By now, everyone who follows the stock markets even a little knows the story of GameStop. The company that sells video games from small stores in shopping malls saw its shares go from $4 to $480 in a few months in spite of dropping sales, persistent losses, malls being closed due to COVID and the entire gaming industry moving to online download. Nobody contends, or pretends, that the stock is actually worth anything like that amount, but as with all things for sale, the price was determined by supply and demand. In this case, demand was driven by hordes of neophyte on-line account holders, many at zero commission broker Robinhood, who bought shares en masse as part of a “movement” to punish hedge funds and other villainous capitalists.
Calling this kind of market action investing is both wrong and an insult to investors. It is really not even speculation. It is, instead, something altogether new. Zero commissions and the internet have turned buying stocks into a strange combination of gambling, entertainment and crowd dynamics. Almost all the young buyers (and they are overwhelmingly under 35) freely confess that they know little to nothing about the stock market, even less about securities analysis and would have no idea how to come up with a rational price for a company like GameStop or any other. They are in it for fun, for entertainment, to be part of something big, and maybe, to make money. Undoubtedly, some made a lot of money as the stock went up to 120 times its price at the start of the craze. Equally undoubted is that many lost a lot of money as the stock plunged from $480 to under $60 in a couple of weeks in February.
GameStop is at the extreme end of a stock market craze, but it is far from alone. Many new entrants to the market have been valued in the billions, even though they lack profits. Most market observers know that Tesla is now more valuable than all the other car companies in the world combined, even though it sells fewer than 1 million cars per year and absent environmental credits, makes no money. Dozens of Special Purpose Acquisition Companies (SPACs), empty shells that raise money on the promise of buying some currently undetermined company at some time in the future, have raised billons of dollars. Many of these shells are promptly valued at 50% more than their only asset, cash in the bank. Buyers of SPACs are paying $1.50 to own a dollar.
At the less extreme but still frothy end of the market, some of these new market entrants have lost billions for their holders as the stock prices slowly settle back towards more realistic values. DoorDash, benefitting from COVID and the closure of restaurants, climbed to $256; it is now at $133, a drop of 48%. Zoom, which so many of us use on a daily basis, hit a high of $589 and is today trading at slightly more than half of that, $321. There are many more examples.
For us, as investors seeking to buy shares of profitable companies at prices that reflect their measurable economic value, the question is what, if anything, the changes we are seeing in the stock markets, and the emergence of a new breed of stock-buyers, means for us and for our clients. Should we be changing our behaviour? Should we be following the trend and buying low value stocks at very high prices? Should we admit that our notion of how stocks should be valued is outdated and has been overtaken by a new paradigm?
Our answer to all these questions is no. We believe that doing what we have been doing for the last twenty-three or so years is not only still reasonable, but more, it remains the best method for long term investors to achieve financial success in the stock markets. To put it another way, we know what we know, and we certainly know what we don’t know. We know how to use fundamental analysis to value stocks. We know how to build diversified portfolios of profitable companies that tend to make money over time. We don’t know how to play the momentum game. We don’t know how to speculate in highly priced unprofitable companies.
It is said that the stock market is driven by greed and fear, and the last twelve months have seen plenty of both. Only a year ago the markets were dropping by 5% or more per day and nobody knew what might happen next. Only six months ago stocks were climbing by similar amounts and speculative issues were going through the roof. Now perhaps there is a third driver: internet frenzy. We don’t know how long this will be a factor, what parts of the market might be affected (or perhaps more accurately, infected) and what, if anything, regulators might do. For us, to the extent possible, it will be business as usual. Are we old and stodgy and out of step with the new reality? We don’t think so. What we do works.
Hey you kids, get off my lawn!