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Part 1: Fundamentals, value, momo, and how markets are priced

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January 10, 2011 – Comments (15)

In the last week or so I have had an interesting insight into how other people view the market and the securities tha compose it, how I do, and got a comment from my former biz partner that shed alot of light onto all of this. 

First, an insight into how I, and other people, view the market.  I tend to look at stocks from a value only perspective.  I don't care if they are dropping or if the technicals are bad, I just look at vaue, for better or for worse (sometimes its worse, sometimes better).  

However, some other people tend to notn see value at all and see only fundamentals.  This occured to me first when readin Whitney Tilsons most recent investor letter.   In it he said this:

" Our analysis of Netflix generated much more attention than we anticipated, which resulted in dozens of emails with great feedback, both agreeing and disagreeing with us, which is what we’d hoped for.  The most interesting feedback, which we hadn' expected, was from the CEO of Netflix, Reed Hastings, who emailed us in a friendly way, saying he had no problem with short sellers, but disagreed with our analysis and published an open letter telling us why we shouldn’t be short his stock (http://seekingalpha.com/article/242653-netflix-ceo-reed-hastings-responds-to-whitney-tilson-cover-your-short-position-now).  He made some good points and it helped us learn more about him and his company and we appreciated his friendly tone (other CEOs should take note that, if one is going to espond to a short seller, this is the best way to do it…).  He sure makes it tough to be short his stock - he's been a great CEO and how do you not like a guy who served in the Peace Corps for two years in Swaziland?

As we made clear in our letter, we think highly of Netflix, just not its valuation and as value investors,price matters a lot.  If we were to summarize the main deficiency in Hastings letter and nearly all of the bullish-on-Netflix emails we've received, it's that there's no discussion of valuation.  They would read the same if the stock were trading at 15x earnings or 75x earnings…but from our point of view, that x valuation gap is the difference between a great long and a great short."

And precious-metals lovers often offer similar sentiment.  I can easily imagine this conversation occuring:

Checklist says "why would you want to be long gold, its way, way above its historical trend of bein worth $1 adjusted for inflation???!!!"

PM lover says "you dolt, governments are printing money, this will debase the currency, this will result in inflation, and gold does well in inflation as does silver, commodities, etc."

Checklist says "but gold has already priced in a drop in the value of the dollar of 50% AT LEAST, if not 60% or 70%"

PM lover says "you just don't get it.  fiat currencies are being debased and there will be inflation.  Golds going up, way up"

Checklist says "at what price do you think gold is fairly valued?"

PM lover says "gold is in short supply, its goin up"

A WHOLE LOT, AND I MEAN A WHOLE LOT, of precious metal discussions don't consider valuation, only fundamentals.  And that is true of commodities in general as well, "goldbugs" (no offense at all intended) aside.  

To the value frame of mind, the "fundamentals only" frame of mind seems a bit crazy, people chasing things regardless of any valuation as long as the story makes sense and the momo is good.  Presumably, to the "fundamentals" frame of mind, checklist and other value frames of mind seem at least as crazy.  "what is that moron doing buying banks in july 2009, doesn't he know that the banks have more problems than a guy with steaks taped to his back in a lions cage?". I am not knockin the fundamentals only frame of mind, I am just observing that it is one I cannot remotely relate to, and I wonder if a value frame of mind seems equally odd to those folks.  To some people NFLX is a fantastic buy because it has growth, good balance sheet, and good momo.  To some people its insane because it has a pe of 75.  Ditto gold, etc.  Apparently, neither side understands the others viewpoint.  

This discrepancy between value and fundamental/momo frames of mind is fascinating to me.  I think that the majority of people are probably wired for fundamentals/momo.  I think, frankly, it would be extremely hard to argue this point.  Simply take these:

exhibit A)  at the march 09 bottoms (at or around) one was widely mocked for buying stocks, especially financials, because the fundamentals of banks were so bad.  Banks were broke, they were going down, they were screwed.  Never mind that my portfolio of financials (almost all insurance and BDCs) had a price/book of 0.11, for real, at the march bottoms.  By late 2009 it was trendy to own financials, even at 0.5 or 1.5 x book.

exhibit B)  the same, but opposite, in the tech bubble

exhibit C)  in 2000 the #1 reason given by proponents of stocks and buy-n-hold investing to buy stocks over gold was recent performance history. i'm guessing here, as I wouldn't have read much about the markets back then

exhibit D)  in 2010 an EXTREMELY common plug given for gold and commodities is how badly they've outperformed stocks since 2000. 

I submit to the group that overall I think that the human mind, in general, is wired for fundamentals/momo more than value.  Thats the basic hypothesis for part 1:  the average human mind is more wired for fundamentals/momo than it is for value.  

And now I shall observe tht, in writing this post, I have come to realize that this is true for me as well, hugely, in my personal life.  I don't think i'm a "value" friend, i'm a fundamentals/momo friend who spends more of his time hangin with his latest and shiniest friends than oldest and, at the core of things, most dear.  Interesting.  

15 Comments – Post Your Own

#1) On January 10, 2011 at 5:50 PM, checklist34 (99.70) wrote:

as all my posts are:  quickly typed and never proofread, so probably some type-o's.

and, its critical that you all understand that this post was written by a man with horrible looking underpants.  Don't believe me?

I was babysitting the neighborhood kids today and wrestling with them on the bed, when one grabbed ahold of my jogging pants and jerked them part way down.  He then exclaimed, running around the house, with tremendous pleasure that 

"I saw checklists underpants, I saw checklists underpants"

His younger brother then announced 

"Chetwist, yous has some terrible looking underpants.  Those are really bad underpants."

And dissappeared for 10 minutes.  Then he reappeared, and announced that he had gone into the laundry room to observe the quality of my other underpants, and offers this

"Chetwist, underpants are supposed to be white or have spiderman or something cool on them.  Your underpants look all dumb with all dumb colors, and they look like shorts, they don't even look like right underpants at all"

So, you have been warned, this post was written by a man who apparently is unable to properly choose underpants.

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#2) On January 10, 2011 at 6:30 PM, Momentum21 (82.23) wrote:

Chet - another nice one. : )

In playing this game I would think that one is more likely to get the instant gratification that momentum plays offer. The trends gets talked up and it is almost like advertising, driving waves of investors into a self-fulfilling outcome. Why not try to ride the wave?

More often than not value stays cheap for longer than people like, so we move into the "shinier" investment that we have been hearing so much about for fear of missing the train.

In the case of NFLX I think that this favor can create some additional opportunities for a company to add-value perhaps (not always but it can)...with precious metals I am not so sure.

I am not the type to buy a NFLX at these levels but you won't catch me getting cute like Whitney on the short side (if in fact he is truly net short). What better way to get yourself attention though? I am sure this becomes a win-win for him regardless.

I have dabbled in using silver as as short hedge but I am not fond of that move either. You need more luck to be a good shortie...or maybe just need to be able to handle more pain.   

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#3) On January 10, 2011 at 6:30 PM, Momentum21 (82.23) wrote:

Chet - another nice one. : )

In playing this game I would think that one is more likely to get the instant gratification that momentum plays offer. The trends gets talked up and it is almost like advertising, driving waves of investors into a self-fulfilling outcome. Why not try to ride the wave?

More often than not value stays cheap for longer than people like, so we move into the "shinier" investment that we have been hearing so much about for fear of missing the train.

In the case of NFLX I think that this favor can create some additional opportunities for a company to add-value perhaps (not always but it can)...with precious metals I am not so sure.

I am not the type to buy a NFLX at these levels but you won't catch me getting cute like Whitney on the short side (if in fact he is truly net short). What better way to get yourself attention though? I am sure this becomes a win-win for him regardless.

I have dabbled in using silver as as short hedge but I am not fond of that move either. You need more luck to be a good shortie...or maybe just need to be able to handle more pain.   

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#4) On January 10, 2011 at 7:47 PM, checklist34 (99.70) wrote:

momentum, thanks.

"value stays cheaper longer than we'd like".  That can certainly be true, and that is a lesson I guess I am just learning.  

I first set into the market in early 09 to "buy value", and after 2 months of heinous market drops, that "value" took off like a rocket with only two truly significant corrections until april 2010.  Pretty much instant gratification with stocks like ash, tck, dow, xl, hig, gnw, et al.  

But, "value" that i've bought since then has certainly not necessarily responded as impressively.  PFE for one, I've been sitting on for 10 months now with less or more no gains.  For the next 10-20 years it'll work great, but in the meantime some distinctly un-value things like GLD and NFLX have certainly done far better.  RJET is another example, putzing around.  I'm up on it like 25% over 16 months, which is fine, but its alot less than the performance of my portfolio and maybe even less than the market itself.  

I've seen some charts that are pretty strange, where some value stock or other sits for 5 years chopping a bit but mostly flat and then suddenly 5-bags.  sometimes to drop back down.  

The value stocks only really move once they become momo stocks.  

live and learn

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#5) On January 10, 2011 at 8:04 PM, WillSurfForFood (77.18) wrote:

I liked your post except I found it a little confusing contrasting "fundamental" vs "value" investing because I always thought they were the same and "technical" trading was for people who studied charts.

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#6) On January 10, 2011 at 8:16 PM, checklist34 (99.70) wrote:

willsurf,

   Apologies, and very good point, I appreciate it.

When I say "value", I  mean low price/earnings, low price/book, low PEG, maybe a beaten up stock, maybe a turnaround play, maybe a cyclical company about to turn north.  Etc.

When I say "fundamental" in this post I mean companies whose industries and business are good.  NFLX, for example, or AMZN as another, for FFIV, or CRM.  Hard to deny that some good things ar ehappening for these companies and industries, but the valuations are so extreme that at this point I don't think there is any way to call them "value".  So when I say fundamental/momo I mean "there's a good story here and the stock is movin up" -vs- when I say value I mean they are cheap on some absolute scale of valuation.  

hope that helped. 

I am probably frequently, as I never take any time to pre-write or proofread my posts, guilty of assuming that what I say is clear when it may not, I really appreciate the question.

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#7) On January 10, 2011 at 11:02 PM, checklist34 (99.70) wrote:

like this:

amazon has lets say 25% growth rate, pe of 70, p/b of 10, p/s of 3 or whatever, close enough.

momo only:  "this sucker is going up, lets get on the train before its gone!"  OR, if AMZN falls significantly "this sucker is toast, pe of 70 is a joke, get out now"

fundamental only:  "great balance sheet, good growth, industry leader, growth industry, lets buy"

value only:  "pe of 70?  you've got to be kidding"

fundamental/value:  "pe of 70, with growth rate of just 25% is not very cheap, plus at some point growth has to slow due to the size effect and future competition from specialized online stores"

fundamental/momo:  "amazon is goin up because of the (fundamentals listed above)" ...  etc. or if amazon starts tankin then it will be because of the possible future competition or something.  Its basically momo, but they justify it elaborately and will never be caught holding a stock that is in a bad industry etc. 

That was hastily typed, but maybe that helps

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#8) On January 10, 2011 at 11:14 PM, checklist34 (99.70) wrote:

one thing, though:  shorting levered ETFs, if you have a brokerage that will work to get you the shares, can truly be a very real-life profitable enterprise. 

risky if timed wrong, and not for the faint of heart, but I have made plenty real life $$ this way

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#9) On January 10, 2011 at 11:18 PM, checklist34 (99.70) wrote:

i smoked alot of crack, apparently, and posted #8 in the wrong thread.  sorry

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#10) On January 11, 2011 at 12:33 AM, Valyooo (99.41) wrote:

checklist, which brokerage do you use?  because tradeking always has fees and very often does not have shares available.

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#11) On January 11, 2011 at 1:13 AM, Option1307 (29.75) wrote:

Your posts are the best there are, keep them coming! +1.

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#12) On January 11, 2011 at 9:47 AM, dragonLZ (99.38) wrote:

Thats the basic hypothesis for part 1:  the average human mind is more wired for fundamentals/momo than it is for value.  

I think the reason for that is the fact that fundamentals are an exact science (add and subtract a few numbers and there you have it - most of the folks can do that), while determining value is an art (the value is in the eye of the beholder - and not many folks can determine it, not even close).

You for example, were able to determine the value of stocks in March of 2009 much better than the average folks, but couldn't determine the value of Gold (it's my understanding you were never bullish on gold).

Or take for example somebody who buys a piece of an old furniture (a chair) for $6 at a garage sale, then at the antique road show (watch it on PBS) finds out some crazy people value it at $30,000.

The guy who sold it thought it's woth $6 (he was probably right on the fundamentals - the chair was old, and he had some newer ones that looked much better, which he was selling for $9).

The guy who bought it probably thought he can sell it for $300 (he thinks he can spot a deal when he sees it - although his wife probably thought he's a moron wasting his money once again). However, the real value was determined to be $30,000 as that's the price chairs like that are selling for at the market of people who know the antique stuff.

p.s.

This is not to say that at some point the same chair won't be worth "only" $2,000 (e.g., people lose interest in that particular kind of chairs or find out the guy who made them back in 16th century had children working in his shop, etc.) or it might be worth $200,000 (e.g., people get even crazier than they are today).

Valuation is a tricky thing... :)

Good Luck.

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#13) On January 11, 2011 at 11:59 AM, anchak (99.84) wrote:

chetwist - surely is funny!

 

I send you an email

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#14) On January 11, 2011 at 2:07 PM, outoffocus (23.09) wrote:

Whats "momo"?  Only "Momo" I know is on Avatar the last Airbender,

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#15) On January 11, 2011 at 3:00 PM, SkepticalOx (99.44) wrote:

#14: momo is slang for momentum, as in a momentum stock or a momentum play (buying a stock that's going up because you think it's going to go higher, or vice versa).

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