Bubble, Bubble, Toil and Trouble
It’s a little early for Halloween, as we are only in January, however we believe that a lot of the current action we are seeing in the stock market is going to come back to haunt many investors. In our recent blog posting entitled Speculating in Market Excesses, we shared our thoughts on some speculative high growth stocks. Now it seems that some investors have moved on from the boring task of trying to identify stocks that may experience high growth rates to just betting on stocks because they are going up.
We have been watching with interest as stocks in old line companies that are experiencing huge structural disadvantages started spiking, beginning around the same time as we published our original article on market excesses in December. We have seen where a tweet from market darling Elon Musk to use Signal messaging service led to a surge in shares of unrelated Signal Advance, a small biotechnology company. However, what we are seeing now is even worse as there is a concerted effort on several investment message boards to move the prices of specific securities. What do these companies have in common? Only that they have a large short interest. A short is where an investor believes that the price of a security will go down in value in the future. They sell the stock without owning it and if it does go down they make money. However, if the stock does appreciate they can lose a large amount, greater than their original investment since there is no maximum price a stock can hit.
GameStop was one of the first stocks where this occurred and the stock is up a staggering percentage from a pre squeeze price of around $11 a share to a current price of over $300. The fundamental news related to GameStop has been limited short of a board member being added that has experience with selling items online and some vague chatter that GameStop wants to build its online business. GameStop is mainly known as a brick and mortar purveyor of video games and related offerings. The company is now being valued by the market at over $25 billion dollars which is more than it has ever been worth in the past despite a very challenged path forward. The individual investors that have created this trend have “won” in that they nearly bankrupted one of the hedge funds that was shorting the stock and it has covered its investment at a huge loss. The question now is how does this end for the individual investors as we do not know of any other way then badly as the business prospects do not support the value being given to the stock.
This is far from an isolated incident in the markets, with shares in companies ranging from challenged department store Dillard’s to challenged oil rig operator Transocean experiencing large increases in price without news related to their business. Dillard’s is trading near an all time high in price despite its business being significantly impaired by COVID. Another company, AMC, was able to take advantage of its large share price increase to raise equity and dilute current shareholders to stave off a bankruptcy filing for the company. That was a good and smart move for company management but it is hard to understand how investors at these prices make money from here. AMC is the largest movie operator in the country and it is struggling with limited audiences and product. Also today the largest gainer on the day is a company with no business and one employee, America Great Health. The company is being valued at $15 billion dollars. We can find no news whatsoever related to this company. A lot of value is being placed on this one person to produce outstanding results!
We have seen excesses like this in the past where investors inflate the value of companies to much more than their probable value. What is new is the scale and also the organization of individual investors buying into these trends. We do not see this gambling trend continuing for long as investors are burned when these eventual towers to the sky collapse under their own weight. What is unfortunate is that these investors may learn the wrong lesson, believing that the market is rigged and that they can’t make money in it. This happened to investors back in 1999 and 2000 and many that were young investors at that time have a large fear of stocks even 20 years later. This is unfortunate but it is hard for many to accept that investing should be boring by its nature and take time. We are using the term “investors” here loosely, as what is being experienced is speculation and speculation is not investing. Investors, as we use that phrase, are individuals who look at stocks as ownership in a business that they would like to own for the long term and look at the operations, profitability and cash flow generated by the business.
So what is a smart investor to do about this? Sticking with fundamental analysis of investments and buying assets when they are cheap and selling when they are expensive will continue to work in the long run. Volatility actually will help long term investors as chances are that investments will overshoot on both the side of being cheap and the side of being expensive. When our managers buy companies they are looking at what these businesses would be worth if they had to buy the whole business at that price. They commonly will also employ a margin of safety around this. They do not view investing as a game or treat it like they are placing bets (i.e. speculation). We believe that this is how we want both your and our hard earned money to be treated and not like buying lottery tickets.
If you’re looking for a more diversified approach to investing or are interesting in a free second opinion on your portfolio, please contact us.