The Danger of a Well-Thought-Out Investment Thesis
I believe that a well-thought-out investment thesis is important and necessary but can also be very dangerous. In the early stages of development, the research alone requires a lot of time, effort and commitment. This process tends to gets us very committed to our point of view and the level of commitment compounds exponentially when we put our reputation at stake by sharing our thoughts publicly. An investment thesis typically explains the WHY and provides a projection of the WHAT (price direction or target). I used the word dangerous earlier because without a thorough understanding of the HOW (which bridges the gap between the WHY and WHAT), the commitment to our work and reputation can leave us completely blind to a fundamental change which proves the thesis wrong. I believe that a question which needs to be asked and answered 100% of the time is, “HOW do things have to progress from the starting point of an investment (the WHY) to the reward at the end if the thesis is correct (the price target or WHAT)?” Understanding the HOW is critically important. If we truly understand, measure and trust the HOW, it can provide us with the confidence needed to remain in an investment and the foresight to exit despite price volatility. My understanding of the HOW as it relates to the auto industry, is the reason behind my sudden change of heart in March and I thought it might be helpful to reflect on the events that led to it.
At the beginning of this year, the biggest threat to my thesis was the successful effort from manufacturers to reduce their inventory to appropriate levels. I say this because when investing in or against a manufacturer, you’re essentially making a bet on production. The inventory data that I track was flashing warning signs in late December and early January suggesting that a hedge was appropriate but it wasn’t enough to change my long-term view. The data in February and early March was supportive of my thesis and the value of the stocks which I cover were trending in the right direction. However, everything changed in the last week of March. I noticed a very significant drop in inventory levels that not only suggested a strong sales result in March but also suggested that new vehicle production would need to increase. What I didn’t say on Twitter was how excruciatingly difficult it was to post this warning after all of the hard work and countless hours that I put into the development of my investment thesis. Before that post, I asked myself, “Could I possibly be wrong after devoting such an enormous amount of time and effort to due diligence?” That question was immediately followed by, “My goodness, what will people think of me? Should I say anything and risk my reputation?” The answer was yes, I was wrong (or early) and I had to say something because my concern for the wellbeing of anyone following my work far outweighed how the message might affect me personally.
The point of all this is to identify why it’s so important to understand, respect and trust the HOW. Without that understanding, I would’ve completely missed the warning signs, lost money on my investments and most important of all, hurt the people that put faith in my analysis. Shortly after thinking that all of my research was a waste of time, I realized that I had discovered something far more valuable than a point of view. I had developed a set of tools (Inventory tracking, Used Vehicle Values and Time to Equity) and a process that would help me effectively invest in auto related equities without bias. I also realized that my fear for loss of reputation due to my change of mind was unfounded. It’s clear to me now that the folks who trust my work do so because they trust the process; and the process has no bias.
I hope the thoughts and information that I’ve shared have been helpful. In my opinion (which is based on the data that I actively track), the bear case for autos is dead for the next 2-5 months. I say this because inventory levels are too low to jeopardize production and used vehicle values are too strong to suggest a slowdown in retail sales. However, I must warn you that while the bear case is dead for now, it’s not dead for good. There are simply too many headwinds in the coming years to let our guard down. While there are a few quality companies that I like in the short-term, there's only one that I feel comfortable enough to give a long-term buy and hold recommendation on.
These are my opinions and the content contained in or made available through this article is not intended to and does not constitute investment advice. Your use of the information or materials linked from this article is at your own risk.