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BUY lithium mining stocks because demand for batteries will skyrocket as every carmaker goes electric. Buy Tesla because it is the best maker of electric cars and will in the future sell millions of cars each year. Buy because it will displace money as we know it.
All of these investment ideas were pitched to me recently. They are all wrong, because they use an expected future event (which may or may not happen) that is already priced in. The investments may still make money, but they will do so only if they exceed today's priced-in expectations.
Economist John Maynard Keynes likened stock investing to judging a beauty contest, where there were multiple dimensions to picking the winner: "It is not a case of choosing those that, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be."
Stock prices are always discounting future events, based on the current best guess of the average opinion. Since the future is unknown, any news means that today's best-guess stock price will be different from yesterday's, and the magnitude of the change will be amplified by how much of that average opinion is bullish versus bearish.
Think back to 1999 when investors were convinced that the Internet would revolutionise everything. Fast forward 18 years later, and this average opinion was spot on. These days even my toaster can be wirelessly connected to the Internet and be called "smart". I even recently bought a pet food dispenser that promises to keep your pooch entertained for hours while you're at the office (CleverPet Hub, for anyone interested). It connects to my phone and tells me daily how engaged my dog was with his new toy.
If anything, all the connectivity benefits the Internet would bring may even have been understated two decades ago. Despite the correct prediction, most Internet companies failed, and there were a very small number of winners like Amazon. The Nasdaq index only surpassed its year 2000 peak at the end of 2016, making it a terrible investment.
The problem with investment recommendations like these is that they take a future projection that people think is self-evident, and assume that it will benefit the share price of a company. This year we have seen all major car companies announce plans to devote their efforts towards building electric cars to compete with Tesla. Even my 74-year-old mother who knows nothing about investments, understands this means demand for batteries will increase many-fold in the coming few years. Lithium is the key component to these batteries, so mining companies that specialise in lithium will therefore benefit.
Guess what? In the last two years the price of Sociedad Quimica y Minera de Chile, the world's biggest lithium producer, has already gained 300 per cent, giving us a stock that is priced at 30 times earnings. That means you're paying 30 years of earnings today. Clearly today's share price is already pricing in that future earnings will be significantly higher than where they are now.
The most famous company that ignited investors' imagination for batteries is Tesla. Despite never having turned a profit, the company is worth more than Ford or General Motors (GM). The investment thesis to buy Tesla is simple: it will sell millions of cars in the future, and no one else will be able to compete with it.
Here are the facts. Tesla made 83,000 cars in 2016. Ford made 3.2 million. In the last five years, Ford made a net profit of US$26 billion. Tesla lost US$3.2 billion, and massively diluted shareholders along the way. Ford pays a 5.5 per cent annual dividend, is valued at seven times earnings, and consensus is that it will earn 17 per cent more in net profit this year compared with last year. Tesla pays no dividend, has no earnings, and is expected to post a 28 per cent bigger loss this year compared with last year.
Tesla would have to get to where Ford already is now in terms of sales and profitability to justify its current valuation. And yet Tesla is the sexy stock to own, while no one wants Ford.
If you had US$58 billion in spare change, which would you rather own? If you choose Ford, with the spare change you can buy all of CapitaLand and still have three billion left over for a nice house. And you would receive more than two billion a year in dividends for spare change. If you don't like American cars, you can substitute BMW instead with a similar outcome. Or you could choose Tesla. (For full disclosure, we own Ford and GM in our investment portfolios; we do not own Tesla.)
The key to successful stock investing is to gauge what investors are already pricing in now, and then assess whether the future will be better or worse. Maybe Tesla will become the global dominant carmaker in the future and start gushing out profits to its loyal shareholders. Or maybe every other carmaker in the world will compete with Tesla to make electric cars as if their lives depended on it.
And finally we get to the newest investment bubble: digital "currencies". In the last two months I've met six millennials who have put all of their savings in Bitcoins and other startup crypto-currencies. They have never invested a single cent in anything in their lives. They're motivated by the idea behind a "currency" that is not controlled by governments and where transactions are anonymous. They're comforted by their generation's acceptance of spending real money for virtual items in mobile games.
The greed of seeing your investment double in value in a few months surely also plays a part. They are convinced that these "currencies" are real and therefore should be seen as an investment. The investment analysis is little more than "Bitcoin has gone up a lot in value, it will therefore keep going up" - the mantra of every investment bubble in history.
In reality, cryptocurrencies function based on the willingness of users to see them as valuable. This cycle starts reinforcing itself by the addition of new believers and can keep going for a long while, and it already looks like there's a full-fledged bubble in this area, with many rushing over themselves to issue new versions of these "currencies" in initial coin offerings (ICOs, instead of the IPOs we know well).
In reality all they are is lines of computer code with zero intrinsic value. Bitcoin and Ethereum may survive over the long term, but all the newer smaller "currencies" will not. And Bitcoin/Ethereum may well end up at values significantly lower than where they are now, as the aspirations to revolutionise global money fail to become real. We've seen this story play out many times before. W
AL Wealth Partners is an independent Singapore-based company providing fund management and advisory services to accredited investors