How the hell do you bet against speculative euphoria without losing your shirt?
John Templeton may have the answer:
In 1999, at age 88, Templeton decided to start betting against the speculative euphoria in the US dot-com bubble.
He knew that many of the newly IPO'd companies were trading at absurd valuations that were completely unsustainable. But betting against parabolic share price movements was a fast way to go broke.
So instead, he targeted stocks that were exiting their 180-day lock-up periods. He knew that insiders were sitting on wildly illiquid stocks and that they'd take the first chance they got to sell. This supply would easily overwhelm any demand.
The stocks he targeted had to fulfill two criteria:
- The stocks needed to have tripled from their IPO price
- Valuation multiples >100x earnings or >20x sales
He then diversified across 84 names, shorting US$2.2 million each.
- The stocks needed to have tripled from their IPO price
- Valuation multiples >100x earnings or >20x sales
He then diversified across 84 names, shorting US$2.2 million each.
He timed the shorts cautiously, putting them on exactly 11 days before the lock-up expiry. The idea was to capture the pre-expiration expiry, and then a wave of selling.
If the stock continued to rise 11 days after lock-up expiry, he would sell regardless of the price. He figured that buyers must have known something he didn't. This became his stop-loss mechanism.
He only covered at 95% down, or if the valuation hit a reasonable level of below 30x P/E
The strategy worked: he made a total of $90 million in just a few months
- 50% of the trades were profitable
- 33% of them hit their stop-loss, which led to losses
- 17% of them he more or less broke even
- 50% of the trades were profitable
- 33% of them hit their stop-loss, which led to losses
- 17% of them he more or less broke even
Templeton called the Dotcom mania "temporary insanity and a "once-in-a-lifetime opportunity". But betting against insanity requires a methodical approach, one that guards you against unlimited losses. Focusing on lock-up expiries does just that.
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