
He cites 3 reasons for buying: 2 emotional, and one rational. The emotional reasons were "pity" on account of having liked the products, and as a "protest vote" against Microsoft. The rational reason was that he saw optionality in a purcahse. He claimed that the payoff was more due to luck than excellent stockpicking skills. He says that he has made similar option plays every year for the last 20 years, noting:
quite a few of them did what out of the money options tend to do: end up worth nothing. (My Eastman Kodak bet did not do so well…)
Given the extended holding period of the stock, I think it’s a surprise to most people that he decided to sell out now. He still thinks the company is below intrinsic value. He is ignoring that, saying that a move to a dividend policy signals that Apple is moving to a more mature phase, and attracting a different type (i.e. the dividend-seeking) investor.
Historically, the market’s largest cap company has underperformed the market for the subsequent decade. (BTW, the largest-cap company in the UK at the moment is HSBC).
When Aswath talked about optionality, it reminded me of Nassim Talebs words about options. Given that the future is inherently unpredictable, your aim is not to be smarter than anyone else, but to buy cheap options with asymetric upside returns. The great thing about shares is that they’re perpetual options (unless and until they go bankrupt, of course).
It also seems to fit in with Geoff Gannon’s recent articles on net-nets. The key is that there’s a lot of optionality in them, too. They’re not so much "out of the money", though, as they have a greater asset value than their capitalisation value.
That would appear to be one way of making money, then. Buy a basket of these options companies. It seem that you have to be prepared to hold for a long time, too, and not look at your holdings! Sitting on your hands is compulsory, because you don’t know when, and how big, the payoff is going to be.
An almost opposite approach is one regularly touted at csinvesting, who observed "people love their lottery tickets". On his blog, he is covering franchises. In that approach, you’re trying to find franchise businesses, and buy them below IV (Intrinsic Value). The discounts you pay are not large – he seems to suggest that a 20% to IV is the region where you’d want to purchase. A 30% discount would be an extreme, and very unlikely, event. At 50%, you’ve done your calculations wrong – perhaps with the exception of extraordinary market events like in 2008 – market conditions which exist in 3 years out of 100. Note that I’m talking about strong franchise businesses here, not cigar butts.
So there’s obviously different expected payoffs between the two types of investing. In the optionality strategy, you’re hoping to hit the jackpot where the winners pay the losers, and more besides. In franchise investing, you’re investing in supertankers, which move slowly, but are unlikely to sink on your watch, comment John Chew.
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