In most periods the investor must recognize the existence of a speculative factor in his common stock holdings. It is his task to keep this component within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration. — Benjamin Graham
Ben Graham had it right. Within every stock price is a speculative factor.
It’s why a company like Align Technology can have a market cap of $31 billion one month and $23 billion a month later. It’s why AMD can drop from $36 billion to $26 billion in a month. And it’s why Nektar Therapeutics can go from $11 billion to $7 billion in the same period. That’s a change of -39%, -38%, and -37% respectively in market cap over one month!
Why those three stocks? Maybe you’ve never heard of them, but if you own an S&P 500 fund, you own all three stocks. And those three stocks are the worst performers in the S&P 500 since it hit a high on September 20, 2018 (and they’re not isolated either).
I was going to post another list like I did a few weeks ago, only showing performance since the S&P 500’s September high, but it would probably depress some people. The past month’s returns don’t look good if you hate seeing losses. Of course, none of it says anything about anything really (in other words, none are recommendations). AMD is still up 71% on the year, Align Tech is basically at breakeven, and Nektar (whatever it does) is -37% YTD.
Graham made another point in Security Analysis that is often ignored:
…the market is not a weighting machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly emotion.
Why does a company’s “value” change so drastically in a short time? Because price is not the same as value. There’s a speculative element within every price that changes based “partly of reason and partly emotion.”
In The Little Book that Still Beats the Market, Joel Greenblatt’s explanation as to why is the best:
For pretty much any company that my students name, the range of high and low prices, over the course of only one year, is huge. Does this make sense?… No! It makes no sense that the values of most companies swing wildly from high to low, or low to high, during the course of each and every year. On the other hand, it seems pretty clear that the price of the shares in most companies swing around wildly each and every year…
So I ask my room full of smart, sophisticated students to try to explain why. Why do the prices of all these businesses move around so much each year if the values of their businesses can’t possibly change that much? …
In fact, it’s such a good question that professors have developed whole fields of economic, mathematical, and social study to try to explain. Even more incredible, most of this academic work has involved coming up with theories as to why something that clearly makes no sense actually makes sense. You have to be really smart to do that…
Well, here’s how I explain it to my students: Who knows and who cares?
Maybe people go nuts a lot. Maybe it’s hard to predict future earnings. Maybe it’s hard to decide what a fair rate of return on your purchase is. Maybe people get a little depressed sometimes and don’t want to pay a lot for stuff. Maybe people get excited sometimes and are willing to pay a lot. So maybe people simply justify high prices by making high estimates for future earnings when they are happy and justify low prices by making low estimates when they are sad.
But like I said, maybe people just go nuts a lot (still my favorite). The truth is that I don’t really have to know why people are willing to buy and sell shares of most companies at wildly different prices over very short periods of time. I just have to know that they do!
As a value investor, months like these are fun. Not scary fun either. Because when emotion overpowers reason the drastic changes can present opportunities to profit:
Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. — Benjamin Graham
- Humble Exits – M. Housel
- Lottery Math is Human Math – S. Godin
- The Economic Cycle that Just Won’t End – J. Rekenthaler
- The George Costanza Portfolio – AQR
- Remembering Walter Mischel with Love and Procrastination – M. Konnikova
- Graham & Doddsville Fall Edition (pdf) – Columbia
- An Alternative History of Silicon Valley Disruption – Wired
- The Automation Charade – Logic
- Pictures at a Basketball Revolution – The Ringer