Snap, Inc. didn’t wait long to let down its eager investors. Year-over-year, revenues in its first quarter as a public concern were up almost 300 percent, but that badly lagged expectations and even fell short of last quarter’s number. User growth was tepid, as well. The former unicorn gained a mere 8 million new customers over last quarter. The markets don’t tend to like growth stocks that stop growing and Snap’s stock predictably reeled on the news, dropping almost $5 to $18.05, well below its $27 March all-time-high and barely above its $17 IPO price earlier that month. Oh yeah, Snap also lost $2.2 billion dollars, most of it in a one-time non-cash charge for stock-based compensation. At least some people are getting rich off the company. Its shareholders? Not so much.
First and foremost, Snap’s drop is a cautionary tale for anyone tempted to buy into an IPO. Numerous academic studies have shown what a bad idea this is. As a group, newly minted stocks underperform the market over any meaningful time period. The great performance by Snap’s primary competitor Facebook is the exception, not the rule. Most IPOs gap up on the first day of trading, but soon fall off. Many become single digit midgets in a few short years. I’ve been around long enough to see this play out repeatedly across multiple industries. Believe it or not, for a time in the 1980s, the hottest IPOs in the market were in the asbestos abatement business. Like Snap, these companies were afforded grotesque valuations on astronomical growth projections. Like Snap, they all soared on their debuts and gagged shortly thereafter. Many went all the way to zero. A few years later, the IPO craze du jour was CD-Rom education companies. They, too, failed to justify their rich valuations.
The “Trump Bump” will soon come to an end, and earnings will once again drive stocks higher or lower. Bulls think 2017 S&P operating earnings could hit $130 per share. Who knows if this happens? Even in times of relative stability, it’s foolish to predict the markets—and probably the only thing everyone can agree on these days is that our current situation is far from stable. There are too many variables, including uncertainties about the policies President-elect Trump will put forward, to have any clue where the market will wind up at year’s end. Will Trump succeed in cutting the corporate tax rate or start a crippling trade war with China? Will he “repeal and replace” the Affordable Care Act or throw the whole healthcare sector into chaos? Your guess is as good as mine, and anybody who claims to know is probably a partisan hack or a salesperson, or both.
One thing we can be sure of is that, as always, a handful of big movers will disproportionately impact the indexes in 2017. Last year Nvidia was that stock. I wish I knew what this year’s breakout name will be, but all I can offer with some certainty is that even if the indexes post another year of low double-digit increases, more stocks will struggle than flourish. Quite a few businesses could vanish altogether. Avoiding these laggards and soon-to-be zeroes is just as important to investing success as scouting for potential five or ten baggers. And one of the best ways to do so is to identify larger secular trends.
Stock picking is hard. Most institutional and retail stock pickers underperform the indexes. But every investor could improve the likelihood they beat the market by following one rule:
Avoid high profile, controversial companies where an adverse news event could produce an overnight price collapse.
Three stocks have proven the utility of this investing rule in spades: Valeant Pharma, Wells Fargo, and Mylan Labs. All three have been scrutinized for behavior labeled unethical by some and illegal by others, and all three have cost their investors in a big way because of it.
Wall Street has always been captivated by controversial companies, controversial leaders, and controversial mergers. Tesla’s shocking offer to buy SolarCity on Tuesday featured all three, so it was no surprise that the deal instantly seemed like a bigger story than the presidential race, gun control, ISIS, and Brexit. It even managed to make the last controversial company that dominated headlines, Valeant Pharma, seem like an afterthought.
A few people have written in asking my opinion of the deal. The short answer is, I believe investors are well advised to avoid both stocks like the plague. As separate entities, these companies are wildly overvalued story stocks with a good chance of going broke. Together, they will form one wildly overvalued story stock with a good chance of going broke.
Earnings, as the old Wall Street adage goes, are “the mother’s milk of stock prices.” But not all earnings are the same. More and more companies believe they can hoodwink investors into accepting the myth that non-GAAP earnings are a better measure of corporate progress than numbers produced by generally accepted accounting principles. In 2016’s first quarter, 19 of the 30 Dow companies reported both GAAP and non-GAAP earnings.
In theory, filing non-GAAP numbers can give a clearer picture of a company’s health by excluding expenses managements consider (or hope) to be nonrecurring, such as charges for divestitures, acquisitions, and foreign currency adjustments. In practice, non-GAAP figures increasingly allow managements to present wildly distorted pictures of their firms’ financial health by omitting the most troublesome aspects of their balance sheets. Valeant is all over the news now for doing just that. But the biggest and, mystifyingly, least talked about expense omitted in non-GAAP numbers is stock based compensation.
I’m traveling this week, so I’m not able to write a new blog post, but I thought I would share the video of the presentation J. Carlo Cannell and I made at last year’s Stansberry Conference in Las Vegas. (Email subscribers can find the video on Youtube by clicking here.) I’m scheduled to present at the conference again this September. You can register here if you’d like to attend.
As last year’s holiday season was kicking off, I cautioned investors for the second year in a row to beware of the traditional retail sector. Since then, things have gone from bad to worse. This earnings season has been an unmitigated disaster, with one retailer after another turning in disappointing reports. Gap, Nordstrom, Macy’s, JC Penney, Kohls, and others have all dropped precipitously.
Some contrarian investors who buy out of favor stocks in out of favor industries have started calling a bottom for these companies, positing that the recent selloff provides an attractive entry price for long term investors.
This is part two of my responses to some of the emails, messages, and tweets I’ve received in recent weeks. Part one was posted on Monday.
A number have readers have contacted me wondering about specific stocks. I generally don’t like to comment on companies I haven’t studied, so I have been reluctant to offer my thoughts on most of them. However, I thought it might be worthwhile to respond to this tweet from Thomas Yarbrough (@tmyrbrgh):
Once again, I’d like to thank everyone who has emailed, messaged, or tweeted at me since my book Dead Companies Walking came out. I’ve tried to reply directly to as many folks as possible but running my fund has taken up most of my time and attention, so I thought I would post my responses to a few interesting questions, comments, and criticisms I’ve received in recent weeks here. Unfortunately, I couldn’t fit everything into one post, so I had to break my responses up into two parts. I’ll post the second half on Wednesday.
First up, an email from a reader named Greg:
“I am a private investor who has been investing on the long side for most of my career. I’ve almost finished your excellent book, ‘Dead Companies Walking,’ and it has inspired me to start trading the short side as well. My immediate question is: Where do you find all the good ideas? It’s fairly easy to find long ideas in places like Value Investor’s Club (of which I am a member), or the published portfolio lists of hedge fund managers. But where do you get quality short ideas? Thanks for your help with this!”
Two high profile commodity companies filed for bankruptcy last week. The first was St. Louis-based coal producer Peabody Energy (BTU). Peabody was the latest coal producer to file, following Arch Coal, Alpha Natural Resources, Patriot Coal, and Walter Energy. BTU quickly fell below $1 on the news. Just a few years ago, Peabody’s market capitalization exceeded $20 billion. On Wednesday, Houston offshore oil producer Energy XXI (EXXI) joined Peabody in bankruptcy court. Four years ago, EXXI was a $32 stock. On Thursday, the day after it announced its bankruptcy filing, it closed at 12 cents.