Talk to any renown investor on what traits define him or her, you may get an indication of the elusive “luck” element. The role of luck in investing.
Shankar Sharma, Vice Chairman and Joint Managing Director at First Global, has always expressed a view that 90% of investing success is luck. It’s the role of luck in investing that plays the game.
Few scoff at the role of luck in investing, but to attribute such importance to the “luck factor” seems a bit outlandish.
Well, maybe not. Let me explain how he picks his stocks and waits for the role of luck in investing.
During the dotcom frenzy, Amazon was the darling of that bubble. Everyone was buying it.
In April 1999, the company’s market cap crossed $30 billion for the very first time. In December that year, Bezos was named TIME magazine’s Person of the Year.
Then the bubble burst, as all bubbles eventually do. And the prophets of doom began to crawl out of the woodwork.
Analysts began to state that Amazon, despite its ‘virtual pedigree’, was starting to look more and more like a plain-old retailer, and the company was seeing the effects of its growth-at-all-costs strategy.
Ravi Suria, a convertible bond analyst with Lehman Brothers, went one step ahead and sounded the death knell on Amazon.
In June 2000, he produced a scathing report where he pulled no punches.
He not only questioned the retailer’s long-term prospects for profitability but put forth the case where Amazon could run out of cash like its weaker competitors.
In its current situation of high debt load, high-interest costs, spiraling inventory and rising expansion costs, we believe that current cash balances will last the company through the first quarter of 2001 under the best-case scenario’
From a bond perspective, we find the credit extremely weak and deteriorating.
The company’s inability to make hard cash per unit sold is clearly manifested in the weak balance sheet, poor working capital management, and massive negative operating cash flow — the financial characteristics that have driven innumerable retailers to disaster throughout history.
In the book The Everything Store: Jeff Bezos and the Age of Amazon, Brad Stone wrote:
For the next eight months. Ravi Suria continued to pummel Amazon with negative reports.
His research became the litmus test for people’s view of the dawning new Internet age.… those who felt that the coming wave of changes threatened their businesses, their sense of the natural order, even their identities, were likely to embrace the sentiments of Suria and like-minded analysts and believe that Amzon.com was nothing more than a crazy precariously built on an irrationally exuberant stock market.
In retrospect, the irony is delicious- Lehman Brothers on the demise of Amazon.
Around the same time, Morgan Stanley’s Mary Meeker also came out with the view that she saw no upside and possible modest downside to her quarterly revenue estimates.
She saw no catalyst for the stock “until they make or break the December quarter” and predicted massive losses for the next two quarters (June and September).
Meeker was no ordinary analyst. Called “Queen of the Net” by Barron’s, and a “market mover” by the Wall Street Journal, she was the diva of the internet age.
The Investment Thesis for Amazon and The Role of Luck in Investing
With this pall of gloom hanging over the stock, Shankar decides to make a move.
It was an amazing contra buy. The stock price had hit rock bottom. The company was incurring losses.
In retail, Amazon was at an all-time low weight. There was plenty of bad news and the sell-side painted a bleak picture.
But there must be one powerful trigger that could turn the fortunes of the company.
Shankar saw that the company had made $139 million in free cash in one quarter. If that was so, the bankruptcy risk was off the table.
This was a powerful trigger that could turn the company around. Shankar got onto a call with Amazon – Jeff Bezos and his CFO, with the sole intention of confirming the math.
Role of luck in investing:
Bought in: 2001
Bought at: $15 (the stock was split thrice between 1998 and 1999)
Current stock price: Over $1,700
Trigger: Cash flow turnaround
By the way, when they decided to go against the herd, Jeff Bezos sent them an email along the lines of “Thanks for the support guys”. How cool is that?
In 2016, Vanity Fair carried a post titled Jack Dorsey and Twitter are having a terrible 2016. Jack won’t forget that year in a hurry. For probably the same reason, neither will Shankar Sharma.
Twitter, the stock, was plummeting to new depths.
Twitter, the company, openly declared that it was conducting layoffs as it wrestled with repeated losses and needed to reignite the growth engine.
Twitter, the board, was contemplating a sale, with Google being the most logical suitor because, despite amazing success in search and smartphones, it had insufficient traction in social networking.
But one-by-one, the contenders back off: Google, Apple, Walt Disney, Salesforce, Verizon, and Microsoft.
Twitter would evoke strong reactions, from bulls and bears. But the general prognosis was tepid at best.
Wall Street was skeptical that Twitter can effectively grow its user base and substantially increase its revenues. CNBC quoted a research note from Global Equities Research stating that Twitter is “toast” and “not even a $10 stock”.
As TIME reported in 2016, when Twitter went public in 2013, it was an unprofitable company.
More than two years later, that hasn’t changed. In fact, the company has lost more than $2 billion in total since launching a decade ago.
It has accrued more than $400 million in losses before going public, but that figure exploded upward after its IPO, largely due to stock-based compensation awarded to employees.
The stock has tumbled shamelessly. When the stock was listed on Nasdaq in November 2013, it was priced at $26/share.
The very first trade came in at $45.10 and the stock closed at $44.90. By December that year, it peaked at $73.31. In 2016, it touched a low of $14.
The Investment Thesis for Twitter and the Role of Luck in Investing
Twitter had a market capitalization of around $12 billion, with $3 billion in cash. So, the net market cap was around $9 billion, which was less than that of even Flipkart.
The bait this time around was that the company had very little debt.
Free cash was about $600-700 million every year, which means that contrary to perception, it was not a cash-burning tech company.
Twitter’s EBITDA was $600 million and was running at about 25% EBITDA. Below EBITDA, it had only depreciation and stock compensation losses.
So while it showed a loss at the bottom line, that was basically some element of depreciation and a big element of the stock options.
Twitter was a solid company, with a solid EBITDA, and a solid free cash flow.
As far as any reasonable method of profitability was concerned – Twitter was a profitable company, and not a basket case.
Comparison with Snapchat
To get perspective, he compared Twitter with Snapchat. Snapchat was to come out with its IPO in 2017 and was looking at a $25 billion valuation, as against $10-13 billion for Twitter.
At that time, Snapchat had 15 crore subscribers as against 35 crores for Twitter.
Snapchat has $300 million in revenue versus nearly $3 billion for Twitter. While the number of subscribers was just around 2x, the revenue was 10x.
That told him that Twitter milks its subscribers more lucratively as compared to Snapchat.
Snapchat was more “fun” (to quote its CEO Evan Spiegel); its self-destructing shared images allow for snappy communication that doesn’t go on the social media permanent record.
But Shankar was looking ahead.
He was of the view that Snapchat is very American-centric with a limited sphere of influence while Twitter, with a vast sphere of influence, was more of a global play.
The news that gets broken on Twitter is much faster than any other media platform in the world.
Do note, this analysis was done in 2016, prior to the U.S. and India elections.
The rise of extreme right-wing politics across the world – be it in India, the United States, or Europe, called for a platform.
Twitter is the only platform in the world where you can vent, troll and attack opponents. It permitted ‘handles’ to reach individuals who they would normally never obtain access to. Which means that the subscriber base would increase tremendously.
Bought in: 2016
Bought at: Around $17
Current stock price: $40
Trigger: It was not a cash-burning tech company, but had a solid free cash flow
WHERE’S THE ROLE OF LUCK IN INVESTING?
Shankar Sharma has a few crucial filters before the stock gets his attention:
Negative Momentum: The stock must be at multi-year lows. The negative momentum should be evident for a while, not just a few months, but for a few quarters at the very least.
Losses: The stock should be preferably loss or near loss-making.
Weight in the Industry: Within its own industry, the weight that this stock occupies should be at the lowest-ever level.
The index is a game of manipulation wherein over-hyped companies find their way into it simply because of a high market cap. (For instance, in 1999-2000, four tech companies – Zee, Infosys, Wipro, and Satyam made their way into the Sensex).
They look at it in the reverse.
Look for a Spark: It could be anything; a new launch like Apple’s iPod that changed its fortunes, a management change as in the case of IndusInd Bank.
Check Sell-side Views: If the Street is by and large pessimistic, it could pay to go against the herd. While this was not really a filter, it was used to solidify their approach to how their analysis stacked up against the negativity.
To be such a contrarian investor requires a tremendous amount of courage. It takes conviction and can be frightening to be on stock against all odds.
But above all, it requires a lot of deep thinking and poring over and analyzing data.
The element if psychology also comes into play when you try to read the mind of the market.
Yet, Shankar believes that this contributes to just 10% of success. It is 90% of good old-fashioned luck that tilts the balance in your favor. It’s the role of luck in investing that plays a bigger game.
You can get into a good trade. You can make a bit of money. But to make 100x your investments, that is the unadulterated role of luck in investing.
No human being could have predicted the stellar rise of these stocks. Not Jeff Bezos or Steve Jobs or Tim Cook.
To capitalize on that role of luck in investing (90%), you need skills, you need to do your homework – that is 10%. Hence, according to Shankar, 90% is the role of luck in investing.
But you cannot get lucky ONLY if you put in the grueling work of 10%.
Cover Image Source: NPR Media
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