When Volatility Is Meaningless

The Weekend Edition is pulled from the daily Stansberry Digest.

When evaluating your investment performance, it's not all about the numbers...

Today, I'll show you what I mean. We're going to talk about your portfolio and mine... and how we should both evaluate our performances.

In case you're not familiar, let me first tell you a little about my publication, Stansberry Venture Value.

Venture Value has one of the smallest readerships at Stansberry Research... and that's intentional. You see, I write only about companies with market capitalizations of less than $200 million or so. (If I recommended the same illiquid companies in DailyWealth, we'd send their share prices through the roof.)

Another unique aspect of Venture Value is that we don't typically use trailing stops. I know, that goes against almost everything we preach. And I often use trailing stops in my personal portfolio. (In fact, I'm a loyal TradeStops subscriber.)

But the extremely volatile nature of small-cap companies can make it difficult to effectively use trailing stops. Stansberry Research founder Porter Stansberry tried that in his previous small-cap newsletter, and it didn't work out. As he explained when we first launched Venture Value...

I made my mistake because I was treating these companies as though they are the same as a 25% trailing stop loss mega cap, and you can't do that.

With these companies, volatility is completely meaningless. It may indicate there's trouble, but it just as likely may indicate nothing. So in Venture Value, we are setting up a research team that's going to guide you on whether to buy, sell, or hold based on the business results, not the share price.

This is incredibly important. We're going to keep coming back to this and coming back to this and coming back to this. If you are the kind of investor who cannot envision the idea that a stock price has gone down 20% or 30% and it doesn't mean anything, then this is not right for you.

Obviously, these dynamics make it difficult to grade investment performance...

After all, if volatility can sometimes be "completely meaningless," then a company's share price isn't the only thing to consider when evaluating an investment.

Back in 2012, my colleague Doc Eifrig wrote a fantastic issue of Retirement Millionaire called "Our 'Three Keys' to Successful Investing." It offered simple, practical tips on how to think about your portfolio. As Doc wrote...

Whenever you invest in something, it's important to write down why you bought it. This means literally getting out paper or an index card (or opening a spreadsheet) and writing down your reasons for owning it – for dividend or interest income or potential growth-driven capital gains. You should note any data or metrics that support your investment decision. (For example, a low price relative to its earnings or cash flow.)

The second thing you need to do is write out when you'll sell the investment. Do it on the same piece of paper and at the same time you're buying the investment. This includes writing out your expected percent return and over what time frame...

This is important as it expresses your plans before you become emotionally attached to the act of purchasing it. Once you own something, "confirmation bias" – the tendency to favor information that confirms your beliefs – tends to cloud your judgment. So it's better to outline your goals ahead of time.

Quantitative returns are important. Again, if you're not making money, what's the point of investing? But shouldn't you also strive to learn something with each investment... take the time to think about it... figure out what went right (or wrong)... and what could have gone better? Following Doc's advice forces you to do just that.

Let me show you what I mean...

In February 2017, I recommended shares of Rubicon Project (RUBI) to my readers.

Rubicon is a leader in advertising technology, controlling many of the ads that pop up all over your web browser. The company was making plenty of cash, but the market hated its shares. After speaking to ad buyers and sellers, and even signing up for subscriptions to the industry's trade publications, I was confident this cash-generating company was a great value.

Things went poorly, almost from the beginning. The company dealt with a boardroom shake-up... some problems with a product launch... and a lot of bad press. But I kept returning to my original investment thesis again and again. The company was still earning plenty of cash flow, and I figured it would successfully navigate through the whole mess.

By November, the stock was down 70%. The entire ad-tech ecosystem unexpectedly imploded, with advertisers pushing back on the fees kept by middlemen like Rubicon.

I checked with my trusted sources... nobody had foreseen this extreme industry shake-up. I felt the tug of "confirmation bias," as Doc predicted, but it was time to throw in the towel.

It was clear my thesis was no longer in play. It wasn't fun, but deep down I knew it was the right call. Ever since, I've stuck to stable, basic businesses... and have steered clear of anything remotely high-tech.

The same day I recommended Rubicon, I also recommended a company called Carrols Restaurant Group (TAST)...

It's the world's largest owner of Burger King restaurants. No high-tech stuff here. Speaking with franchise owners and looking at more than 10 years of financial data, three things were clear:

  1. Well-run Burger Kings generate respectable cash flows.
  1. Therefore, it is better to own as many well-run Burger Kings as possible.
  1. Nobody owns more well-run Burger Kings than Carrols, and nobody has a longer runway to acquire Burger Kings.

At the time, the conservatively financed Carrols ran just shy of 800 Burger Kings, but management had "right of first refusal" on thousands more. Over the course of the year, Carrols began to face some cyclical headwinds, such as higher beef costs. The market punished the company, sending shares down more than 40% from peak to trough.

As with Rubicon, I had to reexamine my thesis. I reached back out to my contacts and reviewed all the numbers again. My thesis was still intact... In fact, I felt Carrols might be a stronger company in 2018 than it had been when I initially recommended it. When Porter said "volatility is meaningless," he was referring to situations like this.

Despite the sharp pullback, I continued to urge subscribers not to sell, and encouraged my new subscribers to establish a position. It would have been easy to look at a big loss in our portfolio and throw in the towel, regardless of the fact that nothing had changed.

But we stayed disciplined. And while the Carrols story hasn't fully played out yet, the market is finally starting to realize what we had known all along. Shares are up almost 50% from their November lows and we're now sitting on a small 7% loss, as of Thursday's close.

The last example I'll share with you today is building-products distributor BlueLinx (BXC)...

I recommended the company this past January. I had spotted some "blind spots" in the company's balance sheet that I knew the market was missing.

It looked like BlueLinx was actually a large company whose value had been obscured by some accounting rules... And the rest of the market hadn't noticed.

Over the next 12 months, I expected that these blind spots would gradually become visible as BlueLinx completed a series of financing arrangements, revealing its hidden value. Taking Doc's advice to heart, I wrote out my expected return and holding period for my readers to see. If things played out as I suspected, we'd be sitting on nearly a double within the year.

Just two months later, BlueLinx bought out its largest competitor for a fantastic price. The company and the entire industry were thrust into the spotlight. Suddenly, the market realized what Venture Value readers already knew: BlueLinx was actually a big company... and had no business sporting a tiny market cap. Shares tripled almost overnight.

Like the breakdown in the entire ad-tech ecosystem, nobody could have predicted this unlikely set of circumstances (including me). But in this case, we were well-positioned to profit. We're sitting on a gain of roughly 200%, as of Thursday's close.

I thought of these dynamics recently as my Dad and I watched the British Open...

We were paying close attention to Stansberry Research's own sponsored golfer Kevin Kisner, who nearly won it all.

A golfer knocked the ball close to the pin when my Dad reminded me of an old quote from golfing legend Ben Hogan...

A shot that goes in the cup is pure luck, but a shot to within two feet of the flag is skill.

I first heard that quote when I was a kid. I don't remember exactly where I read it, but I do remember thinking it was nonsense. Hogan couldn't really mean that, could he? As I got older, something about that quote started to ring true. I see it happen sometimes in my professional life.

BlueLinx "went in the cup," so to speak...

I got lucky. That's not false modesty – it's true. Don't get me wrong, my thesis was right. I spotted a meaningful anomaly in the company's financials that the market was missing, and I put my subscribers in a great position to profit as the story played out.

But the unexpected merger accelerated and amplified everything I predicted... and I didn't see it coming. I knocked the ball to within two feet, then a gust of wind pushed it in the cup. Pure luck? Maybe not. (It's not like I was throwing darts at a dartboard.) But luck certainly played a part.

I could argue it took more investing "skill" to sell Rubicon and maintain my conviction on Carrols...

It's not easy to fight confirmation bias and sell a stock when the facts change (as I did with Rubicon). It's also not easy to hold on to a stock when you're down 40% but your thesis is still intact (as was the case with Carrols).

Venture Value subscribers will benefit more from BlueLinx than the other two. But I learned a lot more from the Carrols and Rubicon recommendations. And I'm certain Carrols will end up being a profitable pick, despite its slow start. It's still "rolling toward the flag."

I urge you to follow Doc's advice. Think hard about your portfolio and try to learn something from every investment.

Overall, I'm proud of our performance in Venture Value...

Even with the big loss in Rubicon and slow start with Carrols, our portfolio is up 28% annualized. And with plenty of stocks in "buy range" today, now is a great time to join us. You can learn more about a subscription to Venture Value right here.


Bryan Beach

Editor's note: In Stansberry Venture Value, Bryan introduces his subscribers to stocks with little or no coverage on Wall Street and market caps as low as $100 million. These small stocks have explosive potential... You could earn up to quadruple-digit gains with the best of them. Learn more here.