Columns · investing · The book

Does Your Index Fund Have “Diamond Hands?”

Yes, these are Roaring Kitty’s hands

Anybody who has read my first book knows that I take a mostly dim view of active management. Still, this week I wrote about an episode central to my upcoming book that proves an exception: how active managers handled meme stocks.

When the market values of GameStop, and AMC went up several hundred or thousand percent based on no change in their fundamental value, active fund managers did the obvious thing – they dumped them and moved on. But index funds, which tend to beat those active managers in the long run, held tight with “diamond hands” because they have to. In some cases they bought more at inflated valuations as their assets grew or as those companies issued shares to their now almost entirely retail base of owners. The only passive investor I’m aware of that was able to take the money and run was Dimensional Fund Advisors (I interviewed their deputy head of portfolio management, Mary Phillips, for the column). Even today, with their share prices (in my opinion) still grossly elevated, the main owners of the meme stocks are the self-described “apes,” many of whom believe there is still a short squeeze looming because of phantom shares.

Active fund managers shouldn’t look a gift primate in the mouth. The last year that funds benchmarked to the Morningstar Large Blend category outperformed that benchmark was in 2013 and before that it was 2009, according to a study by Hartford Funds. Index funds have strung together several consecutive winning years over their active counterparts during extended bull markets in the past, too—for example between 1994 and 1999.

This is one of those cases when owning an index fund can be frustrating. As of today, the top two holdings in the Russell 2000 Value Index – let me repeat, “value” – are AMC and Avis Budget Group, another company that recently got the meme treatment for discussing the addition of electric vehicles to its fleet. Whatever.

Columns · investing

Aching Backs = Big Bucks

Sometimes a fairly small company that I know will otherwise fall through the cracks catches my eye. The latest one is “The Joint,” a fast-growing chain of storefront chiropractic clinics. I learned a lot in the process of reporting it, most of it about the business of franchising rather than the iffy science of back “adjustments.”

The chain had been on a rocket ship ride with its stock up by 3,000% since the current CEO took over in April 2016. Then it took a tumble on a short-seller’s report. I don’t think that the report blew the lid off of a flaky company, as some reports do. But it correctly pointed out that the stock was pricing in some unrealistic growth.

Probably the most analogous company, and one most readers will know, is Massage Envy. Its founder was CEO of The Joint for a while and he sold Massage Envy in 2008 when it was still in its growth phase. It has been stalled for the past decade or so.

Will this do better? Back pain is a big problem, but The Joint has lots of imitators like SnapCrack and Chiro Now with similar no-insurance, subscription-based formulas. It has around 1% of the overall U.S. market and is the biggest storefront player so there is plenty of room to grow. Unfortunately, its revenue opportunity isn’t as big as it seems because clinics charge a lot more and offer more services. The Joint’s market value of $1.2 billion already assumes it will snatch a large share of a pretty big pie at more than 100 times projected earnings for 2023 when its management thinks it will reach 1,000 stores.

Some stores’ impressive profits represent in part an owner-operator’s sweat equity. For both the occasionally underemployed practitioners and their patients, a storefront’s simplicity has been appealing compared with high-pressure clinics. If one views the chain as being at the very early stages of disrupting its sector and assumes that its head start will make it the McDonald’s of back pain then its valuation could be a bargain. But if it is more like another Massage Envy then the stock’s price and its future cash flows are seriously misaligned.

“Aching Backs Equal Big Bucks, but an Adjustment Looms” WSJ, October 16, 2021

Columns · investing

All That Glitters Isn’t Goldman

If you were to hold a contest to design the most-enticing name for a company right now you couldn’t do much better than “RocketFuel Blockchain.” And if you were to pick a bank to associate with it now or really any other time than Goldman Sachs would top your list. But read the fine print before you buy shares in a company by that name written up by Goldman … a lot of people seem not to have bothered.

“Following the release on April 1 of a news release titled “Goldman Small Cap Research Publishes New Research Report on RocketFuel Blockchain, Inc.,” the penny stock surged by as much as 335% in four days. Several lines down is a notice that the research firm, which accepts payment for reports, “is not in any way affiliated with Goldman Sachs & Co.”

And the report’s subject, formerly known as B4MC Gold Mines Inc., and before that as Heavenly Hot Dogs Inc., doesn’t appear to have any revenue and maybe not even a product, based on litigation about a patent that expired. The report was written by an analyst who, while he appears not to have lit the world on fire at more-established firms, has an auspicious name: Rob Goldman.”

Columns

Please Be Kind, Rewind

The documentary category is the first one that comes up when I scroll through Netflix. One of the top choices it offered me was “The Last Blockbuster” which is, as you might have guessed, about the very last Blockbuster Video store in the world (there was one in Perth, Australia that closed in 2019). The chain went bankrupt in 2010 and is sort of a punchline these days, but it’s nice to see at least one hanging on for now. I wrote a short Overheard about it on Friday.

The ironic thing is that it was Netflix that basically put Blockbuster out of business and is now profiting from a film about the very last one. Back in 2000 Blockbuster made what is one of the greatest business blunders in history by turning down an offer to buy Netflix for $50 million. It is worth almost 5,000 times that much today.

According to The Oregonian, the documentary’s popularity has revived the store’s fortunes with people buying lots of Blockbuster swag. If they’re one of the few people on the planet without a Netflix account, they can even rent a DVD copy of “The Last Blockbuster” there.

Columns

Not Quite Supertankers

One of the more overused clichés is “it’s like turning around a supertanker.” As a landlubber, I’ll go ahead and assume that’s true in the literal sense. Financially-speaking, though, the business of hauling oil across the world certainly turned on a dime in the past year. Daily earnings collapsed by 99% from last March to the past week as carriers capable of holding two million barrels became very expensive floating storage tanks when there was a glut and are suddenly hunting for cargoes as big exporters try to buoy prices.

Jinjoo Lee and I wrote about the dramatic turn. Our takeaway was that things are looking up for this extremely cyclical business.

A year after their incredible good fortune, an equal basket of four energy shipping firms has lagged the S&P 500 by 70 percentage points over the past year and is right back to its long-term average ratio of price to book value. With life and energy demand returning to normal, this is no time for investors to walk the plank.

https://www.wsj.com/articles/not-so-supertankers-deserve-a-look-as-pandemic-fades-11615815253
Columns

Bitcoin Traders’ Ship Came in … Then it Was Sold for Scrap

Some very interesting characters who advocate building homes on the world’s oceans tried to make lemonade out of lemons, but it went pear-shaped. They picked up a cruise ship cheaply since the industry is still idled by the Covid-19 pandemic and began auctioning cabins off to cryptocurrency enthusiasts — in dollars of course — to use as a floating base off the coast of Panama. The group rechristened the former Pacific Dawn the MS Satoshi.

Always do your research before an impulse purchase! As I wrote in a brief “Overheard,” the normal maritime laws still applied, even in a country known for its flags of convenience. The insurance requirements proved ruinous.

“Unfortunately, we will not be able to proceed because of archaic big insurance companies that cannot adapt to innovative new ideas,” wrote Ocean Builders Chief Executive Grant Romundt in an email to investors.

According to a Facebook fan page, MS Satoshi was sold for scrap and was last reported to be steaming to a yard in India to be broken up.

Columns · investing

The Curse of Star Managers

I edit more and write less these days, but even when I do write I often forget to link to it here. I’ll try to be better in 2021.

One thing I wrote recently generated an unusual amount of reader email, split about 40-60 between congratulatory and outraged. I said that star fund managers are to be avoided and I used the example of Cathie Wood, whose main exchange traded fund at ARK Invest grew assets by 1,000% last year and gained nearly 160%. She bet big and won on hot stocks like Tesla and biotechs that benefitted from Covid-19 speculation.

I am apparently a misogynist or don’t understand her genius or both. Anyway, the evidence is pretty strong that jumping on the bandwagon once a fund manager graces magazine covers isn’t a great idea whether that manager has a “Y” chromosome or not. You can read more about managers like Ken Heebner and Bill Miller in my book.

The column starts out with a “famous last words” puff piece from The Motley Fool titles “Move Over, Warren Buffett : This Is the Star Investor You Should Be Following.”

So read the headline on a year-end article from retail investing advice site Motley Fool touting the performance of fund manager Cathie Wood. Variations on the “Buffett is done” theme have been around since at least the tech bubble, while the cult of star mutual-fund managers goes back to the 1960s. Such commentators have eventually eaten their words.

Ms. Wood is a savvy businesswoman, but is she a savvy investor? Stock picking skill is very rare and even harder to discern when the manager is riding a hot category. In a bull market propelled by dumb retail money, everyone is a genius. It takes many years to establish whether success is random. And, as I point out, star manager’s performance is often worse than random on the downside. The most promising active funds are those that lagged their peers recently or got a low rating from a firm like Morningstar.

Fund managers are often compared with dart-throwing monkeys. That might be too flattering for those who get the most attention. Hot funds’ performance is often worse than random on the downside. A regularly updated study on the persistence of investor performance from S&P Dow Jones Indices shows that just 0.18% of domestic equity funds in the top quartile of performance in 2015 maintained that through each of the next four years—less than half what one would have expected by pure chance. And of course most actively managed funds lag behind the index to which they are benchmarked because of fees and taxes.

Anyway, the tone of the emails has made me more convinced that some investors in “disruptive innovators” have lost touch with reality. Congrats if you were early — the fund’s performance is pretty impressive (see chart below) — and be careful if you were late.

Columns · investing

Bear Markets

With apologies to Stanley Kubrick, I titled my latest Heard essay “How I Learned to Stop Worrying and Love the Bear Market.

It sounds a bit flippant at a time when so many people are seeing their nest eggs melt down on paper, but the message is important. Retail investors lag the market significantly because of timing errors and the biggest mistakes are made at junctures like these. If the 20% bounce from the coronavirus-fueled low turns out to be a dead cat bounce then it will stoke further pessimism and cause people to either sell or to have less of their wealth in risky assets such as stocks once the eventual turn comes.

I’d love to tell you when that turn will be, but I can’t and neither can anyone else. The important thing to remember, though, is that if you were comfortable having, say, 70% of your nest egg in stocks when the Dow was knocking on the door of 30,000 then you should feel the same way at 20,000 or (gulp) 15,000. The richest gains of the next bull market (no, I don’t think this recent bounce was the start of one) probably will come early on. They always have before.

For example, if you put $100,000 into a plain vanilla U.S. index fund at the very start of the last bull market in March 2009 and had sold at last month’s peak then you’d have $630,000 including dividends. If you had decided to wait three months to make sure it wasn’t another false alarm then you’d have just $450,000.

Bad times are surprisingly good. If you could go back in a time machine and buy stocks at the bottom of every bear market of the past 90 years but had to sell as soon as a recession had officially ended then your annualized return would be a whopping 64%. You would never have lagged the market’s long-run return.

And what if you really can’t sleep at night? Well that’s okay – Covid-19 is enough to worry about! But then you should do one of two things. One would be to dial back the risk you take permanently – no cheating the next time everyone around you is getting rich on pot stocks or whatever the next fad will be. You’ll be that much older and closer to retirement then anyway. The other would be to entrust your money to someone else like a reputable fee-only adviser or a robo-advisor like Betterment or Wealthfront and just check it as infrequently as possible.

Why should you (sort of) like bear markets? Because they’re the time when your attitude can make you a superior investor. Everyone is a genius in a bull market, but tough times are when your mettle matters – no finance degree or superior IQ required. When those glossy brochures from a brokerage firm tell you that the long run return of stocks is 9.6% or whatever, those returns include bear markets that have seen portfolios cut in half or worse.

That’s my usual spiel, which you can read about at length in my book as well, but it’s when I finish giving it and emphasize that nobody on Wall Street knows anything that someone inevitably asks what I think about the market anyway.

I used to get paid a lot to tell people which stocks to buy. Now I get paid a more modest sum to write and edit articles about the same thing. It doesn’t mean you should listen to me about what or when to buy. But, for whatever you may think it’s worth, I’m pretty pessimistic at the moment. If I hold to form then I’ll still be pessimistic when the turning point is reached and we all should be buying stock funds like crazy.

Columns

Paging Mr. Whipple!

I hear that toilet paper in Hong Kong is worth its weight in gold. Well it isn’t – I checked.

You hear it all the time when people talk about a luxury good or one temporarily in short supply: “It’s worth its weight in gold!”

Very few literally make the grade, though—particularly something an ordinary person might legally buy or consume. Rhodium and heroin don’t count. The latest product to attract the inaccurate label is humble toilet paper courtesy of the coronavirus epidemic, or rather the public reaction to it. A rumor in Hong Kong that supplies would be disrupted set off panic buying and shelves are empty. Supermarket chain Wellcome has instituted a purchase quota.

When shortages emerge bad guys soon sense an opportunity, and it was no different in the relatively crime-free city. Thieves stole 600 rolls with a retail value of $218.

Crime usually doesn’t pay, and it didn’t in this case, either. The thieves were apprehended. Had the rolls been literally worth their weight in gold, at least the effort may have been worth the risk. A typical 227-gram two-ply roll would have to be fenced for $11,895, though.

At that price, even a premium newspaper like this one would present an irresistible arbitrage opportunity for a bathroom-goer—and you could even read it first.

Columns

Cruise Companies Will Get Decked

I wrote about the cruise industry. There are often disasters or mishaps like the 2012 Costa Concordia accident or the Carnival “poop ship” in 2013 that produce temporary bargains for people brave enough to pounce on a cheap vacation deal or stock. The latest scary quarantines may be different, though.

There are threats aside from the immediate epidemic. The fact that the quarantines have occurred in Asia may do permanent damage to China’s embrace of cruising in what Carnival management has said it believes will grow into the world’s largest cruise market. About 4.24 million, or 15% of cruise passengers, came from Asia in 2018 according to the Cruise Lines International Association.When cruising was in its infancy in the U.S. it received a warmhearted P.R. boost from “The Love Boat” TV show that ran from 1977 to 1986. To would-be cruisers from China’s emerging middle class, scenes of ambulances and quarantines are leaving a far less heartwarming image than jolly Captain Stubing.