In today’s Exponential Investor…
- Who do you think wins?
- President Pence?
- Markets do as markets do
I’m very excited about this week.
In fact, it could be one of the most exciting week’s we’ve ever seen in Exponential Investor and at Southbank Investment Research.
You’ll hear more about this later in the week, but, whoa, wait till you see what’s coming!
As I say, more on that later this week…
I do have a question though for today.
Last week I asked you who you thought would win November’s presidential election, Donald Trump or Joe Biden.
Here is the result of that snap poll.
However I’m slightly disappointed that no one wrote in to me with the answer that perhaps we’ve all missed.
On Wednesday, no one replied to me saying, “Neither Trump nor Biden will win November’s election. Mike Pence or Kamala Harris will.”
I hadn’t thrown those two into the mix for a good reason.
That reason being they’re both the second-string to Trump and Biden. Pence or Harris can’t win, because the presidential nominees are Trump and Biden.
That’s true, however by the end of the week we discovered that President Trump has “the Rona”.
Now President Trump is 74 years old. That puts him squarely in line of what would be a “vulnerable” demographic hardest hit by Covid-19. We know that Covid-19 discriminates. It discriminates against people that are older, and that have pre-existing health conditions.
Now, we’re not sure if he’s got pre-existing health conditions. But his age alone means he’s 90% higher risk of death compared to someone age between 18 to 29. And that’s coming from the US Centers for Disease Control and Prevention.
Biden, by the way, is 77. He gets it too, and we might be facing a US presidential election fought out by two men in intensive care.
Which raises the question, and I don’t know the answer to this, what happens if one of Trump or Biden is alive to win the election, and subsequently dies the day after?
Does Pence or Harris assume the presidency for the next four years?
I should really research this outcome, but the thought only just came to me. If you know what would happen in that situation, let me know.
Or what happens if both Trump and Biden are dead by the night of the deciding outcome?
Is it then a Pence vs Harris presidential election?
I mean, it’s unprecedented times I know, and the likelihood of this is kind of remote. But it’s not that wild a question to ask, is it?
Not to say I hope that’s the outcome at all. Don’t want anyone to die from anything unnecessarily. But heck you’ve got to think about it, and what happens in that situation.
Like Kit and I talked about in Friday’s podcast, what then happens to the markets?
As soon as the news about Trump’s positive test came out at the end of the week, the markets fell.
Why? I don’t know really. When you dig down into it Trump merely getting Covid-19 should do anything to stock prices. What the market reaction to this tells us is what we spoke about on Friday – the gamification of investing.
I’d hazard to suggest if you asked 90% of the investors that bought Tesla stock in the last six months if they’d looked at Tesla’s balance sheet or cash flows, order book and the reliability of its products, 100% of them would say no.
The investment thesis is that the “stock always goes up” is the root of why they bought the stock. It highlights the mindset that investing is just a game you’ve got to master.
In one sense, yes it is one big game that you get good at over time and you need to try and beat. But there is a fundamental, physical component to buying and selling stocks.
You are buying a real company. You are aiming to benefit from the way they’re run, their ability to grow, to earn, to return to shareholders. Investment in this sense isn’t a game, it’s a skill – arguably an art form.
You pick the ones that you believe have the best chance of achieving success as a company. And that success isn’t predicated on the stock price going up. The stock price going up is a by-product of the company’s success, not the precursor to success.
If a stock price goes up and a company’s performance goes down, that is not a successful company. That’s a divergence of reality.
That’s an opportunity for shorters.
If a company’s performance rises, and its stock price doesn’t reflect this, that too is a divergence of reality.
That’s an opportunity for investors.
You’re nuts buying a stock like Netflix
These are the nuances and quirks of a market that we look for. We look for a company where its stock price hasn’t reflected the true potential and performance of the company. To follow a stock that at its foundations sucks but its stock price has kept going up, isn’t more a thing of skill, but a thing of luck.
At some point, that gravy train ends and it ends fast.
Which is why we’ve been saying there’s a hard end coming for a lot of stocks where there’s a divergence of reality. Companies, namely “Big Tech”, that are trading at earnings multiple in excess of 40, 50-times, sometimes over 100-times, are unsustainable.
For example, if a company trades at 50-time earnings, that indicates an investor would be willing to pay $50 for just $1 of earnings.
Fifty-times premium you’d pay to get $1 of earnings. The bigger the earnings ratio, the bigger the premium investors would pay. But think about that. If I said to you, give me $50 now and I’ll give you $1 this year, and maybe next year $1.20, and if things go well, about 10% to 20% growth in that every year going forward…
… would you take that deal?
It would take decades to get your $50 back by the way of earnings. Is that really the payback period you think is acceptable?
No? Well why on earth would you buy a stock with an earnings multiple at 50-times… or more?
This just reaffirms investors don’t see what they’re really doing, and just play the markets like a game. A game that when you lose, you don’t always get an extra life.
This method of valuation is an imperfect science. But it gives you some indication the bigger those ratios push out the more wildly valued that company is based on what it actually does. Again, a wild divergence of reality.
The point being that we seem to have stepped away from what makes the best investors the best for long periods of time. And that’s investing in companies that can actually deliver with true fundamental value.
An inflated stock price base on potential is fine, and there is certainly a premium to be paid for stocks like this. But it’s a risk/reward payoff that needs to be properly understood.
When you’re buying Netflix at a price/earnings ratio of 89-times, your upside risk compared to your downside risk is wrongly skewed. Your payback period is literally a lifetime.
The chances of that stock punching two or three times higher or actually trading relative to its real value is driven by psychology and magic dust at that point, not actual fundamental valuation.
And your chances of it doubling is limited compared to its value halving. The stock could fall by half, and still be trading at a valuation that’s far too excessive for what they actually deliver.
Acceptable earnings ratios for profitable companies you would expect around 10 to 15 times. Twenty is pushing the limits of wild valuation. Forty-times… 80-times. Frankly I think you’d be nuts to invest in a stock like that of that size, hoping for giant returns.
Take heed. Valuations are ridiculous for the Big Tech markets right now. That will change and when it does, it’s going to crush those not prepared for it.
Editor, Exponential Investor
PS Trump, Biden, Pence, Harris, it doesn’t matter. Markets will do as markets will do. They’ve done so through many presidents, prime ministers and dictators before, and they’ll do it again. Trump and Biden is just a side show. It’s interesting, entertaining and topical. It has minor effects on markets, but long term, really means nothing to your long investment plan.