Good stock, good business, good investment
In a fast-rising market post the March correction, many may start to feel like heroes. With earnings falling, and stock prices rising, investing may seem easy to some, and confusing to others. Even bankrupt companies recently saw their stocks not only rise, but also become the “hottest stocks” (Bankrupt Hertz is one of the market’s hottest stocks. That’s a bad sign – CBS News June 12th, 2020).
To find our bearings, let’s focus on three investing terms that are often used interchangeably, but whose meanings and proper use are often very different: good stock, good business, good investment. In today’s volatile, confusing, and challenging markets, understanding of the three distinct concepts is especially important, and can not only help investors navigate the markets, but also potentially save them a lot of trouble, and money!
This is how we define these terms:
A good stock is a stock that goes up and up. There might be a good reason behind its rise, such as higher profitable growth. Often, though, mere investor sentiment seems to drive many high valuations. Very often the stock’s ascent can be driven by enthusiasm for the story the company shares with investors. Tesla (the electric car manufacturer) is one example of a “good stock” that keeps rising, though profits remain elusive. Good stocks attract momentum investors who only chase the rising prices. Their returns can be very high — as long as the momentum continues.
The trouble with momentum is that eventually it ends; the market wises up and starts to doubt the story. A good example in today’s market would be Netflix. Its stock has risen on ever-higher user growth for many years, and it quadrupled between late 2016 through 2018 alone. Since then the stock sold off twice, and hasn’t recovered its 2018 peak price until two years later, mid-2020. I’d think that the captive audience kept home due to nationwide and worldwide lockdowns definitely helped for now to improve the sentiment around the stock. This 22-year-old company (not exactly a brand-new startup) has been burning cash to provide a constant stream of new high-quality content to users. The problem is that the users not only don’t want to pay for the service, but also share their memberships with a number of friends — further lowering the company’s revenue potential, and thus profits.
We have nothing against Tesla’s electric cars or Netflix’s streaming content; I’ll even admit that those companies have made money for many investors. We believe the challenge with stocks that rise based on hope and growth is the investor’s exit strategy. You need to guess when to get out without losing more than you initially invested. The story and the excitement around the stock do matter at least as much as the fundamentals, but we have no way to measure them. There’s too much guesswork involved: not only whether the price will keep rising, but also what other investors are thinking and hoping for. That’s a game we choose not to play.
A good business is one that can produce growing and lasting profits. It has a competitive advantage, for one reason or the other, it stands out, and the competition has a hard timing taking their businesses away. It could be its well recognized and trusted brand, size, scale, technology, distribution or a combination of all the above. A good business is able to maintain and grow a loyal customer base which is willing to pay a sufficient price for the goods or services that allows the company to make a respectable profit. There might be a few thousand publicly-traded stocks in the U.S., but in our opinion, only a fraction of those have a good business behind them. For a disciplined investor, that list may consist of only a hundred companies or so. When we call something “a good business,” that doesn’t always mean than its stock keeps rising and rising. As a matter of fact, if we overpay for a good business, we may walk away with a loss over time, as the market closes the gap between the price and the value. (As you may remember from earlier articles, we define “price” as what we pay, and “value” as what we get.)
A good investment is one that produces a respectable long-term return in the form of price appreciation, and possibly even dividends paid out over time. If we correctly identify a good business, and have the patience to wait for the price to become attractive to buyers, we believe there’s a fair chance to turn an investment into a “good investment.” If earnings grow or recover, and we didn’t overpay for the business, the stock price is likely to rise, too.
The lower the price and the better the business, the better positioned we are for investment success.
Of course, we, like other investors, are seeking out stocks that go up, but what we like to think makes Sicart different is how we select them. We first need to see a good business whose shares are selling at a good price.
Our investments may turn into “good stocks,” as defined above. Still, there are many good stocks that in our opinion don’t qualify as good investments — not because their share price won’t rise steadily, but because of the risks we’d take on had we chased them. If a good stock doesn’t have sufficiently strong fundamentals to back its rise, it carries a risk of dropping precipitously, possibly even to zero. Long-term investors are in no danger of forgetting the dotcom-era stocks that rose fast and high, and fell to zero soon after, wiping out many a nest egg.
Next time you hear good stock, good business, and good investment in one sentence, remember how these three are not always one and the same. It pays to be able to tell them apart, especially if you want to not only make money, but also keep it.
The information provided in this article represents the opinions of Sicart Associates, LLC (“Sicart”) and is expressed as of the date hereof and is subject to change. Sicart assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by Sicart at any time without notice.
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.