WWII 073: Idea Management Systems Part 2, What is Discounting, Going All-In on an Arbitrage

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Main Topic: Idea Management Systems Part 2

In the last episode, I walked you through the concept of idea management and how it’s an integral part of the investment process. In this episode, I’ll talk about where various types of ideas end up ultimately in my idea management process.

First off, the ideas with short fuses like arbitrages, spin-offs, odd lots and such end up in their own special, customized Excel spreadsheets that are designed to calculate the arbitrage spread whenever I look at it with the must current price. If an arbitrage has the qualitative aspects I am looking for, such as a reasonable spread and a double digit annualized return, then the next step with these is to do a full document review and categorize it as a “Participate” or no. These then become portfolio management items.

Ideas like “generals”, which are companies selling in public markets that are likely undervalued go through a process where I attempt to prove that they are bad ideas. I did a podcast episode which is Episode 37 about the null hypothesis from the scientific method and how I use it in my investment process. If I fail to prove they are bad idea then I continue researching them until I am generally out of material and then I do a valuation using a few different methods, including the multiple of EBITDA method, which was episode 57, a discounted cash flow, and a few other valuations.

The next step with these “generals,” is to record the results of the valuations, pricing, and key statistics in a custom database that I built from scratch to help keep track of ideas. Part of that process is assigning it to one of a few types of watchlists I use for various kinds of ideas. These watchlists will alert me when a price falls below the price I would buy it at with the kind of margin of safety I am looking for.

The key with idea management is to have both a start point, waypoints along the way, and an endpoint. Otherwise, the idea just stays in limbo.

Instead of just chasing random ideas, think about how you can build an efficient, modern idea management system using the tools available to all of us now. My tools are on dropbox and I can access them from anywhere in the world. I can be sitting poolside in the Caribbean and moving ideas through my idea management system, no problem.

Idea management systems are organic creations that each investor creates themselves. Ask hedge fund managers and you will find that these systems are very bespoke, unique creation. Mine is based on value, efficiency, and effectiveness. It is a work in progress and definitely a passion project.

If you have any thoughts on the idea management process, any good ideas, something you do that you think is pretty awesome, reach out

Ask JB: What is Discounting? Should I Go All-In on an Arbitrage?

: Could anybody please explain to me what "discounting" is in financial terms? (self.investing_discussion)

submitted 4 days ago by ronburgund

I am having a real difficult time understanding the definition and hows it applied in a financial sense. I have been reading about it on the internet and my textbook and for some reason I'm just not piecing it together. Thank you for your help!

JB Says: Discounting is the word for considering the “time value of money”. If there is inflation, a dollar is worth less in the future than it is today. If you are going to be getting a lump sum five years from now, to know how much that is worth to you today (present), you discount it. The value it has for you today is called the “present value” of the future cash flow. Investors use this concept in calculating a discounted cash flow valuation. We calculate how much cash can be taken out of a company by an investor over ten years plus a lump sum representing the final value and discount it all back to the present so we know how much to pay for it today.

Ask JB: Profit of a buyout (self.investing_discussion)

submitted 25 days ago by jonhen99

I have a stock that has been bought out. The buyout price is $37.30. The stock closed today at $34.54. The closing date for the buyout is April 20. Could I sell all my stocks (around 15 holdings in a 401k worth about $210,000) and put all in this stock realizing a ~almost $3 a share guaranteed profit? Afterwards I would require most of the original stocks. I have Schwab so only $4.95 per trade.

JB Says: Welcome to the world of merger arbitrage. What you are talking about is a kind of arbitrage that results from offers by one company to buy another. I talked about these types of investments and the outcomes of several in episodes 34, 41, 56 of this podcast. Deals have a number of milestones and a number of risks you should be aware of before you decide to do anything. One my website is a book that you can download for free that illustrates this type of simple arbitrage with three case studies of about ten pages each.

Do you have a burning question on investing you would like answered? Click the button below to send it to me and I will answer it on the podcast!

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About the Author

Jeremy Scott Bailey is an investor, author, entrepreneur and host of the "What Works In Investing?" podcast now available on iTunes. He is founder and Chief Investment Officer of Burgeón Group, Inc. an investment advisory firm that provides portfolio management services to families and individuals.

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