We generally don’t delve into megacaps unless there is unusual stress or
heightened negative perceptions regarding the underlying story. In general,
when it comes to uncovering potentially mispriced securities, we believe
there are two types of investing: 1) “needle in the haystack” investing;
and 2) “the tide goes out” investing.
When it comes to needle in the haystack investing, it’s challenging to
obtain an “analytical edge” with the world’s largest companies, because
there is an army of smart analysts and investors researching such stocks,
so they are priced much more efficiently than less-followed stocks during
normal times. Simply put, the odds of finding the proverbial needle in the
haystack are higher when fewer investors are looking in the same stack
(among some nanocap and microcap names, we occasionally have virtually no
When megacap prices become attractive
However, occasionally there are periods when the largest stock markets and
the most analyzed big companies become attractively priced. In such
stressed times, much of the analytical horsepower of the well-paid army of
investors and Wall Streeters is muted. In essence, “the tide goes out” in
periods like the financial crisis of 2008-09.
The stock prices of well-known companies become attractive because the
actions of investors are driven by emotions based on the latest headlines,
rather than on any disciplined analytical rigor. Moreover, sometimes
selling begets more selling, as some players are forced to dump their
positions, irrespective of long-term fundamentals. Indeed, we believe the
dangers and opportunities from “tide goes out” investing are possibly even
more acute today as the rise of ETF investing make it easy to sell groups
of securities at the push of a button.
During these times, one needs a “behavioural edge” (to be inversely
emotional) instead of an analytical edge, and to have the grit to buy
securities when the narrative becomes challenging. The same is also true
for individual securities. The future is generally less predictable than
commonly believed, so when negative narratives on near-term outlooks drive
down stock prices, it can create opportunities. Indeed, by using his
behavioural edge when the tide goes out is practically the only time that a
large cap investor like Berkshire Hathaway’s Warren Buffett is able to buy
any real bargains.
Although we will not comment on specific securities, the prospect of an
increase in regulation is a good example of just the kind of buzz that is
needed to create attractive prices for well-known megacaps.
People tend to buy and sell individual stocks based on “stories.” But
stocks aren’t usually cheap and popular at the same time. Recall, there are
really only two kinds of companies: companies that are having
problems and companies that are going to have problems. And the
companies that are having problems (perceived or real “bad
stories”) are generally more likely to be mispriced by investors.
Patience is still a virtue
Nevertheless, we believe patience is another key component of behavioural
edge. Don’t necessarily jump at the first stock price dip until you have
had a chance to assess the impact from the change on the company’s
fundamentals (analytical edge). It is important to keep in mind that
“problems” can persist for many quarters or even years. After all, the only
difference between salad and garbage is timing.
Finally, although patience tends to be a very underappreciated contributor
to the wealth creation process, sometimes too much patience can be a bad
thing. True story side note: We actually had a sizable open bid for Amazon
in late 2014 that just missed getting filled by about $10 per share when it
was trading at sub-$300 levels. That error of omission caused us to miss
+$1,200 per share on the upside, or a five bagger in less than four years.
We correctly identified the potential opportunity which the market
misunderstood, but we were “too cute” on our price execution in hindsight.
For multiple quarters, we had patiently watched as Amazon’s stock price
kept falling and falling. Although we felt the stock was a bargain, we
thought we would get still get filled by being a just little bit more
patient. We were wrong. The stock took off and has rarely looked back.
The lost upside still stings, particularly because our long-term thesis was
correct. Reflecting on the lessons from investment post mortems is
important. One important lesson is to not to get too cute on pricing when
bidding on Compounders. Another lesson from this error of omission was that
it further reinforced the
secret rule of investing #2 as noted in our previous commentary.
Felix Narhi, CFA, is Chief Investment Officer and Portfolio Manager at PenderFund Capital Management.
He works alongside David Barr, Pender’s President, in setting the
direction of Pender’s overall investment strategy. This article first
appeared in the
Pender blog. Used with permission.
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