The Story Stock MarketGary Mishuris, CFA
I was watching the stock prices of our companies drift down, day by day. The market value of our portfolio slowly decline. No fundamental news. Just a steady drip-drip-drip of lower stock market prices.
As a two-decade investing veteran, I have seen a thing or two in the market. I started as a professional investor a couple of months prior to September 11th, 2001. The bear market that followed the dot-com bust was my first trial by fire as an investor. I remember sitting in a conference room with other analysts, guessing where and when the S&P 500 would bottom out.
I cringe when I think about how futile such an exercise was and the opportunity cost in terms of bargain hunting that I was paying by spending my time in this way. But that is the truth – that’s what I did two decades ago. I am not proud of my behavior then, but I learned from that mistake and grew as an investor.
That experience helped me weather the 2008-2009 market crash much better. I did a fair bit of bargain hunting and buying distressed securities. Probably not as much as I could have though, as in the back of my mind was the thought of “what if this unprecedented financial crisis is truly different?” Overall I did well and kept my temperament at an even keel. I am sure I missed some distressed investments because of my caution, but it also made me pass on the really cheap-looking financial stocks that a number of legendary value investors were buying hand over fist. You don’t need me to tell you how it worked out for them.
Having invested through two market crashes, the COVID-induced one of 2020 was much easier. The talk about “unprecedented” this and “unprecedented” that didn’t cause me to stray from my job of acting rationally, and I was able to invest in some incredible bargains for the partnership. My earlier formative experiences (and mistakes) have allowed me to do much better this time. Experience, learned from properly, matters a lot in investing.
Why am I sharing all of this with you? My point is that I have experienced a wide variety of market environments first hand, and have studied the history of many more. And yet, this drift down of most of the stocks in the portfolio was puzzling. It wasn’t preceded by some market shock or by negative company-specific developments. It was happening in a complete vacuum of plausible explanations.
At the same time, stocks that were already priced at the limit (or beyond) of rationality, kept drifting upwards. Again, no real news. They were floating up, just as steadily and inevitably as our stocks were drifting down.
And then it hit me. There was an explanation. We own a bunch of boring, cash flow-rich companies in the partnership’s portfolio. They are priced at a level which implies a very pessimistic view of their future – a substantial decline in cash flows from current levels that my analysis leads me to believe is unwarranted by the facts. However, they lack one important characteristic which is currently greatly prized by the current market: a story!
Stories, however, are plentiful among the companies whose stocks have been drifting up. Stories about how their current businesses will grow at astronomical rates for many years. Stories about how they will come up with completely new business lines in the future. Stories about how legendary their CEOs are.
So the recent pattern appears to be quite simple. If the company has an exciting story about a rosy future, people bid up its stock. Other people notice, get excited about the story, and do more of the same.
On the other hand, if a company doesn’t have an exciting story, people on the margin abandon its stock. It doesn’t matter how cheap it was or how undervalued relative to intrinsic value. If it was a cheap stock and was at 7x free cash flow, then why can’t it be a cheap stock and be at 6x free cash flow? Or 5x? It’s still just a boring company with no good story.
You might be wondering why this can’t go on forever and what will cause things to change. Let me assure you that everything I know about investing strongly suggests that this too shall pass, like so many of market’s excesses in the past. What I can’t tell you is when. It might go on for weeks, months or maybe even years. However, as long as the management teams of our investments do intelligent things with the cash flows that our companies are generating, our holdings should increase in value over time. And when the gap does close, we should be amply compensated for the wait.
Since so few things in investing are truly new, perhaps it’s appropriate to end with a quote from Benjamin Graham:
Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic change or deterioration in management.
That is how I am spending a good portion of my time – making sure that my investment theses are sound, looking for ways that I can be fundamentally wrong about the companies and making sure that managements are deploying the companies’ cash flows in a way that increases intrinsic value. Value investing is supposed to be painful at times, which is what deters the vast majority of investors from utilizing this approach. One of my biggest advantages is the temperament to stay rational regardless of what is happening in the market, and to continue to make decisions based on the relationship between price and value. That is what I have done in the past, and that is what I will do going forward, however long the story stock market lasts.
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Article by Gary Mishuris, Behavioral Value Investor