The #1 Source of Alpha in L/S Equities: Most Don’t Realize It
Identifying top-line inflections.
Have you ever wondered what ~50-60% of ideas put in the book by long/short PMs at the top multi-managers are driven by?
I’m guessing you haven’t. It’s kind of a weird thing to wonder about. But seriously though… it’s an important question to ask.
What are the predominant types of tradable ideas?
If there are just a few “types of ideas” or factors that drive the majority of alpha-generating positions, it’s something worth paying close attention to because you may want to build parts of your process around it.
On average, ~50-60% of ideas, long and short, that actually go into the book are driven by or significantly influenced by top-line inflections.
We will get into the nitty-gritty details with examples, and I will define what I mean by “driven” and “significantly influenced by”. But the bottom line is: if you want to make money every year, you need to be able to identify top-line (revenue) inflections.
Even if you “have duration” and consider yourself a longer-term investor, you still need to know how to identify them. As we will explain in the post, you will just often use them differently in your idea generation and, more broadly, your investment process.
You should go through The Best L/S Analysts Detect “Change” write-up before reading below - we will revisit the example. On Tuesday, a lot of people commented on the LinkedIn post to get it for free, but it started gaining a lot of traction and LinkedIn temporarily blocked the account because it thought the comments were from automated bots…. Apologies. We are still waiting on a response from them.
There is a new post on our Phoenix page here. Just follow and comment there, and we will send you the pdf. If you already commented before, feel free to message us directly, but I would really appreciate it if you could re-comment. Thanks for the support.
A lot to cover, so let’s get straight into it.
Did you just make up the ~50-60% number?
Firstly, no. Once you start doing the job yourself and talking to many other analysts, you begin to get a feel for the types of ideas everyone’s looking at. But it's important not to get too fixated on the specific number / percentage. The key takeaway here is that across many sectors, top-line inflections are one of the most common sources of a variant view (we will explore exactly why).
Secondly, it’s clearly sector-dependent (and to a lesser extent, style-dependent), and it’s more accurate to think in terms of a range: ~30–80%.
At the upper end of that range are consumer/retail and TMT/internet names, where ~60–80% of ideas tend to be top-line driven. Then you have healthcare and industrials, which fall more in the ~30–60% range. Finally, financials and energy tend to sit at the low end, closer to ~10–30%.
Of course, there are always exceptions within each sector, but broadly, you can think about idea generation across this spectrum.
Why is revenue (top-line) such an important part of having a variant view?
This is an important question. Revenue is genuinely one of the most important and repeatable sources of a differentiated view. Why?
The most predictable alpha source
Because it's generally the single most measurable and predictable alpha source. As an analyst, you can do real, scalable work to diligence revenue - channel checks, alternative data, TAM analysis, etc. All of these make revenue trackable and accurately forecasted. As a result, that’s where the stock price action is. Investors can only react to incremental information they usually have visibility into. Take Amazon, for example. We already know that with the right setup of alt data, channel work and projection skills, you can get an almost real-time read and accurate estimates on AWS and retail revenues and their drivers.
This is also, by the way, why Consumer and Internet/TMT are so heavily influenced by top-line, because investors have direct and granular visibility into the top-line of many of the stocks within those sectors.
You can get philosophical here: Well, “if everyone is doing all the research above to track top-line and inflections, shouldn’t I be doing something else?”. As you will learn below, top-line is always important for a stock/company, just in different ways depending on your time horizon and strategy. Stock prices react to changes in expectations and revenue is the most visible one. Even if those two things weren’t true, it is hard to maintain a high velocity of ideas by ignoring revenue inflections, both short- and long-term ones.