The Anatomy Of A Big Winner: How To Hold A Big Winner
For prior parts of the “Big Winner Series”, we discussed common mistakes to avoid when looking for big winners and then the primary factors that make up a potential big winner. As mentioned in the previous articles, finding big winners is not easy, and the hardest part is the act of holding on to them long enough to let them become a big winner in your portfolio. In this article, we are going to look at methods to help an investor hold onto a big winner once they have found one.
Comfort With Uncertainty And Volatility
When dealing with individual stocks, volatility is the price of admission for getting outsized returns over time. However, in the case of big winners, an investor needs to understand volatility will be something you will come across. When dealing with these types of stocks, especially if they are earlier in their “story”, there will be some level of unknowns and certain things that simply cannot, or will not, be known at the time.
With more uncertainty comes more volatility but this also means there is more potential for outsized returns for a patient investor that can take advantage of what might be irrational short-term moves. Sometimes a stock will simply see a big drawdown because of issues totally unrelated to the company itself. It might be a shift in sentiment, a broad market pullback or something else entirely out of the company’s control. The point is, there will be times of volatility that an investor needs to understand will happen and be able to sit on their hands (or buy more) when the volatility occurs. It won’t matter how well you know the company, how right (or wrong) you are, or how wrong the market is, volatility and times of uncertainty are a feature, not a bug, for general investing as well as for big winners.
Patience And Knowing What You Own
Once you have accepted the fact that volatility will happen at some point through the lifetime of an investment, you can look at two aspects that help to deal with that volatility—having some patience and knowing what you own and why you own it. These two aspects tie into each other, because knowing what you own and why you own it helps you to see the forest through the trees and helps with patience. You should have a good idea of the opportunity set that the company faces when you find a potential big winner. Understanding the fundamentals of the company, what they do, and how they do it, as well as who their competitors are can go a long way to understanding what you own.
Owning companies with strong balance sheets can also help add comfort with what you own and allow you to think longer-term. Strong balance sheets give a company some options and allow it to weather any storm that may, and will, come its way. This added flexibility or cushion also allows the investor to be a bit more confident through the tough times, knowing that they have a strong enough balance sheet to get through the bad times. Strong balance sheets also help to reduce the risks of surprises such as a company having to do layoffs, requiring financing because funds are getting tighter, or its inability to respond to competitive threats that may arise.
Investing in general is something that requires patience. ‘Rome was not built in a day’ and a ship does not turn on a dime. Things take time, building a business is hard and hiccups or speed bumps are bound to happen along the way. In a market that increasingly seems to focus on single quarterly numbers, being patient and thinking long-term seems to increasingly be a superpower.
One thing to keep in mind, however, is not to be complacent. Knowing what you own and patience are not an excuse for turning a blind eye when management is not executing or for ignoring an investment thesis that is starting to change. The line to walk between allowing some room for error at a company and when something has fundamentally changed is a tough line to draw but one that needs to be monitored.
Thoughtful Sizing
Thoughtful sizing is something that needs to be considered before an investor decides to buy a stock and is one of the most critical decisions about holding onto a big winner. At what weight do you want to own the stock initially? At what weight would you consider is a full position? Of course, the optimal decision can only be known in hindsight, but generally, we tend to prefer approaching weightings with an equal weight approach. This means that all companies in a portfolio have an opportunity to generate returns, as opposed to adding hurdles where weights are tilted more toward “high conviction” investments that don’t give the other stocks as much of an opportunity to participate in portfolio growth. With that said, we think a bit of a different approach can be taken with “big winner” potential investments.
Typically, these types of stocks are earlier in their growth runway. This means two things: Uncertainty is higher, and they have plenty of time to grow to their full potential. Given this, we think that weightings should start on the smaller side of a portfolio. This gives a nod to the higher risks inherent, and the potential your timing will likely be far from perfect. Starting small gives the company some time to earn a bigger position in the portfolio by growing organically.
Meanwhile, if the inevitable drawdown for the stock in question occurs early, the position won’t be so big that an investor gets “scared out of it” and does the wrong thing at the wrong time (due to it being positioned too large). If this scenario occurs, it allows an investor to add to the holding at better prices, since the weight was smaller to begin with. Alternatively, if it were a full position, even if an investor was able to continue to hold, they would be far less likely to add to the stock at more attractive prices.
To sum up, starting with a smaller position sizing with a big winner gives an investor some options. If the thesis is correct, it probably works out fine regardless and there will be plenty of time to add to an already growing position. If they are “wrong” in the short term, a smaller weighting offers an opportunity to add to the holding at better prices. If they misjudged the stock completely, the loss will be manageable in the context of a diversified portfolio.
Adding To Winners
The final key to big winners is adding to those winners. This is related to position sizing because in order to add to a big winner, the position needs to start small enough that you have space to add to it without making it too large of a position in a portfolio. In a perfect world, you would know ahead of time with certainty that a company was going to be a big winner, but this is not how the world of investing works.
We prefer adding to stocks that are winning (momentum) because it is confirmation that good things are happening. Maybe the company pays down debt, has a few earnings reports that confirm the business trajectory, or sees some sort of event that de-risks things materially. These events are opportunities to add to a winner because it is confirmation that the thesis is working and fundamentals are moving in the right direction, while the risks to the investment are also decreasing. Lower risks mean that holding the stock at a higher weighting is more justified, as uncertainty is decreasing and volatility is declining. Remembering that the company is still likely early in their lifecycle, adding holdings at higher prices should still mean that the company has plenty of potential to grow from those new, higher levels.
Adding to winners is not easy to do—you are supposed to buy low and sell high after all! In these instances, buying low, buying a bit higher, and a bit higher again, then selling when it is very high, can work out just fine. In these types of scenarios, an investor is likely to quickly come across the issue of the holding now getting too large and the decision of trimming for risk management will quickly come to the forefront. A good problem to have in our view!
While this is the last in the “Big Winner” series, it is certainly not the least. Holding on to winners is the most important part of investing, and relates to the biggest mistake we see investors make, which is selling too early. These big winners don’t always come, and not every opportunity will turn out as expected, but if searched for in a prudent manner, they can make a big difference. So, the next time you find a big winner, hold on, because they can be life-changing!
Ryan Modesto, CFA - CEO, i2i Capital Management