124 - How I Value Trade Stocks

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.