“All that glisters is not gold;
Often have you heard that told:
Many a man his life has sold
But my outside to behold:
Gilded tombs do worms enfold
Had you been as wise as bold,
Your in limbs, in judgment old,
Your answer had not been in’scroll’d
Fare you well: your suit is cold.’
Cold, indeed, and labour lost:
Then, farewell, heat and welcome, frost!”
I had to do this.
A quote from William Shakespeare. About how all that glitters is not gold. Or what seems to be gold on the outside may not be gold on the inside and what seems to be gold on the inside may not be readily apparent to others on the outside. The depth of this man’s wisdom is timeless and such is William Shakespeare, a man remembered for his profound literary works.
This idea that not all glitters is gold can also be applied to sensible investing. The glamour stocks of today will be the down trodden of tomorrow due to the reversion to mean, a mental model borrowed from statistics.
I would have to say that in a small subset of glamour stocks, the above may not hold true. Some glamour stocks continue to be glamour stocks because of the strong moat which they posess. And this is the realm of Warren Buffet and Charles Munger. From my experience, it is very difficult to spot such opportunities. And even when you find a company that is moat-worthy , how does one determine the price to pay for such a company? That is absolutely the reason why Warren Buffet mentioned that to be successful in investing, one need only find 20 such companies in a single lifetime and sit on it. Personally, i have not reached that utopian situation. I am still working on it. But I have developed my own mental models to deal with this issue but that is beyond the scope of this article for now.
What I’d like to talk about today is the downtrodden, the beaten down, the ugliest of the ugly if I may. Reminiscent of times gone by, I remember myself to be invested in a company called Matex International probably more than a decade ago. This company was a penny stock by all definitions and trading at a very low price. I remember then that naysayers were saying that me discussing it as an investment idea was absolutely offensive to a person’s intellect. But when I hear ignorant folks talking that way, I just tend to brush them off. They obviously have not heard of the tenets of inteligent investing and diversification as portfolio insurance. As Ben Graham said “The stock investor is neither right or wrong because others agreed or disagreed with him; he is right because his facts and analysis are right.” What more can I add to that quote there? Those pearls of wisdom we all ignore so frequently. In fact, I would like more people to disagree with me for then I would know that as a proxy, I stand apart from the crowd.
Matex International, a textile dyeing company, did okay for me then, rising 60 to 70% in months on the back of some catalyst. What I can tell you about Matex is this. It sure isn’t blue chip. It isn’t a company that possessed a moat. In fact, it was a company with absolutely low gross margins and not to mention, only mildly profitable at times.
So this is a very counterintuitive form of investing. Investing in the ugliest of the ugly did yield promising results for me back then. It probably still will over the next 5 to 10 years of my life until I reach a portfolio size that is too large to allow meaningful participation in a small penny stock like Matex International. However, knowledge in securities analysis is incremental over time and it is always important to keep an open but skeptical mind to investing ideas and to learn as much as one can.
When would Matex International revert to mean? Quite honestly then, I didn’t have a darned clue. All I knew was that it made sense to include it as part of a diversified portfolio. It worked out well on hindsight. But of course, not all of these opportunities are going to work out well. The idea is to increase the odds to your favour by selecting the right companies. And maybe, just maybe, if you are proficient enough after years of real world experience, you could use the Kelly criteria to your advantage.
Let me also give you an example of a failed glamour stock. (This is dependent on when you bought it of course) I am sure many of you have heard of Dairy Farm. Current price to book ratio is approximately 7 times. 2 years ago, it was a lot higher.
But do take a look at this.
The company was profitable with growing revenues and profitability. But in it recent fiscal year, it dissapointed investors due to a fall in profitability. Its share price fell from about $14 to $6 and it rebounded to where it currently stands at greater than $7.
Is the company valuable now? I am honestly not sure. But a price to book of 7 makes me think that it is really hard to justify that value. Unless its growth can continue on its upwards march, unless the decrease in earnings is a temporary setback, then it may very well be worth what it is currently. Even so, is there any margin of safety to this current price? I am uncertain. But what I do know is that this once upon a time high flier only had to suffer a one time fall of close to 17% in its profits from its prior year and the result is a halving of its share price . When investors project growth as a never ending trend and beyond they tend to pay a high price for it.
This is not an isolated example in itself and is not meant to be anecdotal. I could very well quote you at least a dozen or more examples to back this claim.
This all leads me to say with caveat, pursuing glamour stocks may lead to underperformance while a conservative dirt cheap strategy of buying securities may be more sound, more safe.