Investment Risk: Are You Betting on the Right Horse?

 

I was once a bookie.

Well, a part-time job during my university days. Working weekends at the Totalisator Agency Board (TAB). Taking phone bets on horse racing events from all around the country.

I was part of a team of over 200 operators. It was great fun. I’d place bets for people, watch the races, and update on winnings and balances after the event.

 

Wellington Cup. Source: Wikipedia

 

One thing I noticed, there was often a firm ‘favourite’. And that favourite often didn’t pay much. Because it was expected to win.

Customers who won big tended to risk big bets on horses down the pack. ‘Great Gatsby’ was one I remember. He had a huge payout. Far from a favourite. One of my clients bet ‘each way’ (to win and place). Gatsby did both, netting thousands.

 

The stock market

 

When it comes to the market, you’ll also tend to notice this phenomenon. At least you used to. Until a new system started tipping things — which I’ll get to in a moment.

‘Favourite’ companies are typically more expensive to buy. Since the market thinks they will win or place on the growth front. Sometimes an attractive and steady dividend can help too.

When I say more expensive — we tend to value companies by earnings and assets. For a ‘favourite’ company you might pay a much higher multiple of earnings (P/E — price to earnings) and a higher price-to-book value to own that stock.

Tesla Inc [NASDAQ:TSLA] looks to be one such ‘favourite’. It trades at a P/E of over 1,000.

By conventional analysis, it could be profoundly overvalued. But, in the race, the market seems to think it has massive growth potential with its innovative electric vehicles. And Elon Musk is proven in the harness.

Well, there’s a new app in town which could be boosting the cost of favourite stocks even more. And I’m concerned at some of the valuations.

 

 

The Robinhood effect

 

Robinhood is a commission-free share-trading app with a game-like interface. It is attracting millennials to investing like never before.

One potential problem is that its hordes of investors are often inexperienced. They have little knowledge on how to value companies. Instead, they look to see what everyone else is buying. And the logic runs, ‘Well, if everyone is buying this, it must be great…’

You know what your mother said. About following everyone when they jump from the bridge into the river. Without first checking the bottom.

To me, stock-picking via herd-jumping is not investing. It is gambling. Giving inexperienced individuals investing apps like this is akin to giving children automatic weapons. It is very easy to rapidly deploy and leverage funds.

 

But it creates another problem for value investors

 

When a large, gamified herd starts chasing ‘favourite’ stocks, they amp the value even more. You get some crazy valuations. If you’re in and out at the right time, fine — but, generally, it’s almost impossible to time things. And that is gambling.

This is not the sort of investing we do. We look for companies that sit at value and have long-term potential for growth, often with income (dividend yield) along the way.

These days, we need to try and separate out any Robinhood-type effect. And be realistic about valuations.

It is often the company that is not the favourite, but is temporarily ignored or discounted by the market that end up as the ‘Great Gatsby’. With the fine payoff.

But more important is you’re investing in the business because you believe it has value and potential. You see quality there.

Some will say that you cannot pick winners. The market always prices them correctly. This is not true; the market is not always efficient. And during times of disaster and fear — such as Covid-19 or a potential no-deal Brexit — the market will nearly always misprice a handful of good assets.

This is exactly what happened with certain property-based stocks in March 2020. We spotted a couple. And in once case enjoyed growth of over 80% between March and October, with added dividends of around 5% p.a.

We profile this business and more in our Lifetime Wealth Investor Research. And we explain why and where we see value. If you’re into investing for the long-term — not gambling for the short — this research could be indispensable.

 

Regards,

Simon Angelo

Editor, Wealth Morning

(This article is general in nature and should not be construed as any financial or investment advice. To obtain advice for your specific situation, please seek independent financial advice.)

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Simon is the Chief Executive Officer and Publisher at Wealth Morning. He has been investing in the markets since he was 17. He recently spent a couple of years working in the hedge-fund industry in Europe. Before this, he owned an award-winning professional-services business and online-learning company in Auckland for 20 years. He has completed the Certificate in Discretionary Investment Management from the Personal Finance Society (UK), has written a bestselling book, and manages global share portfolios. Simon is a shareholder of Wealth Morning.


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