Dips can keep dipping

The risk-off trade is dominating markets. It means that anything marginal is getting hammered, with only the strongest investment cases standing tall.

This is painful for those who entered the markets in the past 12-18 months, as the riskier names have been a favourite for inexperienced investors.

The biggest shock to many local investors has been the capitulation of the Naspers/Prosus group. This cocktail of complexity, eye-watering executive compensation and investments in questionable growth companies across the world tastes terribly bitter for investors. Instead of returning Tencent dividends to shareholders, the management team has earned a fortune while investing in wonderful verticals like food delivery, a business model with unit economics that make airlines look like cash cows.

At the time of writing, Naspers is down 35% this year. Prosus is down 38%. Tencent has lost just 11% of its value. Sure, a perfect analysis would adjust for the currency differences. With a gap like that, you don’t really need to. The message sent by the market is clear.

Experienced investors will tell you that there are in fact three certainties in life: death, taxes and market cycles. Jumping into the market at the top and running away at the bottom is the most effective way to destroy wealth. Doing the opposite is the dream (for both you and the SA Revenue Service) but it’s difficult to achieve.

Being aware of this phenomenon and acting accordingly is half the battle won. Managing emotions on the way down and the way up is critical. As I often write, the arts of investing and trading aren’t as different as people think. Fundamental and technical analysis can and should be used together. An overlay of macroeconomics is important in trying to figure out where we are in the cycle.

People forget that a company that has fallen 50% can easily fall another 50%. That would take it to a 75% drop from the peak. An investor who bought the peak and got out 50% down has the identical percentage return to the zealous dip-buyer who didn’t do the fundamental analysis to realise that another 50% drop is plausible.

Nobody can get it perfectly right — not even the most famous global fund managers. If you read any of Peter Lynch’s work, you’ll find that he discusses how often he was wrong, especially in appearances on stock picking shows where he was part of a panel.

The trick was that he held a highly diversified portfolio and was right far more often than he was wrong. There will always be mistakes in a portfolio. The difference is that the best investors know when to let winners run, cut losers or take profits at the top of a cycle. This information is never shared in public by these professionals, as they cannot (and will not) share the details of every trade. They are constantly revisiting their thinking and aren’t shy to change their minds when circumstances dictate that they must.

One of the biggest risks in a sell-off is to assume that things simply “cannot go any lower”. Unfortunately, they can. They can, and they do. Blindly buying every dip is an excellent way to dig yourself a very deep hole in a stock that ruins your love of investing.

Zoom traded at more than $550 during peak madness in October 2020. It’s now under $110, which some would see as a no-brainer opportunity. Dig deeper and you’ll find a company that is trading on a price/sales multiple of about eight times, with an expectation for sales growth in the next financial year of 11%. Yes, 11%! There are factories with broken windows in the wrong part of town in SA that have better revenue growth prospects than that. Those factories aren’t trying to employ highly indemand tech resources in the US at a time of extraordinary wage inflation.

Zoom traded at under $70 before the pandemic and I believe it can get back to those levels. That’s another 35% down from where we are today, after the share price fell 80% from its peak. Though Zoom has far more users than it had before the pandemic, expenses have also ramped up spectacularly and are expected to grow at a far higher rate than revenue in the next 12 months. I am not suggesting that Zoom is going out of business. I just don’t think the share price reflects the fundamentals.

Netflix peaked at nearly $700 in November. It’s now trading at $360, a monumental drop of nearly half its value in the space of a few months. The company is now trading on a price/sales multiple of under 5.5 times.

Would you rather buy Zoom on eight times or Netflix on 5.5 times? I bought neither.

I bought the Meta dip instead. And only time will tell what the right decision was.

One of the biggest risks in a sell-off is to assume that things simply ‘cannot go any lower’. Unfortunately, they can. And they do