Last semester I participated in a stock trading simulation tournament with my finance core classmates. The game was a fun opportunity to put into practice many of the principles that we
learn about day to day in the finance program. I ended up doing pretty well and
posted 20% returns on the four-month period. I realize that those are above normal
returns, and some may call in luck. During the same period the S&P 500
remained flat. I am a believer that the in the short term stock prices are
somewhat random and disconnected from actual economic value added by the
companies. But I also subscribe to the
value-investing thesis that future cash flows are worth something today and
that the market does not valuing some firms appropriately.
In order to build
a portfolio, I stuck to fundamental analysis and I probably had a bit of an
advantage over some of the other students because I have been working at a
mutual fund shop on a part time basis for the past two years or so. I am
responsible for the financial analysis of various small cap companies owned in
the value fund managed by my boss. So, before this game even started, I had a
pretty good idea of which stocks would have been good plays in a game such as
this. I picked deep value stocks to
build my portfolio because I knew that in order to win a game such as this, you
would have to find stocks that were a little more volatile. For that reason I
picked smaller companies that were severely undervalued for whatever reason
(obviously the market didn’t think they were undervalued, but according to my
fundamental analysis, I came to the conclusion that future cash flows demanded
a higher valuation).
My best stock pick
was Research in Motion, which I held for the whole period. It was up almost 80%
over the four months. My basic thesis was that even though the market hated the
stock, it was trading at about 60% of its liquidation valuation. On top of
that, if the company could manage to make a comeback then future cash flows
would demand a valuation of at least 3-4 times what it was trading at. The
market was rooting against it, so I picked it up (perhaps on a speculative
basis, but it certainly paid off). The rest of my stock picks had similar theses,
but still haven’t realized the same amount of price appreciation. I picked up a
few of my positions on price contingent orders. I used buy limit orders to purchase
American International Group. I shorted LinkedIn also due to its fundamental
analysis, but I realize this is risky business because the market might have
crazy ideas about a stock for quite some time. Normally I wouldn’t short a
stock unless I could also match it with some put options to minimize my
downside risk. I didn’t make any money shorting this stock and I was probably
at a net loss after accounting for the costs associated with shorting a stock.
I also put a
slight amount of money into a Vangaurd REIT Index ETF on the idea that the
housing market was on a recovery. Not much happened with this position. I don’t
really like ETF’s because of their higher correlation with the market as a
whole. In my opinion, diversification is a double-edged sword. It can obviously
help protect your portfolio against idiosyncratic risks, but it can also take
makes market returns the best-case scenario. I am willing to take on more firm
specific risk in the hope that I can find long-term returns that beat the market.
The academics tend to refute this idea and might consider it elementary, but to
that I respond, nobody ever got rich by settling for market returns. Another one of my strategies
for the game was to max out my marginal account. I wanted to be as levered as
possible in order to amplify my returns. I wanted to be in first place or last
place – and I ended up being in both at different times. Luckily I ended up on
top to finish the game off.
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