Position Sizing with the Kelly Criterion

The Kelly Criterion is a mathematical formula to determine the optimal dollar amount to bet in a given wager or investment. Say you’re offered a bet where you are a 60% favorite to win and it pays 2:1 in your favor—Kelly suggests betting 40% of your net worth. If you were offered this exact bet a million times, betting 40% of your net worth each attempt (adjusting as you go) would net you the most amount of money in the end. Thus, 40% is the optimal bet size given those odds and payouts.

I’m betting no one (myself included) would actually bet 40% of their net worth in the above scenario—even if they knew the odds and payouts were legit. Most of you probably read that previous paragraph and thought 40% was insanity. I think one of the more interesting takeaways from the Kelly Criterion is how few people live their life in a way that optimizes their net worth over the long-term (again, myself included). And most of us aren’t a little off the mark, we’re not even in the ballpark of what’s optimal. If the above offer was made to all Americans, the average bet size would probably be less than 1% of each person’s net worth (with many doing a nominal amount like $10 per bet).
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How much do we really know about our investments?

I’m a big space nerd. To the point that for my birthday two years ago my girlfriend flew us down to Houston to tour the Johnson Space Center (spoiler alert: it was awesome). Some of my favorite books the past few years have either been about the Apollo missions or how we’re going to get to Mars. So you can imagine how excited I was last year when we were out getting drinks with friends and one of the friends-of-a-friend was a woman who works at NASA. I basically bombarded her with questions the entire night.

One of the main things I was asking her about was what obstacles they still need to overcome to be able to get to Mars. She was giving me some pushback on what I thought I knew about space radiation and I remember starting the next sentence “I know [random blurb about space radiation].”As soon as I was done blabbering I thought to myself “why the hell did I just start that sentence with ‘I know’? I’m talking to a freaking NASA scientist about space travel and all I’ve done is read some books and online articles about the topic. That hardly counts as knowing.”
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How to Value Bitcoin

I’ve done a lot of reading up on crypto currencies and blockchain the past month—not because I want to invest in it, but because I find it fascinating and potentially life-changing. Just last week I was traveling internationally and I can’t tell you how many times I thought to myself “this would be so much easier if everyone was using a Bitcoin app on their phones.” I have no idea if Bitcoin is the MySpace or the Facebook of the cryptocurrency future, but it’s fun to learn about either way. One thing I haven’t seen much of is people attempting to value Bitcoin.

I’ve read plenty of logical sounding arguments for why Bitcoin will be $20,000 or $50,000 in 10 years, but those people rarely mention the discount rate that needs to be slapped on those estimates. Even if you’re a Bitcoin bull, you have to admit it’s an incredibly risky asset and there’s a chance it’s worth $0 at some point in the future. Given that, a high discount rate is required. When I value profitable, growing public companies that have little debt on their balance sheet I use an 11% discount rate. Thus, I’d say any discount rate on a Bitcoin valuation needs to be significantly higher than that—maybe 30-40%—though I wouldn’t fault anyone for going even higher.
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Why I Prefer Founder-Led Companies

Followers of this blog won’t be surprised that I much prefer investing in founder-led companies. I will admit I am very biased when it comes to founders. I have started a couple companies myself, am a member of Entrepreneurs’ Organization, and tend to love all things related to entrepreneurship. I believe companies led by their founders often have intangible assets that are nearly impossible for a professionally managed company to replicate.

How many times have you heard a hired CEO describe the company as their baby? Probably never. But I have heard many entrepreneurs describe their own companies this way. Loving a business like it’s your own child doesn’t guarantee you’re a good CEO, but that obsession can make up for a lot of faults.
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Why I Like Where Food Comes From (Forbes.com Interview)

“What about Where Food Comes From initially caught your attention as a value investor?

Where Food Comes From checks several of my favorite investment boxes: small, founder-led, high insider ownership, zero debt, profitable, and growing. I love industries that have long runways of growth ahead of them. Where Food Comes From benefits from several major trends in food—organic, non-GMO, gluten-free, animal welfare, and more generally, consumers demanding transparency in the food chain and wanting to know where the food they eat comes from. I like large industry tailwinds because it makes business much easier. In a fast growing market, competitors are less likely to engage in price wars or other detrimental practices. This is because most participants are growing revenue, even if they’re losing market share. Growth is harder to come by in mature markets so there’s more likely to be competitive practices that are harmful to all participants.”

The above is an excerpt from an interview I did recently about Where Food Comes From. The rest of the interview can be seen at The Business (And Stock) Behind Where Food Comes From.

As of this writing, Wiedower Capital owns shares in WFCF. This is subject to change.

Like Founder-Led Small-Caps? Here’s a List of All of Them.

For a while now I’ve been wanting to go through all small and micro-cap companies that are still run by their founders, but I could never find a list anywhere. So I finally decided to generate the list myself. I started by downloading a list of companies that fit the following criteria:

  1. Market cap less than $500 million
  2. Average daily volume of at least $5,000
  3. Share price of at least $0.05
  4. Only companies with up-to-date reports (so no grey or dark companies)
  5. Based in the USA
  6. No biotech or pharma

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Why Trupanion Could Be A Long-Term Compounder

I published a write-up on Seeking Alpha yesterday about Trupanion (TRUP). The summary is:

  • Trupanion is building a durable competitive advantage in an industry that is set to grow 10x+ over the coming decades.
  • The company is still run by their passionate founder who has the vast majority of his net worth in Trupanion stock.
  • The current valuation looks very expensive, but starts to look reasonable the farther out you look.

Read the full write-up here: https://seekingalpha.com/article/4090526-trupanion-long-term-compounder

As of this writing, Wiedower Capital does not own shares in TRUP. This is subject to change.