Other people’s money

How should you react to what other people are doing with other people’s money? Should you react at all?

How should you react to published insider trading (not the illegal kind)? As a case in point, the multinational apparel retailer Hennes & Mauritz dropped from 360 to 117 in three years during heavy insider buying.

By the way, IPOs, stock buybacks and insider purchases all peak at the market peak, so don’t confuse insider activity with opportunity

What about when an incumbent sells a large stake to a newcomer? Is it news when 5% of the company changes hands from one known entity to another? Which party could be assumed knows more?

What about large moves in the stock price. Do the sellers know more than you? Is there valuable information in the price move?

NB: Sometimes a changed price or price trend actually affects value (through better or worse access to capital, e.g., in banks or vulnerable companies in need of finance that can give a high return on capital)

How do you and how should you react to what other people are doing with their money?

  • on the stock exchange
  • privately (neighbor buys a car)

Do you buy a stock because you see it has increased in price?

Do you buy a car (or a kitchen) because your neighbor did? Or because you read in the paper that the kitchen renovation business is booming?

Conclusion

Actually, stock prices are a good gauge on general sentiment, on other people’s wants, needs, fear and greed. However, it’s mostly a game of group psychology and herding – in particular for single stocks which are prone to sectarianism (see Tesla for an illuminating example, where no profits and an endless stream of broken promisies and debunked claims of fantastical innovations haven’t deterred the company’s followers).

What does work very well in terms of other people’s money is patterns for entire markets. Money sloshes around the world from country to country, sector to sector, asset class to asset class. During bull markets investors become indiscriminate in their buying which creates strong trends, and convergence of valuations and price movements. But when investors start losing their faith, or their cash flow, convergence turns into divergence, the market narrows to fewer and fewer things that still “work”

In the end other people’s money show the way from the topping formation of entire markets down into a bear trend, through a set of signals of risk aversion and indecision: High yield bonds increse their spreads to less risky alternatives, an increasing number of companies set either 52 week lows or highs, fewer companies and sectors lead the overall market upward, the range of valuation multiples between industries, sectors and companies increases.

On the other hand, if you are a value investor with a strong view of the cash flow outlook for a specific company, it need not matter whether the market is turning bearish or not. Just make sure you don’t get surprised by profits turning to losses, dividends turning to requests for new share issues, or dwindling profits and cash unexpectedly activating expensive debt covenant clauses.

It’s not supposed to be easy.

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One Comment

  1. Tesla, of course, has never paid a dividend, but as I posted on my blog a few weeks ago, I don’t think they can survive 2019 without issuing new shares. That will push their share price down, and so will the impending collapse of Solar City and flaccid sales in Europe. But investors buy the shares anyway, in spite of the high risk and lack of growth potential.

    There’s a lot of psychology in stock prices. Like you said, people buy stocks because they see other people buying them. They don’t even care what the actual value is; they assume that the herd will stay on the same course and they can unload the shares later on a Bigger Fool.

    Other people invest in a company (like Tesla) because they like their product or their Story. But at the end of the day, a great product all too often doesn’t translate into a successful business. Great stories usually have tragic endings.

    If I were playing the markets (but I’m not a gambler) I’d look for the un-sexy companies that make money but the herd isn’t interested in because they aren’t flashy and don’t have a Story. Adult diapers, kitchen sinks, and potato chips make money every day. Solar panels and electric cars, not so much.

    Popularity of an asset – like of so many other things in life – is a good indicator that it’s junk.

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