I’ve recently made a habit of reading every post on a thread before I post a reply. I want to make sure that I have something positive to add rather than just repeating what’s already been said. The price of success is that this board has become somewhat unwieldy. I often ignore entire threads as I haven’t time to read everything.
I don’t know about you, but I have some personal truisms. For example, maybe 4 times out of 5 I find convenient parking spots. This defies logic. It’s like flipping a fair coin and having it reliable come up heads 4 times out 5. I can’t explain it. But I assure you it’s not just my imagination. My wife and daughter have both observed my uncanny ability to get good parking spots. Conversely, I can pick a line at Costco or the grocery store or almost anywhere and it will inevitably take longer to check out than if I had chosen a different line. The one I picked may have looked like the shortest, but somebody closer to the register will have picked up an item with no scan code on it, or there will be a problem with their payment method, or they’ll get in argument over an expired coupon, or you name it . . . My wife has commented on this as well. When I buy a new stock, maybe 75% of the time it will go down in price shortly after I buy it. These are truisms in my life. They’re not universal, you can’t draw any conclusions from it. It just is.
What I’m getting at is that some things happen no matter what you do. Sometimes, these inevitabilities are personal, some of them are more general. The vagaries of the stock market are inevitable, they are predictable in that we all know they will occur, but not very predictable with respect to when they will occur or how big they might be. It’s interesting in that there are many financial writers who make a living predicting what the market will do and when it will do it. Good lord! The yield curve is inverted - a recession will be upon us in six months - Oh, never mind, long term rates just went up so not to worry. I’ve not studied it in order to see if any of these folks actually have a consistent track record of being mostly correct, but I doubt it. It’s like mutual fund managers, most of whom can’t consistently beat the S&P index, yet they still have jobs.
I’ve argued that while many of our investments share some common characteristics, they can’t be referred to as a “sector” in any traditional sense of the word. Well, setting that aside, it can’t be denied that they swooned almost in unison at the end of July last year, they kind of bottomed after about 2 - 3 months but, IMO you couldn’t call it a turn around any time last year. Then, as if by magic, since the first of this year there’s been a surge.
This is a long winded introduction to my observations about valuation. Let’s start with the historical argument, which can be summarized with the observation that with time all investments revert to the mean, so it’s futile to even try to beat the average. Well, I’m not a financial historian but I’m willing to grant that the first part of this argument, reversion, is probably true. However, the second part is only true if you in fact hold everything you ever buy long enough for it to actually experience that dreaded reversion. And it also ignores that you may well make a bundle between then and now even if you do hold the investments indefinitely. But guess what, at least for my portfolio I no longer hold a single share of Skechers, Skyworks, or for that matter anything I held just a few years ago. So if you’re reasonably alert to the performance and changes in the landscape around your investments, this problem is not all that hard to avoid. Yeah, you might miss an obvious exit point once in a while (i.e., Nvidea, at least for me), but even though I am admittedly often slow to sell, I’ve not been stung all that badly. I’ve got results to prove it.
Let’s move on to a related argument, which is this time, just like every other time is not different. This is the bulwark of the arguments over valuation. These SaaS/cloud stocks are all in bubble territory, they’re all over-priced driven by momentum and none of them are worth the ratios they sport. Woe unto those who maintain positions in these frothy issues, you’re all doomed and bound for a painful fall. So let’s unpack that.
What’s a “bubble?” Seriously, that’s an important question. Is there a difference between a momentum stock and a stock that sports a high valuation or is it an equivalence? I don’t know what the magic EV/S might be that distinguishes a “fairly” priced equity versus a “bubble” priced one, but let’s arbitrarily say it’s about 15x. If you’re invested in companies below that number, you’re in safe territory, or at least not “bubble” territory. Above that number and you’re in danger. Again, I’m not a financial historian and there’s no way I’m going to spend hours let alone days analyzing that assessment, but I’m willing to gamble that there’s a grand total of zero statistical evidence to back that up, holding all other factors constant.
Mind you, I’m not arguing that there is no such thing as a bubble. Though I’m not a historian, I think almost every investor (and a lot of non-investors) are familiar with the tulip craze in the 1600s. By no means the only bubble, just one of the better known ones. The dot com mania is another of more recent memory.
How can you separate a bubble stock from a justifiably highly valued one? That question pretty much goes to the heart of the issue. When we experience a down turn and the naysayers flock to the board to issue their warnings (or “I told you so’s”) the underlying assumption is always that high valuation equals bubble. It has to be an a priori premise because without it, there’s no basis for the warning at all. I’m actually not going to waste a lot of your time describing the difference. Saul has repeatedly pointed out why these investments are not the same as bubble momentum plays and truly are a departure from the investments of the past - even the very recent past. In a nutshell: real products, real customers, real revenues, real margins. These companies are not strictly selling promises (although, all of them do sell some promises. Promises about new products, services and processes which they reliably tend to keep). Companies that sell mostly promises with little to back them up are prone to be bubble stocks (I make a caveat for biotechs which always sell promises until they field their promised products - this is the primary reason I avoid these investments, though I have done well with a few recommendations Bulwnkl has brought to the board).
We need to understand that high volatility and high risk are two separate phenomena. High valuation investments lend themselves to high volatility. There’s tons of evidence for that. But just like the macro phenomena I referenced earlier, when and how far the price swings might occur for a specific investment is not predictable. You can pretty well bank on the fact that it will happen, after that, all bets are off. This is one of the things I find somewhat amusing about so many SA articles that provide the advice that goes something like, “Great investment, but too highly valued, wait for a dip. When the price drops to $X make your move.” Good luck with that. They never once make an observation about the cost of a missed opportunity - never.
Recently on the board Saul and another member (Bear?) had a discussion about valuation. Saul more or less asserted that he ignores valuation in his investment decision making process (if I’m getting this mixed up or confused, please correct me). The other board member countered with something like if the EV/S ratio went to 100 you wouldn’t buy, therefore you are sensitive to valuation. Saul essentially replied that he was not going to be drawn into a reductio ad absurdum argument. Of course that’s a vaild observation, but it’s irrelevant with respect to our investments or our decisions about them. Our investments are priced based on market equilibrium that balances supply and demand. It is what it is because that’s what the market says it is. Will it be the same tomorrow or next week? Most likely not. Will it be higher or lower - your guess is as good as mine, let’s both concede it’s a guess. Will it be higher or lower in 6 to 12 months? From Saul’s point of view (mine too) if the answer to that question isn’t “yes” with a pretty high degree of confidence, the correct action is to sell rather than buy, or possibly do nothing depending upon other factors.
One more point and I’ll stop . . . I was surprised at my own reaction during last years contraction in our investments. I got somewhat panicky, at least at first. I had always known it was coming and I thought I was emotionally prepared for it, but when it happened, and then got worse, and then got worser I got very uncomfortable with the erosion of value in my portfolio.
But, to my credit, my action in the face of the deterioration was to do nothing. I didn’t sell, I didn’t trade in and out of my positions, I didn’t do anything. Somehow I found the fortitude to recognize that really nothing much other than price had changed. It was still the same companies, products, strategies, management, competitive threats, even performance, all those things were pretty much the same. So when I thought about selling, I also thought about what will I do with the proceeds? Just sit on the cash (and pay capital gains tax). Buy gold or bitcoin or blue chip or . . . I just couldn’t come up with any good alternatives, so I did nothing. I might add that at no time did my portfolio ever enter negative territory. Yeah, at the nadir it dropped back to where I was last February, but that wasn’t all that bad really. When I got serious about investing, which was about the same time I started following this board, I set the goal of 20% per year. I felt that was a stretch but achievable goal. My portfolio dropped to from up near 80% to up just a hair over 20%, but never went below that level. I closed 2019 at up 34%. As I type this post, I’m up 12% for the year (and I swear, my portfolio is not a copy of Saul’s).
I know, this is a long missive. I hope some of you find some value in it.