A large percentage of top hedge fund managers and billionaires who have outperformed the market for decades share a similar mindset in regard to building a portfolio. They seek out stocks that represent attractive asymmetric investment opportunities. These exceptional stocks come with two characteristics:
1. They have very little downside risk.
2. They have enormous upside potential.
Understanding asymmetric investing as a concept isn’t difficult. The hard part is finding the right stocks to own so that you can put it into practice.
Step 1:
Find companies that offer downside protection. That downside protection can come from a huge cash balance on the balance sheet, cash flow from a legacy business unit or real estate value that supports the current value of the stock in the market.
Step 2:
Once you find a stock with solid downside protection, look for huge potential that the market isn’t pricing in. In other words: Pick solid companies with free lottery tickets attached. Ulike lottery tickets, the odds of success aren’t 1 in a million but more like 1 in 5, or even better.
These lottery tickets could be, for example:
A new business line with exploding growth that lies within an existing company
A hidden asset that the market doesn’t know the company has that will soon be monetized
A blockbuster announcement on a new product, discovery or business practice that is a game changer.
Certain industries are perfect for this type of investing approach. For example, look at biotech stocks, where potential blockbuster drugs undergoing trials can be attached to companies with massive amounts of cash in the bank or existing cash-flowing operations from drugs already in production. If the blockbuster new drug realizes its potential, the stock is a home run.
If the drug falls flat or not bringing the results you wanted, the stock price is supported by cash that the company holds or cash flow that it generates from the rest of its business. The key to successfully deploying this strategy is patience.
Great asymmetric opportunities rarely come around, but when they do, they can produce exceptional results. You have to do a lot of analysis to find a top asymmetric investment but if you do, you bag a homerun.
Sven Franssen