Trades from 2020-07-15

I've been trading much more actively, and I'm going to start keeping a journal of every trade I make on the day I make it with a quick summary of my reason behind each trade.

I sold my stake in FMC.

I don't think FMC is either overvalued or undervalued. I also don't think it's particularly volatile or likely to become one of those two things any time soon. I'm increasingly looking to generate income off my portfolio by selling covered calls. (I also sell some naked puts.) My stake in FMC was an odd lot which is unsuitable for selling covered calls. Its appreciated significantly since I purchased it in absolute terms and also relative to valuations metrics (i.e. its P/E and Price/Revenue are inflated relative to what they were when I purchased, and I thought it was undervalued when I bought it, so I think the increase was justified by the fact that it used to be undervalued, but I don't see anything that has materially improved.) I actually originally purchased it when I was researching good lithium stocks before it spun off LTHM, so its not even in the business I was interested in when I purchased the stock. In short, I invested in FMC when I thought it was undervalued while being an exposure to a particular industry to which I want to hold exposure, and I don't think its either of those things right now. If it was a more volatile stock, I would wait until I thought it was overvalued to sell (or at least until my call options were hit).

I have a more philosophical reason for this divestment. I think the best investment advice I ever read comes from Paul Graham. He gave it not as investment advice but as advice for founding a start up: "Live in the future and build what's missing." I think that's fundamentally the best way for companies to achieve profitability regardless of whether they are startups or established businesses.

FMC is no longer part of the future I believe in. Fertilizers and pesticides have been an incredibly important part of 20th century history. I believe they have made the modern world a better place by bringing down the cost of food, increasing the food supply, letting more people survive and improving the quality of lives of the people who are alive. I don't foresee them having the same effect on 21st century crops, and to the extent that they continue to be used, I don't think they will be useful in nearly the same quantity that they were before. The future of farming is artificial intelligence, genetic engineering, cultured meat, and ultimately cultured produce. In the mean time, human population appears to be peaking. In thirty years, I think there will be dramatically less livestock than there is today, much more targeted and intelligent delivery of nutrients to foodstuff, and fewer human mouths to feed. All of this adds up to less need for fertilizer and pesticides. Meanwhile, there's a clear trend in consumer demand for pasture raised animal products and organic produce. Farmers looking for the best way to boost their profitability have opportunities to cater to these markets. In the very near term, I see FMC continue to increase its earnings, but on the scale of five years or more, I see nothing but headwinds for its business. I'm not a particularly early adopter for most things, but I do tend to join trends before they become mainstream. There is now enough evidence in favor of pasture-raised animal products from the human health benefit perspective in addition to ethical concerns over the treatment of animals that I no longer by dairy, eggs, or meat unless they are free range, pasture raised, certified humane, or similarly conscientiously produced. I still buy non-organic produce, but if I could by GMO produce that hadn't been exposed to pesticides or unnatural fertilizer, I would buy those instead. I'm still waiting for a movement in produce that is aligned with scientific principals as applied to what's best for human health and the future of this planet, but I'm increasingly convinced its coming. The production of meat and other animal products has shifted dramatically in this direction in the past 20 years. New agricultural products like marijuana are being very scientifically produced as well. Unless we someday reach the point where technology can no longer be improved, every business will be obsolete in an eventual future. It's just a matter of how soon that future comes. Right now, I think I see a future being built where FMC's core business is obsolete.

A lot of the time when I close a profitable position, I continue watching the company to see if another buy opportunity presents itself, but I don't plan to do that with FMC.

I reduced my position in FSLY

I entered FSLY at 28.14. Since then, I've considered trading it many times. Every time I've considered trading it and not traded it, I've regretted the decision. I considered doubling down when it fell at the start of the lockdowns because I really didn't see how it would be adversely affected by them. I considered selling it on the way up when it was in the 80s, 90s, and ultimately hit 100. I considered selling it on the way back down at about 92, and as it passed through the 80s. Its really hard to value companies before they are profitable. I don't know have any clue what FSLY will ultimately be worth. I would guess its market cap will eventually be much more than $10 billion unless a big player like Amazon, Google, or Microsoft decide to focus on beating it at its business in the very near future. However, there are other risks. Bandwidth for transmitting information increases faster than processing power. It's possible that it grows fast enough that FSLY's business is obsolete before it really gets off the ground. Overall, I'm still bullish FSLY in the long term. It seems like it occupies a good niche that will have few entrants and that there will be moderate demand for its services. However, I still see a lot of risks to the stock, and its going to be very volatile in the short run. When I say I'm bullish on FSLY, I mean that I think owning it is positive EV. However, I still think its overvalued because I think the expected sharpe is pretty bad at its current valuation. I'll be more surprised if it never trades below $60 again than if it does. I'll also be more surprised if it never trades above $120 than if it does. I like 38% revenue in a stock, but I don't like 39% growth in cost of revenue. This is a recipe for volatility.

I also sold a call at $90 for August.

I'm thinking about potentially selling a put tomorrow.

I bought a January 2021 put on Apple at 300 per share.

I think AAPL is ludicrously overvalued. Its revenues are declining. The smart phone market is saturated. Its share of the global smart phone market it declining. Revenues put an upper bound on earnings. For declining earnings that look like they are going to be declining for the foreseeable future a P/E of 7 isn't crazy. That's the state of Apple's price/revenue ratio. This is absurd.

Moreover, I think its going to be found guilty of additional anti-trust law violations in both Europe and the United States. I've thought that Apple was in flagrant violation of every aspect of the spirit of anti-trust laws since I first worked on creating an app for iPhone back in 2011, but since I came to that conclusion, I thought it was obvious that they had been doing so for a long time. Everything Apple has done in the last 15 years is anti-competitive in ways that harm consumers, ever since they made it possible to transfer an iTunes library from Windows to Mac while making it impossible to transfer back from Mac to Windows, they have been profiting off of deliberately anti-competitive practices that harm their customers. I think that that's already egregious. Then they started making non-standard connections for all of their devices simply because they could get away with doing so. If you own an Android product from a reasonable manufacture, its chords are compatible with a huge number of products from other manufacturers because they are standards-compliant. Not so with Apple. They invested money into designing and manufacturing non-standards compliant chords for precisely the purpose of being non-standards compliant so that they could be the only ones to sell their customers those accessories. Then they locked down that app store ecosystem to a degree never before seen in a computer of anything approaching the popularity of the iPhone or the iPad. There were a lot of other things since then, including at least two that lead to legal trouble (illegally conspiring with publishers to fix prices on ebooks and sending out updates to their legacy devices that were intended to drain the batteries of those devices more quickly) but now, they've started booting apps from the app store for being free apps that don't generate any in app revenue for Apple either. As a result, regulators in Europe and the United States are finally looking into the legality of their app store practices. Meanwhile, they've killed any defense that they could possibly have. Apple deliberately shipped malware to their own customers (battery draining), and nobody who knows anything about tech security can still say with a straight face that Apple's devices are more secure. There was a time when zero day exploits for hacking Apple devices commanded significant premiums over zero day exploits for other devices, but that time is now long past.

If that wasn't enough reason to be bearish Apple, the global environment has become hostile to their business model in other ways. We're entering a phase of de-globalization and increased fragmentation. India just banned TikTok and a bunch of other Chinese apps from its app store in response to a border conflict over contested territory with China. China already has much more control over what apps it allows than India does. France has started working to give its businesses a local advantage. The United States is doing the same thing as seen in its protectionist attacks on Huawei in addition to all of Trump's trade wars. I expect governments to regard Apple's app store model and the way it has positioned itself as a curator of what is available on its devices with increased hostility as that becomes something that governments want to increasingly do themselves. I don't think the government of China or France wants Apple to have any say over which apps are allowed in the store and which ones aren't particularly if there is any evidence that Apple is protecting the interest of American companies at the expense of local companies. (They are, by the way. They deliberately reject similar apps to existing ones to prevent there from being too many options for similar functionality. Since American companies tend to be first to market, this practice favors American app makers.) Add to this fights with law enforcement over whether or not Apple is obligated or should be obligated to allow/help law enforcement agencies to extract information from e.g. a captured terrorist's phone, and we have a general pattern of Apple occupying the role of a global political power rather than just being a technology maker, and I expect that to increasingly put regulatory headwinds in Apple's way more so than the headwinds arising from mere fragmentation of the market.

I don't think Apple will ever grow into its current valuation.

I don't know whether it will continue to increase in value for the next six months or stay flat or fall, but I'm willing to put a little bit of money into betting that it falls.

I don't like take net short positions because the markets can remain irrational indefinitely, and buying a put is taking a net short position. This is as much a token gesture as it is an investment. I didn't put much money into it. I also prefer shorting options to going long options because I like time decay to work in my favor.

I acknowledge that even if my analysis of Apple's valuation is correct, taking a net short position by buying a distant out of the money put is probably still a negative EV trade.

I initiated a long position in CVS.

CVS is one of the companies that appear to benefit somewhat by the current pandemic and its related lockdowns but that has nevertheless failed to rebound to its pre-pandemic share price. They have strong revenue growth through recent history (albeit, some of this is due to an acquisition). Their earnings are somewhat lower than they otherwise would be due to amortizing their Aetna acquisition. Ignoring the amortization they are trading at a forward P/E of about 9. (Taking the amortization into account, they are trading at a forward P/E a little north of 12.) Additionally, they are paying a 3% dividend. I think the correct way to think about dividends is to treat them like the after tax amount in your tax bracket is being bought back. In other words, assuming a 33% tax bracket (to make the math easy), I think it makes sense to think about a 3% dividend as though 2% of shares are being bought back annually which basically means that when converting earnings growth and revenue growth to per share numbers (which we should do), we add a little more than 200 basis points to the numbers we see. I think CVS has also been net buying back shares, but I don't have the numbers in front of me at the moment. I did just look at their earnings report and see 8% revenue growth overall. After taking into account the fact that they are paying a 2% dividend, I think it's fair to think about this 8% revenue growth as though it were 10% revenue growth. (Actually a bit more than that.) It's earning growth is so high at the moment as a fraction of revenue, that it doesn't mean anything, since it's completely unsustainable. However, those earning can potentially accelerate dividend growth and buyback growth.

I see two ways of looking at these numbers that make sense:

1) You can treat the Aetna revenue growth as organic growth and distribute across the ten years of its amortization to calculate the revenue growth and look at the GAAP P/E.

2) You can treat the revenue growth due to the Aetna acquisition as not real but also treat its amortization as not real.

I prefer option 2, mostly because CVS has already done the work to make it easy to calculate it. Once that is done, I see CVS as a company with a forward P/E of 9, dividend+revenue growth of more than 10% per year on a per share basis, and earning growth exceeding revenue growth in the short term.

That looks pretty cheap to me.

A quick note on Tesla

I've done other trading Monday and Tuesday, but I just want to quickly mention Tesla.

I sold a third of my remaining TSLA position on Monday at $1720. (I sold half of my stake a week and a half ago at just over $1500. So I'm down to 1/3 of my initial holdings.) I've been a Tesla bull for a long time. I've only really been doing discretionary trading for a little over two years, but Tesla is one of the oldest positions in my portfolio. However, I can no longer justify its valuation to myself at all. The only bull thesis that I have left is that there is still a greater fool built into the market when it does get added to the S&P. I haven't sold my entire position yet because I think there's a decent chance that Tesla is profitable again Q2 in which case, it most likely gets added to the S&P this year. I could see it going to $2500 if that happens. If it's not profitable this quarter, there's at least another five quarters before it gets added to the S&P, in which case, I see it falling to below $500 by the end of the year. Either way, I would consider an appropriate value for Tesla to be somewhere around $600 per share. I can still tell a compelling story to myself about why Tesla could go up from here. I can tell a lot of compelling stories to myself about why I think Tesla should be the most valuable car company in America. I can tell myself a lot of stories about why I think it has the potential to be the most profitable car company in the world. I can't tell a compelling story to myself about why Tesla should have double digit price revenue or why it deserves to be the most valuable auto manufacturer in the world. (Part of my story about why it deserves to be the most valuable auto company in America is that the words I have for the US auto industry are not particularly flattering words. I think there is a compelling story for why Tesla has the potential to become more valuable than Toyota if it executes on everything it looks likely to execute on, but that is not the same thing as saying I think it's reasonable for Tesla to currently be worth more than Toyota.)

Am I net bearish the market?

Maybe.

I've been net selling for a little while recently.

I am currently about as bearish as I've been since I started actively trading. I have been slightly levered in my primary brokerage account for the past two months, and today's trading returned me to being net long cash in that account. (After taking into account that I also have some cash in the bank, I've stayed net long cash across all of my assets or very close to it. I don't think of my cash in my bank account as being available for trading, so I don't do that calculation. I think of cash as money that's available to spend in the next year, and so I calculate the maximum leverage I am willing to take based on that. I'm willing to enter positions to the point where I am about 20% levered in my brokerage account and hold them if they move against me until up to 50% levered, but I've never been bullish enough to become more than about 5% levered.)

I think its more accurate to say that I am trying to consolidate my holdings into fewer positions than it is to say that I am net bearish.

However, I'm also as defensively positioned as I've ever been. I have about a third of my long holdings in companies that I expect to do better if the lockdowns and volatility continue for a lot longer than they would if things reverted to normal today.

In descending order of size, those positions are: Virtu, Interactive Brokers, Progressive Insurance, Gilead, JPM, and CVS. (I'm arguably also still long Zoom. I've sold a covered call that is now in the money. So I have downside exposure to Zoom, but no upside.)

Most of my other holdings are high growth tech stocks that I think will be fine with or without the lockdowns continuing. Most of them are helped directly by the fact that people are doing more remotely, but are exposed to the overall strength of the economy. Companies like Slack, Etsy, Dropbox, and Carvana. I've net taken money out of these sorts of stocks to put money into more defensive companies in the past couple weeks, but not because I'm pessimistic about them. I just think the valuations have gone crazy in the recent run ups. I've been adding to growth stocks that haven't had 100%+ returns year to date while reducing my exposure to the ones that have.

I recently initiated positions in Dropbox and Huya and have added to a few other aggressive growth stocks.

I also took a (small) position yesterday in a retailer that filed for bankruptcy earlier this year: Tuesday Morning. It's a discount retailer that is trading well below book. I don't know whether to characterize that position as bullish or bearish. (Hurt by lockdown, helped by recession, possible that shareholders get paid more than current price even in a complete liquidation.) I also entered it in a way that could be either construed as net bullish or net bearish. I sold my position in another discount retailer (OLLI) to enter it, and invested part of the profit from that position into this new one. The new position is much smaller but also much riskier than the old one was.

Overall, the markets seem as crazy to me as they've ever been. I don't think this is a bubble. I think it's too weird to be called a bubble. I think the market is extremely distorted. I see several companies that have valuations I consider absolutely ludicrously high: Apple, Tesla, DocuSign, Nikola, and Beyond Meat, to name a few. Beyond Meat is the only company on this list that is mid cap by the typical definition of that phrase. All of the others are large cap. DocuSign is currently valued at $35 billion. (I think Fastly's lunch is safe from everyone except big players. But I think every Tom, Dick, and Harry is going to launch a competitor to DocuSign. Dropbox just launched one called HelloSign. This business has good synergies with Microsoft, Adobe, and Slack as well. I see any of the four names just mentioned as being more likely to win at DocuSign's business than DocuSign is.) In the dot com bubble, a ton of companies that should have been microcap are valued like they were small cap or mid cap. That's not what's going on in this economy, at least not in my analysis. I think the companies with the highest market cap tend to look more expensive by valuation metrics as well at the moment. I'm not sure if this has ever happened before.

For the most part, I don't see a lot of companies that look ludicrously overvalued to me right now. Apart from Tesla, I've fully sold all of my holdings in companies that I thought were valued crazy high. Lately, I've been reducing my positions in stocks that seem reasonably priced to start increasing my positions in stocks that seem undervalued to me. I'm not sure whether Netflix is overvalued. It's growth seems to justify its valuation. However, I'm absolutely convinced that Netflix is overvalued relative to Disney. I think we are going to see a very similar phenomenon to Amazon/Microsoft play out with Netflix/Disney/Viacom. Amazon invented better economics for selling software than Microsoft had been using (cloud computing). They did very well off of doing this. They will continue to do very well off of doing this. Microsoft will benefit more from it in the long run than Amazon does. Similarly, I believe Disney will ultimately be the biggest ultimate beneficiary of the shift to streaming. They have the largest portfolio of products that really benefit from it. Also, as anyone who has a sufficiently younger sibling knows, the Disney channel on TV is as much an infomercial as it is a form of entertainment. With Baby Yoda, Disney has proved that it still knows its old tricks. I had an art teacher who used to describe Disney as the company that figured out how to put a rat on a stick and make everyone want to buy it. (She consistently used the word "rat" as a pejorative for "mouse" or "rodent" or other small creature she disliked. I know a couple other people who do this, but she was the only person I know who frequently referred to Mickey Mouse as a rat.)

I think Disney is an obvious buy. I have a position in them. I'm not planning on extending it any time soon because other opportunities including ViacomCBS look even better to me at the moment.

I think "the market" is probably overvalued at the moment, but only because the most overvalued on a percentage basis are companies that already should be some of the most valuable companies on a dollar basis. I think Tesla is overvalued by somewhere around a factor of 3. It's not uncommon for a high growth company/story to be overvalued by somewhere around a factor of 3. It's unprecedented for that company to be worth $290 billion. I think Apple's overvalued by about a factor of 2. That's really not that ridiculous of a multiple. It's really common for multiples to expand or contract by a multiple of 2 or more. However, historically, the most valuable companies in the world have been less affected by price swings than smaller growth stocks. This is not happening today. Out of Google, Microsoft, Apple, and Amazon, all but Google look overvalued to me, and Google doesn't look undervalued. If you held a gun to my head and forced me to buy a FAANG stock, I'd do some research for a while to pick among Google, Facebook, and Netflix, but I lean towards Facebook as my initial pick. Google, Facebook, and Netflix are also the three smallest market cap of the stocks typically considered FAANG. I'm not sure that Google deserves to be valued less than Apple or Microsoft. I'm pretty sure that Facebook should be the less valuable than Google, Microsoft, Apple, or Amazon. I'm pretty sure that Netflix deserves to be the least valuable company of those three. Apart from Apple, I don't really think the valuations are miordered. It makes sense to me that Amazon is the most valuable company in the world. I think it deserves to be the most valuable company in the world. Google and Microsoft seem like they deserve to be in the top four to me. At this point, Facebook seems like its priced pretty much appropriately to me. Netflix sort of does too. I'm tempted to look at this situation and say that megacaps are overvalued, but that isn't a fair summary. I even think there is an undervalued megacap tech stock. It's the largest tech company not typically considered part of FAANG. It's a leading manufacturer of payment processing and social media applications, and it is also the most successful company in the space that Facebook is trying to pivot into to supplement its social media earnings: video games. It's called TenCent. Just by virtue of not being a FAANG stock, it hasn't participated in the FAANG rally, but it's got better earnings growth and revenue growth than any of the companies that have and it has a better track record of continuing to find ways to profitably diversify its operations giving it a much higher potential ceiling in my analysis than any of the rest of these companies.

I think we're seeing an echo chamber of unparalleled proportions with companies that are everyday names to Americans, particularly American millenials -- most of which are named the same thing as their flagship product -- being likely to be extremely overvalued; whereas, companies that American millennials can't necessarily name offhand are priced reasonably and often even undervalued. I can think of exceptions of the form of companies that are household names looking like they are valued fairly or even undervalued, but I can't think of any examples in the opposite direction offhand. Everyone  I know has heard of and talked about Nikola, Telsa, Beyond Meat, and all of the FAANG companies often. If you've signed a lease recently, there's a good chance you've used DocuSign. Zoom is another company that seems like a reasonable candidate for companies that I'm tempted to call overvalued.

I read a lot of articles about how its crazy to believe the people trading on Robinhood are the ones moving the market, but it certainly looks that way to me. It's also much more believable to me than those articles paint it as. The argument that says this isn't happening is about how little of the total money invested is invested by mom and pop traders trading from home. However, there are quite a few reasons that these traders could be disproportionately effective.

1) Smart traders who are investing large amounts of money into a position are trying to invest it in a way that minimizes the direct price impact of their trade while they build up their position. People trading from home aren't doing this. (There are a lot of ways to increase or reduce the impact on price of a share bought or sold.)

2) Less and less money as a fraction of total investment is being invested by smart traders or by anything resembling intelligence guiding their trading. Instead, passive investing in ETFs has been growing significantly over the past few decades. Most ETFs, particularly the most actively traded ETFs and the most held ETFs have minimum size requirements for inclusion but don't have maximum size requirements. This results in them amplifying price movements.

3) The smart money isn't necessarily looking to find stocks that are overvalued or undervalued based on any traditional ideas of value. Instead, they are trying to predict direct movement of prices. The best trade in the market today isn't being able to spot the company that is going to provide steady returns for the next 10 years. It's being able to spot the next company that all of the mom and pop traders are about to pile into before they pile into it and being able to get out of it before they get out.

There are only four things that keep the market fairly priced in the long run:

1) Bankruptcies.

2) Return of capital by companies.

3) Correlated holdings across different investors.

4) Margin calls.

Correlated holdings allow dividends to help keep the market efficient even if they aren't reinvested. Buybacks directly keep it efficient.

Bankruptcies eliminate all of the value in a particular stock.

Margin calls end bubbles. The most arrogant and aggressive traders think they can't lose by betting everything they have on exactly what's been working for them so far. After that, periods of forced buying or forced selling (more non-discretionary trading that is just as dumb as a stock getting added to an ETF) cause prices to swing the opposite way from whence they came.

There is a notion that a lot of people seem to have that the stock market is either in a bubble or its not. I don't think things are that simple. I think a few individual stocks are overvalued. I think they are so overvalued in absolute numbers (not percentages) that an ETFs which are market weighting those stocks are also overvalued at the moment. This can make the market look overvalued, but my definition of "a bubble" is something like the idea that if I blindfolded threw a dart at a wall covered in the names of stocks, it would most likely hit a name that is overvalued. I don't think we're in that circumstance at all.