One of my recent reads is The Smart Money Method: How to pick stocks like a hedge fund pro (November 24, 2020) by Stephen Clapham.
Naturally, when he mentioned “Asymmetric Pay-offs” I have to share the quote:
My favourite opportunities are those with asymmetric pay-offs. Here there is potential for considerable upside, but not a lot of downside (or vice versa for shorts). Sometimes, a share will have fallen out of favour with the market. It usually takes a catalyst – an event such as a change in management – for the market to become more enthusiastic, and for the share price to factor in the recovery opportunity. Whatever the idea, and wherever the source, this concept of a reward which is not commensurate with the risk is a critical objective.
As a special situation investor, I am drawn to areas where there are unusual rewards. This usually involves a higher element of risk. The trick is to find companies which have asymmetric pay-offs. In these cases, there is an element of downside risk, but the upside is significantly higher and you have a good reason to believe in the positive pay-off, because of a change in a fundamental driver.”
Stephen Clapham. The Smart Money Method (p. 32). Harriman House. November 24, 2020.