Rufus: Quest for the safe stock
Rufus: Quest for the safe stock
You can't trust charts to tell you about business risk. The holy grail 🏆 of investing is PIV. And a BIG TECH WARNING🥺
Rufus needs a safe stock to invest and make profits. People are making so much money, why can’t he?
Life is getting expensive, prices are going up. His lifestyle needs cash to sustain itself.
He starts searching for them on the internet. He starts talking to friends and bankers for tips. He reads the media.
They all recommend the high flyers of the time. The Big Tech names and some high-growth stocks that only go up. One of his friends is a bit more astute and spent years working in investment management; he has a different message.
He recommends a few companies that have conservative balance sheets, decent competitive advantages and future growth. Rufus quickly disregards them as “too risky” when he uses his iPhone to check their 5-year charts.
He saw that they are volatile with ugly price moves. He confirms his belief that the prevailing narrative is right and ignores his friend.
Without further ado, Rufus puts some money on those only-going-up technology growth names and starts watching the show. He expects them to continue going up for no particular reason.
“If they went up for 10 years, why shouldn’t they continue going up in the future?”, he ponders.
A market correction comes and his holdings drop ~10%. He checks the charts and sees that all previous corrections were in fact buying opportunities. He quickly buys the dip.
He once again defers from researching the names he is investing in. He never once read a single financial statement. Besides he feels confident about these companies because he uses their products every day.
“I don’t have time to research these companies. Bank analysts do that for me! Nothing bad could happen to them…” he so self-righteously proclaims.
Analyst reports are conflicted and change their views as the market changes direction. That has 0 value to Rufus as an investor, but he doesn’t know it.
Someone told him that but he ignored it because the market was going up and he didn’t care.
Markets recover making new highs and Rufus feels vindicated. He feels that he has been rewarded for his bravery and self-sacrifice to jump in when markets were crashing. “This is easy” he thinks.
After a few months, the narrative changes and worries about inflation and interest rates surface. Markets get a bit shaky and after a few weeks start to break down. Rufus doesn’t worry because he is used to the current paradigm. He knows every drop is an opportunity to buy the dip.
He takes the drop lightly because it’s slow and not serious. He disregards it as transitory. The drop accelerates but now he’s committed. “I’m not in this to lose money!”, he tells himself.
By the time Rufus realises he made a mistake — he is down +50% on a company he knows nothing about. During that time analysts changed their ratings and their rhetoric as prices turned south. Rufus was left holding the bag.
What did Rufus do wrong?
Rufus was investing in a market-centric way. He was looking at charts and analyst recommendations as a view into the companies he was investing. But charts, analyst reports and the stock market direction have little to do with the long term value of a business.
In the same market-centric way, Rufus rejected his friend’s recommendations because they looked risky and volatile. It is very hard for Rufus to understand that a share price may be dropping for 2 years while a business is actually creating value with a lot of room to go.
These market-centric things are mere shadows of the truth that Rufus needs to discover. People think companies are their stocks and stocks are their companies, but they are not. If only life was so linear!
Rufus needs to ignore all this noise and focus on the truth.
Quest for the the Holy Grail🏆
The holy grail in investing is Intrinsic Value (IV) and the Price (P) you pay for it. In the calculation of IV — volatility, trends, charts and analyst reports are meaningless.
If I could offer Rufus a few words of advice, I would start with.
“Yes, charts may have their place but…always look at the fundamental side of your investing life.” 🎶 🎶
Using current prices and prevailing sentiment about companies to invest in their equity can be tremendously risky. Current prices cannot tell you where a business is going in 5 or 10 years.
A few pointers for Rufus:
The holy grail of investing is Price to Intrinsic Value.
Intrinsic value is about the present, but it is very much about the future too.
The only thing you know for sure in the P/IV calculation is the current price (P).
IV is a rough calculation and it varies greatly depending on the scenario that unfolds.
Volatility, trends, direction, market or analysts views, the news, coffee shop chatter and conventional wisdom tell you nothing about a company’s intrinsic value.
On the contrary, if (almost) everyone is positive about a given company, the price is possibly above intrinsic value because the market overpays when happy.
If (almost) everyone is pessimistic, the price is possibly below intrinsic value, because the market underpays when sad.
This means that the stocks you think are safe and immune to business risks, can crash to nothingness. Big Tech warning in the Appendix👇
Safe stocks don’t exist, and safe businesses don’t exist either. Safe is not the word to use for something that is uncertain, even if it is more certain than others. And that’s a big if.
Focus on risk/reward and price/intrinsic value to make money in investing.
Approach investing like a businessman.
Think for yourself.
“If people cannot write well, they cannot think well, and if they cannot think well, others will do their thinking for them.”
George Orwell
Appendix: Gene Munster, superstar analyst on CNBC… 🤯
September 2nd, 2021…Apple’s stock is a great investment, could hit $200 a share.
December 27th, 2021. Tech investors should enter 2022 with healthy dose of caution.
January 14th, 2022. Nasdaq faces 20% correction that will likely last three months.
BIG TECH WARNING ☄️
This post is a preamble to a future letter on the risks of investing in Big Tech. I have been working on it for a few weeks, current market movements are simply coincidental.
Yes! There is no doubting these are strong and profitable companies with amazing growth, but in some instances cracks have started to show.
Let’s start with the most important layer, which I believe to be the legal & regulatory theme.
U.S. States lawsuit Vs GOOGLE LLC
https://www.theregister.com/2022/01/15/googles_facebook_advertising/
The alleged 2017 deal between Google and Facebook to kill header bidding, a way for multiple ad exchanges to compete fairly in automated ad auctions, was negotiated by Facebook COO Sheryl Sandberg, and endorsed by both Facebook CEO Mark Zuckerberg (now with Meta) and Google CEO Sundar Pichai, according to an updated complaint filed in the Texas-led antitrust lawsuit against Google.
Texas, 14 other US states, and the Commonwealths of Kentucky and Puerto Rico accused Google of unlawfully monopolizing the online ad market and rigging ad auctions in a December, 2020, lawsuit. The plaintiffs subsequently filed an amendment complaint in October, 2021, that includes details previously redacted.
Attached the 242 page PDF file of the lawsuit against Google.
Facebook ($META) is stuck in the crosshairs of this and will not get off scot-free. Pushback has been growing against the famous internet group, as their control of more aspects of our digital life grows.
And let’s not forget about the Cambridge Analytica scandal.
Excerpt from Cambridge Analytica Data Scandal.
Information about the data misuse was disclosed in 2018 by Christopher Wylie, a former Cambridge Analytica employee, in interviews with The Guardian and The New York Times. In response, Facebook apologized for their role in the data harvesting and their CEO Mark Zuckerberg testified in front of Congress. In July 2019, it was announced that Facebook was to be fined $5 billion by the Federal Trade Commission due to its privacy violations. In October 2019, Facebook agreed to pay a £500,000 fine to the UK Information Commissioner's Office for exposing the data of its users to a "serious risk of harm". In May 2018, Cambridge Analytica filed for Chapter 7 bankruptcy.
SWITCHING COSTS..so what?
Facebook’s strategy to lock us in with no chance of escape has worked up to now, but how fragile is this business model? Does the online user have no will of its own? Do alternatives not exist?
We contend that alternatives do exist. And there is a chance that one day users will leave Meta's platforms en masse. How much will intrinsic value drop then?
“According to Warren Buffett, intrinsic value can be defined simply as the discounted value of cash that can be taken out of business during its remaining life.”
Meta acquired Instagram and Whatsapp, integrating them with its own internally-developed Facebook. But what will happen if they can’t acquire the next big success? A success that is a threat to their existence?
The global pandemic has shed further light on the fragility of the Big Tech.
Their censoring of views opposite to ones supported by the “establishment” can be seen. Intervention from these otherwise independent platforms, into domains other than their own, has spurred the need for alternatives.
You understand that this is a complex adaptive system right? Messing with it too much won’t get you what your grand design tells you that you’re going to get.
George Soros on Big Tech dominance
Soros spoke about this at Davos 2018, 4 years ago exactly. It’s important that you read the excerpt from his speech below.
Billionaire investor George Soros bashed Facebook and Google in a speech at the World Economic Forum in Davos, saying that it’s “only a matter of time before the global dominance of the US IT monopolies is broken,” according to a transcript obtained by CNBC.
Soros said the tech companies were a “menace” and “ever more powerful monopolies,” that would be tempted to “compromise themselves” to enter the Chinese market, where they have long been banned.
″[A]s Facebook and Google have grown into ever more powerful monopolies, they have become obstacles to innovation, and they have caused a variety of problems of which we are only now beginning to become aware,” he said, according to the transcript.
“They claim they are merely distributing information. But the fact that they are near-monopoly distributors makes them public utilities and should subject them to more stringent regulations, aimed at preserving competition, innovation, and fair and open universal access,” he said.
The temptation to among these companies to cooperate with authoritarian regimes like China in order to get access to those markets “may well result in a web of totalitarian control the likes of which not even Aldous Huxley or George Orwell could have imagined.”
“Davos is a good place to announce that their days are numbered,” he said.
Predicting the future by inversion, Risks for Passive Investors
Now that we have seen that the business values of some Big Tech names are far from “safe”, let’s move on to valuation to see how PIV fits in.
“A great business at a fair price is superior to a fair business at a great price.”
Charlie Munger
What about a fair business at a bad price?
The bull market from the bottoms of 2009 and 2020 has been led by Big Tech. As these names have gone from strength to strength, the indices rallied, and passive investing was the most to benefit.
The continued success of passive investing is tied to the success of the indices.
And the trajectory of the indices is tied to the success of Big Tech as the 5 carry a 25% weighting in the S&P 500. A simple rerating on these names (which would affect the general market) could cause drops in the S&P 500 of historical proportions.
That doesn’t mean you should not invest in the stock market, that just means you shouldn’t let big stock market cycles tell you what to do with your capital.
The Fed, big business trends and the ascent of passive investing.
Interesting older letters on the matter:
Appendix 2: Investing in Apple Shares, 2013
I first invested in AAPL in December 2013. Relative to earnings, shares were much cheaper at the time than now. In fact, most of the trillions (!) in value that AAPL has created these years has been from P/E multiple expansion and not from pure value creation.
I am not negative on Apple and I believe the company has a bright future. But I am certain that Apple’s future will not move up in a linear way, and I am certain that company prices (share prices) move much more violently than their underlying values.
Are the passive investor fanboys ready for something like that?
This letter was a Monty Python tribute to Shrubbery Capital🌳
Nice read :)
Great piece, i would enjoy reading more if your thoughts about the passive complex. Black rock is 10 trillion AUM let's hope the American worker keeps saving in their funds so that we have an automatic dip buyer.
Just imagine both the fed and black rock tapering hard to imagine we escape that without a scratch.