How I Find the Profitable Nuggets in the Marketplace
If you invest money in the stock markets, either through mutual funds, or directly, through a broker, you probably do the same things that other investors do. You pick up the newspaper every day, open it to the financial pages, and look up your stocks or mutual funds. Or maybe you subscribe to an Internet stock-tracking or trading service, and your portfolio comes to you on-line every fifteen minutes or so. Maybe you smile because your stocks or mutual funds are going up. Maybe you frown because they fell from the last time you looked at them. But mostly you sigh, because the market isn't giving you any clear indication as to whether you made the right choices.
Certainly, over time, if you stick with the stocks and mutual funds in which you've invested, you'll do pretty well. According to Ibbotson Associates, a Chicago-based research firm, stocks have proven to provide the best return on your money over the long haul, with the least risk. That sounds surprising because everybody knows that the stock market has had periods when it has crashed, but it's true. Stocks are a profitable, low-risk way to make your money grow over the long term.
The problem is always relative return. Are you doing better than the market averages? Better than the rate of inflation? Better than your friends? Could you be doing even better? Do you get tired of listening to other people tell you about the great stocks they bought that have gone to record levels, while your mutual funds and stocks are just barely keeping pace with the market averages? Do you get irritated when you hear stories about people making great fortunes in the market, while your stocks seem to ho-hum along? Do you begin to wonder why some people just seem to have better access to information, and why they make better investment decisions?
I'm normally pretty cheerful; but when I think about what a hard time the average investor has keeping up with the experts, I sigh just the way that you do. In fact, if I could put one of those tiny electronic chips that you find on greeting cards-the ones that sing "Happy Birthday," or some such message, into this book-I'd program my chip to heave one great big sigh every time you opened the cover. That's because I feel so sorry for the average investor.
Here's why. I run a company called OTA Off The Record Research (or just OTR) which is based in San Francisco. We supply information to large institutions that invest pension money, mutual-fund money, and private money. The information we supply is designed to help those institutions make better investment decisions, both in buying and selling stocks. OTR Research has been supplying this information for several years and, frankly, we're really pretty good at what we do. Institutions rate us among the best sources from which they regularly buy information, so I guess that means we must be doing something right.
OTR performs marketplace checks. Simply put, we have about 150 people who go out into the marketplace and find out what is going on, who is buying what, how much they are buying, and how often they buy. We look into how a company is doing relative to its competitors, and how an industry as a whole is doing. We translate that information into reports our clients then use to help them determine whether to buy or sell stocks, and which ones. It's that simple. When we do our job well, the institutions make big money and outperform the standard stock indices by which everyone measures performance. When you see a mutual fund or a pension fund that is beating the Standard & Poor's 500 index, chances are that information supplied by us helped them make a buy or sell decision which improved their performance. Even when we don't supply the information, it's probably fair to say that the fund is using a marketplace-check information model similar to ours.
I heave a sigh every time I pick up a newspaper or a business magazine because ordinary investors could be doing much the same thing that I do, and getting better returns. You'd be surprised at how little extra information I'm talking about. One good nugget per year for each of the stocks you own can propel your returns into the upper ranks of performance. Let me give you a few examples.
In the late summer of 2000, everyone was hot on Nokia, the Finnish maker of wireless telephones. It seemed as if everyone had a mobile phone, and that the growth of the industry was going to be endless-both for new subscribers, and for people upgrading their existing phones with new technology and services. People were looking at the mobile-phone market as one large market, but one of our sources pointed out that it was really several markets. There was a business-user market, where demand was stable and even rising, and a student and personal market, which was price sensitive and unstable. Our source told us that Nokia was moving aggressively into the lower end of the market and would therefore have to change its product mix and accept lower profit margins on its products. We advised our clients in July 2000 that Nokia's earnings growth was going to slow, which it did almost immediately. The stock dropped $20 per share, or 33 percent. Our clients, who had sold Nokia before it fell, were protected.
Or take our report on the cruise-line industry. For years, cruise lines have been a major growth industry, with bookings rising at double-digit rates almost every year for a decade. The two pure plays in the business, Royal Caribbean and Carnival, responded the way companies are supposed to when demand is rising: They added lots of capacity. Not only more ships, but much bigger ships, until, by late 1999, capacity began to outstrip demand, which meant that people who were booking cruises could wait longer to book them, thereby driving down the price per cabin. Both cruise lines got hit with a double whammy-they had too many unsold berths, plus they were discounting the cabins they were selling. We began advising our clients about the overcapacity crisis, even as the cruise lines were maintaining that they were selling out their ships. Our findings were in such conflict with Wall Street that some of our best clients questioned our report, until we told them to call their own travel agents and see if they could get a reservation. They could, and very soon thereafter, the entire industry suffered a steep drop in valuation.
Not all of our reports are negative. Sometimes we spot a positive trend in a negative industry. For example, in 1999, there was a lot of talk about the dangers of genetically modified (GM) food. As a result, all of the companies that made GM seeds, such as Monsanto, saw their stock prices hurt by the controversy. But then we discovered Delta and Pine Land, a company that sold GM cotton seeds. People didn't mind wearing goods made of GM cotton. They just didn't want to eat GM foods. So, while the industry as a whole was falling, the firms that bought Delta and Pine Land on our advice saw their shares appreciate 40 percent.
Sometimes we see companies do things that don't immediately make sense. For example, the beer industry has been under competitive price pressures for several years, as the large beer makers-Anheuser-Busch and Philip Morris (Miller) slug it out for incremental market share. As a result, the stocks of both companies remained low because they could not improve their margins. But then during 1999, we noticed that Anheuser-Busch-which makes Budweiser and Michelob-would periodically raise prices in a single region of the United States. If a competitor did not raise them as well, A-B would cut their prices. But if the competitor did not challenge them, the higher prices would stick. We went positive on Anheuser-Busch because we felt that both sides of the beer war wanted and needed profits more than they needed market share. We were right, and A-B's stock rose 50 percent.
These are just a few examples of what happens when you search out critical nuggets of information in the marketplace. You either profit by being in on a share price rise at the beginning, or you avoid a share price fall by getting out before the bad news becomes generally known. Finding such good information takes a little time and effort, but it isn't impossible. We live in an information-saturated society. If you know where to look, you can get all sorts of helpful indicators, even of very large swings in the market.
But instead of hunting for real information, increasingly, investors spend a lot of their time hunting around for tips, which are not the same thing as information. And, increasingly, those tips come from the Internet.
Right now, according to the National Association of Securities Dealers, something like 15 percent of the total volume of shares traded comes from retail investors in electronic trading, who move in and out of stocks in seconds. These short-term investors are like schools of frightened fish, shifting their positions in response to every little upward and downward movement of the stocks in which they choose to invest. Often, those movements are influenced by nothing more than rumors, which are found on the Internet, in investing chat rooms and at financial Web sites that purport to give out real information.
Most of that information is bogus at both ends. It is often wrong about the stocks that are hyped and the stocks that are savaged. There are many stories about small, and micro cap and Internet-based stocks that gyrate wildly based on rumor. In the summer of 1999, a rumor that Source Media (a company that provides streaming content) was the subject of a bidding war between America Online (which went on to merge with Time Warner), and Microsoft. The Source Media's share price soared 50 percent on ten times the normal trading volume. Then the rumors whipsawed the other way, and the stock was traded down. Six months later it was trading at about where it was before the rumors and hype began. Eventually, investors came to look at the company based on a rational business model and priced the stock accordingly, not on the bias of the spin from the rumor mill.
But don't think that this can only happen to the small and thinly traded companies. In early January 2001, Bank of America Corporation, one of the largest banks in the world, was trading along very nicely, fueled by positive actions of the Federal Reserve. Then the California electricity crisis hit, with both sky-high consumer utility bills and rolling blackouts. A rumor spread through the institutional investment community that since the bank, which is very strongly tied to the California economy, held vast quantities of bonds and commercial paper from state based utilities, its portfolio was under stress and that defaults were likely. The bank's stock price, which had closed on January 4 at $51.50, opened the next day at $47.75. That translated to a loss of market capitalization of around $6 billion. Suddenly $6 billion had disappeared. That day the volume of shares traded was almost three times normal. The rumor was taken so seriously that management issued a short statement that began: "We know of no basis to support speculative rumors about our operations. We are conducting business as usual." Well, not quite business as usual if you are issuing statements like that.
Eventually, investors took a long, hard look at the situation and during the next five days of trading the stock recovered to its former position. As the month ended the stock had risen to 54.
The point is not whether Bank of America was a good investment or not. The point is that even a company of its size and reputation can be affected by rumors. Rumors based on neither fact nor rational projection.
Even when people don't fall prey to Internet chatroom hype, they still get their information from the wrong places. One of the most common "sources" of information today is the endless round of talking heads on CNBC and CNN/FN. Every time a stock goes up or down, there is a commentator explaining what is happening, or an analyst or even a CEO or CFO coming forth with an explanation. Well, those aren't explanations, they're excuses. By the time these geniuses turn up in the mainstream media with their opinions, the damage has been done. The stock you own has already tumbled, and someone is offering up a reason that seems to make sense. But if it was so obvious after the fact, why wasn't it obvious before the fact, when, if you had heard it, you could have taken some action to save your portfolio.
Let me give you a good example of what I mean. In late September 2000, Intel warned analysts that it might have a profits shortfall of as much as $500 million, and the stock immediately lost a big chunk of its value, and set off a whole wave of technology stock selling. Should Intel's news have been a surprise to anyone? Not if you visited Intel's own Web site now and then, it wasn't. Technologically savvy investors who had been to the site as late as mid-August knew that Intel was already having problems with its latest Pentium chip, and had recalled an existing chip because of problems. Those delays and recalls translate directly into lost sales, because computer manufacturers have to seek alternate sources, such as chips from Advanced Micro Devices (AMD). The information was out there for anyone to find. You just had to know where to look. But the mainstream media didn't bother to look, and instead were caught scrambling to come up with excuses to explain Intel's woes.
The rumors and hype, and the inadequacy of the mainstream media are among the reasons I decided to write this book about marketplace checks. You spend too much time and work too hard to accumulate money for investment to just give it up to a marketplace made up of people who care so little about how hard you work for your money.
I'm not saying that the Wall Street community is irresponsible. Overwhelmingly, the people who run brokerages and sell-side firms are honest and responsible. But they aren't terribly interested in you, no matter what their commercials say. They are interested in moving money around, in investment banking, and in earning fees for their companies. You are just a fee machine for Wall Street. If you want to earn real money, you have to take real responsibility for your money.
We live in a high-speed world, an environment where opportunities can seemingly be lost in seconds. I say seemingly, because most of those opportunities are more apparent than real. The reality is a little different. Much of the real movement of stocks is based upon information that filters its way into the marketplace, not by Internet-spawned rumors. But even if Internet day trading didn't exist, you, the average investor, would still need all the help you could get. There are better returns to be had, and with a little knowledge and discipline, you can achieve those returns, whether it's on your mutual funds or on the stocks you purchase directly.From the Hardcover edition.
Excerpted from Off the Record by Craig Gordon with Stephen Kindel. Copyright © 2001 by Craig Gordon with Stephen Kindel. Excerpted by permission of Crown Business, a division of Random House LLC. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.