Volatility Is Opportunity Not Risk

I have been investing in the public markets for over ten years now. Five of those years were as a professional investor at a hedge fund. Throughout this time I invested in multiple industries, businesses and researched over 500 different companies.

From my experience in the public equity space I can confidently say that public market investors are an interesting breed. Investors in this space will claim to be long-term investors. “We invest with a time horizon or two plus years,” they will say. But despite the “long-term” mandate, they will focus 90% of their effort trying to predict what the next quarter will look like. Which I have wholly fallen victim to.

As an example, I’ll spend months trying to figure out how a company generates free cash flow. I’ll talk with industry experts. Speak with the management team. Tour facilities. And use all publicly available information I can to forecast what free cash flows will be in the future. Despite my seemingly long-term approach to cash flows, I’ll try to figure out what sales and net income will be on a quarter by quarter basis.

Its hard not to do this. When valuations move up or down 20 plus percentage points based on a single earnings event, its tough not to become a quarterly investor. What is worse, is when Mr. Market quotes what your assets are worth every single second of the day.

Getting quoted an asset price every single second of the day is what makes public equity investing one of the most interesting asset classes out there — and frankly, one of the best places to make money off of others emotions.

Take the COVID-19 pandemic as an example. Was there any other asset class that lost over 30% of its value in a single month outside of public equities that you could have easily invested in? I don’t think so.

Sure real estate prices and the small business down the road might have lost 30% of its implied valuation, but the owners of those assets couldn’t just dump them into the markets as there wasn’t liquidity. And anyone who wanted to buy a house or small business during middle of the pandemic just couldn’t as liquidity dried right up.

But not in public equities. In fact, if you wanted to buy equities during the March 2020 lows it was very easy to find liquidity as everyone was dumping everything they had. By taking a long-term approach to owning a business, anyone who bought in the March lows made an absolute killing.

What I am trying to say in this long-winded letter is that public equity investors tend to have short-term time frames, are highly conscious of volatility and equities tend to get priced based on the next quarters implied cash flows — not the long-term ability of a business to generate cash.

If you want to outperform the market remember these points:

• Volatility is opportunity. Where is another place on earth where you are quoted different prices of an asset every second of the day? Use this opportunity of constant pricing to buy an asset when Mr. Market hates the asset and sell when Mr. Market loves the asset. If you can control your emotions, an investor focused on owning businesses for a great price will outperform.

• When volatility comes knocking remember you are buying a portion in a business for its long-term ability to generate cash flows. The cash flows generated over the long-term are what really matter here. Not the how much cash flow can be generated in the next three months.

• Take advantage of other investors emotions. When an asset price falls double digits in one day it is time to take a closer look at what the long-term value of that business is worth. Investors tend to overreact to negative and positive events. When bad news comes out investors sell first and ask questions later. Ask intelligent questions and make business like decisions.

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Snippets

• Shortage of Railroad Workers Threatens Recovery: America’s freight railroads are struggling to bring back workers, contributing to a slowdown in the movement of chemicals, fertilizer and other products that threatens to disrupt factory operations and hinder a rebound from the pandemic, according to shippers and trade groups.

  My Take: If you have been following the letter you know I am a bull on fertilizer companies. With Q2 earnings coming up, I am excited to see how much money CVR Partners (“UAN”) will generate. I have seen rumors from analysts smarter than me that think they could have $5-7.00/unit of distributable cash flow. If UAN is anywhere close to generating that kind of distribution the stock will re-rate majorly to the upside.

• Spanish language Hemisphere Media gains on report of potential sale: Hemisphere Media (“HMTV”) rose over 7% yesterday on reports that the Hispanic TV and digital media company is exploring options, including a potential sale. The sale deliberations come amid a wave of deal making in the Spanish-language TV industry. Hemisphere’s bigger rival Univision Communications Inc agreed in April to merge with Grupo Televisa SAB’s media assets in a $4.8 billion deal, amid competitive pressure from Comcast Corp’s Telemundo.

  My Take: I am pretty bullish on Hispanic media assets. I recently wrote up an idea of a extremely small and illiquid Spanish media company that is way under the radar of any Wall Street analyst. If my forecasts are anywhere near being directionally correct it could be a multi-bagger. That being said, I think the Hispanic media space has potential to be a hot new media space in terms of political spending. 2020 was a great political spend and 2022 could be another banner year. I think you will see investors start to sniff around these assets in future years based on political potential alone.

• Update: I posted a quick update yesterday on four catalysts that could happen when our favorite play tied to the booming steel industry reports their earnings in a couple of weeks. If you missed it check it out. I am highly bullish on the future results.

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