The Importance of Dry Powder for Investors

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and special guest Zach Abraham discussed The Importance of Dry Powder for Investors. Here’s an excerpt from the episode:

Jake: Yeah. I’ve heard you guys have a lot of conversations about this one, especially when it went down. This is an extreme example, but it really is a good microcosm. We had GameStop on our screens going back to 2015.

Tobias: It was the cheapest thing in my screen for a long time.

Zach: Oh, yeah. And just sitting there going, “Look, this thing’s probably dead catalyst.”

Jake: Melting ice cube.

Tobias: Off sheet liabilities in the leases too. That was always a little bit nerve wracking. Yeah. Sorry, keep going.

Zach: Yeah. No, man, it was a dog with fleas, to say the least. But when it got crushed, we took a position out at about $9.50 cents I want to say. We had a very tight stop on it. I’m not going to come back here and say, I just knew– [crosstalk]

Jake: Wrote it to 300. [laughs]

Zach: Yeah. This is a perfect example of what I’m talking about. So, we got in when co and took a spot on the board, because at that point, they had 120% short interest. You looked how cheap it was and I was like, “Hey, there’s a really good chance you could get a short run.” We thought the short run could take it at 35 bucks or 40 bucks. That was our outlook. So, we bought it between $9 and $10 somewhere in there, and we wrote it up. I went to dump it at $38. By the time the trade went through, it executed at $43. That’s how fast it was moving.

Jake: [laughs] Yeah.

Zach: I walk out of the office that day with my chest sticking out going–

Jake: Feeling great.

Tobias: [laughs]

Jake: 10X.

Zach: 10X in the next seven trading days.

Jake: Oh.

Zach: People are like, “Why didn’t you hold it?” And we’re like, “Because we knew it.”

Jake: [laughs]

Zach: We knew it was a joke at $35 or $40. And this stuff, and everybody always tells you that. “Man, it taught me a lesson.” I feel like at the peak of the next cycle, I’ve written it down, but I need to find a young guy.

Tobias: Yeah.

Zach: Who was that?

Jake: Drunken Miller.

Zach: Yeah. Because should I have sold the whole position there? No, I probably should have let 100 to 150 basis points ride and stop loss it. But you’re looking at it and going, “This is just insane.” I know what this thing’s worth. It’s not worth anywhere that near that. And then it 10Xs

Tobias: But having said that, we’re going to go through a regime now. It’ll be like the early 2000s, where you buy something and it runs up a little bit. If you don’t sell it, it runs back down again. That’s what I remember value being like through, whatever it was, 2002 to 2007. You buy something cheaply, but it’s not that great. And so, when it hits value, if you haven’t moved on from it, it just goes back to where you bought it from. They do that loop to loop for years and years and years without going anywhere. And then you’ll be never selling that environment, feel like, “Where have all my returns gone?”

Jake: Yeah.

Zach: Go ahead, Jake.

Jake: I was going to say, I try to take a little bit of a stoic approach to this, and that there’s a certain amount of the return that I deserve for the work that I’ve done. And then there’s other parts of the return that I don’t deserve because it doesn’t fit with how I want to do things. If someone else gets that portion of the return profile, then good for them. But that wasn’t mine. I’m going to get my safe version that I want to get, and they can have that part.

Zach: Yeah. That’s very similar to the philosophy that we’ve deployed. I wouldn’t change the way that we did it or the way that we managed, and we haven’t, because you’re right. You have to accept the irrational part of this job. It’s going to happen at times, but man, just real money–

Jake: So fun to watch.

Zach: Oh, and it’s hard to miss out on. It reminds me that– I’m forgetting what his name was. I’m sure you guys know him. The guy on CNBC that comes out, and he’s talking about this stock, and then they ask him what the company does.

Tobias: Oh, yeah.

Jake: Oh, I’m smart.

Tobias: [unintelligible [00:58:01], something like that.

Zach: Yeah. [laughs]

Tobias: He should have just said, “That’s not what I do. I don’t know them that deeply I’m like a– I look at the trends. I don’t care what they do,” which is probably true. That’s probably what he does.

Zach: Yeah. And just you get into those environments.

Tobias: It’s stressful being on TV. I get it. You say silly things.

Jake: Your brain just shuts down. [laughs]

Tobias: It does. You get that full-on fugue.

Jake: Yeah.

Zach: I know, but you never forgot what a company did, right?

Tobias: I just didn’t know in the first place.

Jake: Yeah.

[laughter]

Zach: Yeah, because that’s you getting long without understanding a company. That’s your MO.

Tobias: I have a slightly different perspective to Jake’s that Jake gets the return that he thinks he deserves. I just think whatever you do is going to be the wrong thing. If you sell it, it’s going to run. If you hold on to it, it’s going to fall back down. So, just do what you think you should do and just never look at it again. Or, don’t look at it until it comes back into the screen and you get to buy it long again.

Zach: Yeah. Man, the Costanza portfolio.

Tobias: I don’t Costanza myself. I still try to do what I think I should be doing. I know that, at every single point, whatever I do will be the wrong thing because I have done it. It’s like that shrouding is whatever you do is just the wrong thing. So, don’t worry about it. Just do it and expect it to be the wrong thing and move on.

Zach: Yeah, The man in the machine that’s constantly taking the counter side of every trade, right?

Tobias: That would be smart.

Zach: Yeah. Again, I’ve just learned that lesson though that I think– You know what’s really hard for me is finding that line of being especially managing other people’s money as a fiduciary. Finding that proper line of doing the right thing, managing risk properly, but also taking enough. That balance to me is very, very difficult, especially in this environment. You know what I mean? I would love to hear how you guys’ balance that, because that’s something that we constantly wrestle with. Where are we being too conservative? I battle with that. I feel like it’s like talking about position sizing. I don’t feel like there is a right answer.

Tobias: Size up the ones that don’t work and you size down the ones that do. You never buy enough of the ones that do work.

Zach: [laughs]

Jake: My similar lament is that, you want to be in the market generally, right? Owning American, especially in the last century, but owning global businesses has been a good way to build wealth for a long period of time. The timing of these things is incredibly difficult. I don’t think it’s hard to time markets, it’s hard to time factors. However, there are opportunities that occasionally are thrown up that are just so blindingly obvious. You want to have some dry powder, some part of your capital that’s available to jump on those rainy-day opportunities.

And that then means that capital has to sit there for a long period of time. So, how much of it to have in base load? Like I’m just going to own a lot of businesses, and I’m going to do pretty well on average as a base. How much do I keep carved out for just the super no brainers and really being opportunistic? That balance to me is like an interesting is difficult to thread the needle on.

Tobias: Yeah, perfectly spurted. Nothing to add.

Zach: Yeah. I don’t really have anything to add either, but I’ll lament with you because– Watching that whole stuff go off in 2020 and 2021, I understood why those stocks were going up. We made a few trades here and there. We had a nice 2021. But looking back on it, we saw what was going on. We should have capitalized on it more–

Tobias: Stole some equity.

Zach: Yeah, we should have been more aggressive.

Jake: Borrowed a billion dollars at 0%?

Tobias: Raised a SPAC.

Jake: [laughs]

Zach: I probably wouldn’t have gone that far. No zero days to option expiry in the client’s portfolio. Yeah, it feels reckless at times, but knowing when insanity is ruling the day and getting on and riding it, because as long as I’m really managing my risk and really defining my exposure and things like that, one of the things we tell our clients is that, really, you can own anything in a portfolio. The question is, how much do you own? It’s the sizing that kills you. It doesn’t mean everything should belong in a portfolio, but you guys get my drift.

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