Mental Models discussed in this podcast:
- Value Trading
- Horizontal Risk Shifting
- Rebalancing
- Look-Through Earnings
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Show Outline
The full show notes for this episode are available at https://www.diyinvesting.org/Episode124
Value Trading Definition
- Partial selling of a core holding to buy more of another core holding.
- If the core position size is 20%, you may buy up to 25% or 30% of a surplus position when relatively undervalued and then sell it back when it is relatively overvalued.
- Key: Using valuation specifically to change the weightings in your portfolio
- Necessary assumption: Assuming you have a sufficiently good comparable idea
Goal
- Only value trade when the exchange is clearly beneficial
- High bar
- 50-100% increase in look-through earnings
- I use a spreadsheet that constantly calculates look-through earnings for each position.
Horizontal Risk Shifting
- Diversification of my risk by reducing my exposure to a single stock without having the value trade component. May not increase look-through earnings but minimizes risk.
- Say splitting a 30% position in Coca-Cola into a 10% position in KO, Pepsi, and Dr. Pepper.
- Want to target similar P/E ratios or better, but this has a lower bar.
- Really used mainly for overly high current allocations or used when a stock is highly valued.
Summary:
Value Trading is the process of rebalancing a portfolio using valuation specifically to adjust the weightings of your individual stocks. I value trade to optimize the performance of my portfolio, increase returns, and reduce risk.
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