There is an old saying disciplined, long-term investors utter quite frequently: “Sometimes the investment you don’t make, is the best investment you made.” This could not be any truer than in the instance when you stumble across a great product made by a not-so-great company and somehow find the discipline to not invest in the company.
In today’s environment this danger lurks everywhere. Why? Well, there is more available capital to be invested then ever! In 2017, private equity firms raised a record $457 billion, outpacing the $414 billion raised in 2007. This massive raise leaves private equity firms with over $1 trillion to dole out. This never before seen amount of capital does two things: 1) Increases company valuations, and 2) Gives capital to ideas that might not necessarily deserve it. Essentially, there is too much money chasing too few good ideas.
You may not realize it, pretty much all publicly traded companies were once private companies. And these days, especially in the technology industry, companies want to ramp up (i.e., grow) fast therefore require outside capital (i.e., money from private equity firms). So, it is these well-funded private equity firms that are driving the bus here. The bus that is all about return on investment, therefore, it is in their best interest to see high valuations, regardless of their merit. Then these exaggerated valued companies find way to the stock market.
Turning our attention back to the public stock market, it is littered with poorly run companies with popular products that ill-advised customers/fans will invest in. Many times to only see the stock market place a true valuation on the company at some point in the future. This can be over a few months or a few years… but the day of reckoning comes at some point (unless of course a company turns the corner, financially).
The most glaring example these days is Tesla. For full disclosure, Tesla does not meet our investment criteria to even consider investing in it, but it is definitely a polarizing company, so we do read/discuss this company all the time. You would be hard pressed to find a Tesla driver that doesn’t gush about how much they love driving that car. So, does that make it a great investment?
Well, Tesla has yet to make a profit, burns through a ton of cash to the point they consistently need to raise money, and most recently I read their basic package Model 3 sells at a loss. After reading/listening about this company for the past few years it appears there is valid concern they may never be a profitable company. You never know what can change, but for now, that seems to be the narrative. But, based on Tesla’s market valuation, the adoration of Elon Musk, and of course the love of the car, you would think Tesla is about to put GM, Ford, BMW, etc. out of business. Probably not a reality.
At any point in time, a stock can trade at levels that are not supported by their financials. But, if you are a true long-term investor, you need to be able to cut the emotional tie you have for the love of a product and free yourself up to make a rational, clear decision on a company’s ability to produce value of the long-term. Last time I checked, companies are in business to make money and we as investors are in business to do the same. We try not to lose sight of this somewhat basic, but sometimes lost thought.