Long-Term Capital Management (LTCM) Applicable to Today’s Market

Written by

Jae Jun

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What You’ll Learn

  • How to spot good quality stocks using OSV’s quality snapshot
  • What are the red flags smart investors should watch out for (using TSLA as example)

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A 1999 article by Michael Lewis on Long‐Term Capital Management makes the rounds today. Warren Buffett has spoken about his role and you can get a quick summary of his edition from this youtube video.

Ultimately, Buffett’s bid to bail out LTCM was rejected and the Fed ended up bailing them out. But here’s what Buffett mentions in his talk.

  • The guys that ran Long Term Capital Management have the highest average IQ
  • They all had deep experience and intellect of the industry and business they were in
  • They invested hundreds of millions of their own money
  • They all went broke

“But to make money they didn’t have and didn’t need, they risked what they did have and did need.

That is foolish.

That is just plain foolish.

It doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you it just does not make any sense. I don’t care whether the odds are 100 to 1 that you succeed or 1000 to 1 that you succeed. If you hand me a gun with a million chambers in it, and there’s one bullet in a chamber and you said, ‘Put it up to your temple. How much do want to be paid to pull it once,’ I’m not going to pull it. You can name any sum you want, but it doesn’t do anything for me on the upside and I think the downside is fairly clear. So I’m not interested in that kind of a game. Yet people do it financially without thinking about it very much.”

So how does this translate to today’s market?

Whether it be in yesterday, today or tomorrow, your portfolio should be balanced to fit your current situation. If you’re nearing retirement, it isn’t a good idea to invest your nest egg on that hot cannabis stock everyone is talking about. That’s foolish.

Highly leveraged portfolios tend to have a history of being wiped out too.

Unlike LTCM, there is no Fed to bail out investors.

I’ve shared ideas like ADBE that is still on my watch list.

Great subscription business but market valuation matters and ADBE is too rich for my taste. Keep it on your watch list until it comes down to earth.

Weight Watchers (WTW) is another example of a subscription company that’s turned things around and proven me wrong.

I lost money on WTW previously as I sold out before Oprah decided to join the company. Since then, cash flow has improved, debt lowered, and subscriptions have been strong.
It’s currently rated B in the Action Score with a strong showing in the Quality and Growth score.

One of my favorite screens to quickly check a company is the quality snapshot.

Here’s one for WTW.

  • Strong Piotroski score
  • Safe Altman Z score
  • Safe M score
  • Consistent DuPont ROE breakdown analysis
  • Normal ranges for accruals

Compare that to a company as leveraged as TSLA where danger signs are flashing everywhere.

  • 2 pts out of 9 for the Piostroki score
  • Altman Z showing danger
  • M score shows safe because Tesla isn’t manipulating earnings. It’s just bad fundamentally.
  • DuPont analysis shows the company is running on leverage
  • Balance sheet accruals are down big. Companies with low balance sheet accruals tend to have below average returns on equity. Analysts expect the company to lag.

With those numbers, 1-5% is the ideal range for a position in TSLA.

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