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Valyooo (99.63)

The "pricing-it-in" conondrum

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March 29, 2013 – Comments (20)

Much finance and economic theory states that over the long run, all assets should give the same returns, otherwise markets are inefficient.  I'm pretty sure most people on here know that is hogwash.  I was giving some thought to the process of how that would even possible, and I don't see how that could theoretically be possible.

So it is obvious that some fields are going to grow at a higher pace for at least the short term than others.  In the 1990s I think it was obvious that tech stocks would grow really fast.  If everybody knew this, they should be priced so that the stocks don't outperform even if the sector does. Then I thought about the process.  Ok, so maybe you price tech stocks at a p/e of 40.  But then what happens when their earnings grow 20%?  The stock is still going to jump 20% to maintain a p/e of 40.  The only way I could see it being able to price it in, was if the stock was priced at a p/e of 40, and over the years of growth it was subsequently priced at lower and lower p/e's, so that as earnings grew fast as expected, multiples contracted, so that the total price of the stock would move the same amount as the market, and eventually the sector growth becomes normnal.

 

No idea if anybody followed any of what I just said, but if you did, is that how theoretically markets would be efficient with pricing?

20 Comments – Post Your Own

#1) On March 31, 2013 at 1:47 PM, somrh (85.96) wrote:

Yeah that sounds about right and it works out if you play around with a DDM and calculate NPV. Because eventually that growth will have to slow down so the price multiple will contract over time.

For example, during the growth phase, when no dividends are paid, all return with be via price appreciation. So in terms of PEs you'd have:

1 + R = [ PE(f) * E(f) ] / [ PE(i) * E(i) ]

And since E(f) = 1.2 E(i) (20% growth) you end up with:

1 + R = 1.2 * PE(f)/PE(i) 

Assuming a cost of equity of R=10%, PE would contract by 8.3% (1.1/1.2).

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#2) On April 02, 2013 at 6:06 PM, CCharing (86.90) wrote:

ancahk I am trading 10 mini contracts. 5 dollars a point = 50 a point fo 10. I shorted 15 puts 14200 strike (keep in mind futures trading at about 70 points uner spot) at 114 points each which comes out to 171 points of protection per contract. 14364 (my entry) + 171 = 14535. The delta is 0.33 per contract but I am short 1.5 put per contract so it is roughly .5 of exposure Those futures currently trade for 14433, I still have 102 points before I am no longer covered by my puts.

If dow falls to 14200 (or below, my gains are hedged below that) , I will open 5 more short contracts at 14337 so I have no tail risk and I will make 114 + 165 = 279 points x 75 points a contract is 21k, I am doing this in a side 100k portfolio, so my math was off, it is a 21% upside. If it does not fall I do not open the other 5 contracts and I lose 0.34% per point it moves over 14535 before april 19th.  Again that is the futures price, which is somewhere around 14585 in the spot price. I highly doubt it moves much higher than 14585 by April 19th, but hey, I have been wrong before, and if that happens I can close out my options and rehedge with higher strike puts or average down at 14600 because that is the absolute highest I can see spot going. If the random truly moved randomly than no single strategy would be better than another in which case my case makes no sense. I don't believe this to be the case though. But again, I coul be wrong

I am wondering what became of this position?  I remember reading this and thinking that such a trade based on a arbitrary "predilection" was probably a bad move since markets move based on aggregate sentiments.

If the position was held it represents a fairly painful impairment (considering the trade duration)... 

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#3) On April 03, 2013 at 12:06 PM, JustWokeUp (87.70) wrote:

Reading this is both fun and nauseating... I understand the macro part of the conundrum, but the explanations were just too much.

Is investing really this hard? :)

Here's a response to Valyooo: I don't think P/E moves with the earning and stock price to "maintain" a certain number. I think P/E is more driven by future prediction of how the business will do in the future.

So a current P/E of 40 means we predict the future earnings will grow 40% due to some conditions of the business. When the market no longer thinks that earnings will grow as much (e.g. the patents have expired, the product pipeline dries up, people no longer like the services, etc), P/E will drop.

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#4) On April 03, 2013 at 2:40 PM, Valyooo (99.63) wrote:

@#2

The options expire in two weeks and the futures are at 14492.  So, I still have 43  points before I start feeling real pain, and I shorted 3 more this morning, so, kinda sucks, but still convinced will become a big winner 

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#5) On April 03, 2013 at 2:41 PM, Valyooo (99.63) wrote:

Also, what makes it any more arbitrary than any other trade or investment in the history of mankind?

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#6) On April 03, 2013 at 6:45 PM, CCharing (86.90) wrote:

I guess that would depend on what you define as a "trade" vs say an "investment" or "Arbitrage." 

Here is an example of two trades:

Shorting the derivative of a broad based index, profiting if it declines.

Vs

Say a large hedge fund receiving a call from a high leveraged company's CEO asking "if" the fund would be interested in an additional equity offering "IF" the company decided to go with a dilutive offering to shore up its balance sheet.  The CEO might press the fund manager to sign an NDA before disclosing additional details - to which the fund manager might decline (therefore he has not "wall crossed" - can't be implicated for insider trading).  The fund manager might then conclude that given the phenomenal run up recently in the company's shares in conjunction with a marketwide rally and given the very real consideration of a dilutive offering to hang up the call and proceed to short the company's stock.

I think it's clear that one of the above trades is more "arbitrary" and has less edge/less potential for mispricing...

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#7) On April 03, 2013 at 6:54 PM, Valyooo (99.63) wrote:

Alright maybe in that particular case which is incredibly hard to come by and not alway legal, but how about compared to an ordinary stock trade or directional bet on say McDonald's or coca cola or gold ? Or any of the picks you've made on caps for that matter

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#8) On April 03, 2013 at 7:06 PM, CCharing (86.90) wrote:

Margin of safety is important.  For debt you could pore through and see the likelyhood of the bondholder being made whole vs the discount it is currently trading at.  I guess Graham's knack for buying things trading at less than net working capital is fairly effective when examining equity.

One could also extract relative value.  I worked at a long/short equity fund that took positions based exahustive research.  It felt different...

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#9) On April 03, 2013 at 10:55 PM, Valyooo (99.63) wrote:

Yeah you're right, I had no basis for my short. It's not like I use a combination of seasonality technical divergence time cycle analysis valuation analysis sentiment analysis breadth and quality analysis fed cycles or gann cycles. Mine were just abitrary unlike your godlike ability of assessing interest rate and inflation risk on bonds 

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#10) On April 03, 2013 at 11:38 PM, CCharing (86.90) wrote:

I'm alluding to distressed bonds that are trading 15-20 cents on the dollar that have short term unlockable catalysts (i.e.bankruptcy) within a timespan of months within the context of the current interest rate environment - and your biggest objection is about inflation rate risk/interest rate risk?

You claim to be an instutiutional player but you're making directional bets based on a sum of the parts evaluation about vague macro trends (with no way to evaluate timeliness) and you deride my offhanded comment as requiring "godlike ability"?



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#11) On April 04, 2013 at 3:26 AM, CCharing (86.90) wrote:

I read in a previous post that you were a "professional trader": 

"Megashort is just being a snatch napkin because he doesn't understand real world trading and I call him out on it all the time."

Hey Harry I wasn't knockin you.  I am a professional trader...I only make money if I time the market correctly.  and I spend 80 hours a week doing it...so please, I don't like when people tell me sometjhing I spend 80 hours a week on can't be done :)  it's as insulting as the efficient market thing, which buffet has pointed out.

This being the case I have a "trade" for you.  I think chimpcontest used to offer $500 - if you can make more than $30K per year making these "macro" trades that you seem supremely confident in.

The only rule is they have to be "macro" or index based (and can't have concluded intra-day -i.e. you can't say 5 minutes ago I did this and now I'm selling.).  Preferably these trades will be like the one you initiated above (spanning more than a week).

I would love to see the PnL on your "100K portfolio".  40K is pretty measily- I have former classmates who can clear that in a day at Jane St. 

 

shouldn't be a probablem for a professional such as yourself - and I'm not asking for you to put up anything on the other side of that wager.  if you have further questions, I can clarify. 

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#12) On April 04, 2013 at 3:26 AM, CCharing (86.90) wrote:

30* typo....

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#13) On April 04, 2013 at 11:00 AM, Valyooo (99.63) wrote:

That's a side portfolio. I'm not really sure, what are you asking? A macro trading contest? Ill wipe the floor with you, no problem. But if you're asking me to post my p&l statement on caps, no chance, I'm not an RIA

 

Also your distressed debt scenario seems pretty arbitrary. You can't be sure somebody won't default 

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#14) On April 04, 2013 at 12:21 PM, Valyooo (99.63) wrote:

By the way what crawled up your butt that you comment on my blogs and seem generally upset with me? Do I know you?

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#15) On April 04, 2013 at 1:06 PM, CCharing (86.90) wrote:

Do I have some vendetta against you?  No, I am just skeptical by nature.  I'm not sure what kind of boiler/chopshop you work at but I know that the buldge bracket banks all require you to register private accounts with their own compliance departments - and I don't think they appreciate their traders making side bets - especially not flow traders.  So obviously you don't work there...  And considering you claim to make money calling market tops/timing your strategy is not suited for any of the prop firms -most emphasize stat arb, advance programming knowledge and you're macro-bent doesn't play well in interviews.  So I conclude that you must be at a firm where you put up some collateral and they provide leverage/charge a fee for hosting your trading activity.

 I am not a macro trader so your wiping the floor comment is moot.  I work in a research capacity. And there will be no PnL posting required, just call some more trades like the above and we can see if the sum total of your trades amounts to anything approaching a livable income.  I mean considering you broadcasted one such trade by your own volition on an internet board I figured you'd have no problem demonstrating a few successful ones in the same manner.  Savvy? 

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#16) On April 04, 2013 at 1:23 PM, CCharing (86.90) wrote:

I think your default comment is kind of naiive considering I was strongly implying that being one of the catalysts to unlocking value.  Most of the situations I was assigned to involved assuming a default scenario- we are talking about recovery value... 

I don't doubt that you are knowledgeable- but you have accumulated only enough to be dangerous to yourself. 

There are many special situations where risk is very very low.  In some cases there is only counterparty risk.  In 2008/2009 in a fwe select cases it made sense to short the equity if you were long the debt and still extract a differential value.  That doesn't even approach the risk of a directional bet - which you are obviously free to make. Just don't blow up.

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#17) On April 04, 2013 at 5:26 PM, Valyooo (99.63) wrote:

It's not a boiler/chop shop. It is a tiny fund that I run with one other person, we know the investors personally. Do you know what a hedge fund is?  It's not a bank, so I don't know where your compliance issues come from.  It is also not a prop fund, so again, what are you talking about?  I did not put up any collateral and there is no fee charged.  I run the fund.   I am not a rich fat cat wall street guy by any means, but I am not working for a chop shop.  Even though I am unhappy with the current position, I am still up 68% this year.  I take half as profit so investors are up 34% this year.  Most of it came off of three big trades, and personally I am not incredibly happy with the results because I know the execution could have been much, much better, but as far as my investors, they are not going to complain about where the 34% came from.

 

If we can talk, without the unecessary hostility towards eachother, then give me the rules and I will "paper" trade through this blog with whatever dollar amount you choose and we can make this an ongoing game, no problem at all.

To be completely honest with you, my fund (which again I said is pretty small), is going to be liquidated this summer, because I cannot get alone with the CEO (the only other employee).  He takes forevet to set up legal infrastructure and does some not-so-legal things and lies to me often, and I am uncomfortable working with him. However I just set up a limited partnership with griffin416 (another caps player).  We will be forming our own hedge fund.  For the first year we are only managing our own and family and friends money, as a side job, while I work full time to support myself, as I work on building up my fund to something I can do full time, which will take 1-2 years.  But I am not lying about myself, I have a proven track record that I know I can use to make money with, I just need to build it up for a year under the name of the new LP before I market it.  I am 23 years old, it's not something I can do in one day.

 

As for the debt-stock spread, it makes sense, and its a good strategy, but from a theoretical point of view, if the risk-reward was that good, the market should have priced it better so that there is no high reward low risk opportunities, if the market were efficient.  Since the market is not efficient, your strategy works, but is the same reason why my strategy works...because I notice patterns that work repeatedly, mine are just macro.

Give me the rules and I will post my trades on here (or through email if you wish) 

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#18) On April 04, 2013 at 5:33 PM, Valyooo (99.63) wrote:

I have made good returns using my strategies, but they are mostly non-mathematical.  I have read as much as I possibly can about trading and economics etc in my life, and I am actually starting a self-teaching program for myself to learn all of the math I forgot from when I was younger, plus some new stuff I never learned (I need to re-teach myself trig, geometry, calc 1-3, linear algebra and statistics, but then want to also teach myself ordinary differential equations, abstract algebra and real analysis....probably wont do any topology).  I will need about a year for the first half, after that, do you have any good suggested reading on statistical arbitrage?  I am always looking for new trading strategies and that is one I never learned about.  I never traded for a firm, only for myself and the people I know, so I am lacking in that area.

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#19) On April 04, 2013 at 8:47 PM, awallejr (82.72) wrote:

But I am not lying about myself, I have a proven track record that I know I can use to make money with, I just need to build it up for a year under the name of the new LP before I market it.  I am 23 years old, it's not something I can do in one day.

Val I only but wish you success.  But as I said elsewhere you strike me as a person who needs to learn lessons on his own.  You were just finishing High School when we were going through one of the greatest stock crashes in history.  

Many people on this site have decades worth of experience.  I would urge you to take advantage of that knowledge base.  But I have to be honest you do make some wacky predictions. I can only judge by what I read.  

You sort of remind me of another blogger goldminingXpert. I and others would get into many an argument with him.  He would insult readily. Be steadfast in his predictions. But in the end he eventually came back and humbled himself after having learned some harsh lessons.

If you can beat the S&P  for 10 years with real money then that would be a track record. I hope you can but don't underestimate the difficulties you will face.

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#20) On April 05, 2013 at 9:53 AM, Valyooo (99.63) wrote:

Unfortunately, most of the predicitions I have been most public about, I was wrong on many of them....but, that aside, I still pull in about 40% a year since 2009, and my partner, griffin416, has been beating the s&p by 15-20% a year since 1998, so I have his experience as well, that is much more significance

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