Don’t Buy Netflix Stocks Just because Everyone Else Is

You just saw one of the largest British political defeats in history.

Prime Minister Theresa May’s watered down exit plan was shot down the other day.

Not only did pollies vote against the plan. The against votes won by a landslide.

There were as many as 202 votes for May’s plan and 432 against.

The Australian Financial Review (AFR) is calling it ‘the biggest margin of defeat for a government motion in at least a century.

The paper continues:

The pound jumped against the US dollar after the vote, as traders bet that the March 29 deadline for Brexit would now be extended.

‘…Business groups are not confident about the government’s level of preparedness for a no-deal Brexit, and many companies are still cobbling together contingency plans.

Fund managers have tweaked their positions since. And I expect there will be a whole lot more fiddling around as we see 2019 play out…

A person is smart; people are dumb

In the movie Men in Black, Agent K, played by Tommy Lee Jones says ‘A person is smart; people are dumb.

The quote related to telling the people of Earth that aliens exist. But it works just as well for the investment industry.

Individual investors are actually pretty smart. They know they want to buy businesses cheap and sell them dear.

They like to buy good businesses, ones that can compound earnings year after year.

All fund managers know this too.

It’s why their ‘About Us’ usually goes something like this…

‘We are intelligent capital allocators that follow a disciplined approach of buying undervalued securities…blah, blah, blah.

Yet when you put people in a group and pit them against each other (the stock market), things get real ugly real quick.

Instead of buying stocks for less than their worth, fund managers start thinking about near-term performance. They want to wow clients with blockbuster returns made within months.

So they step away from what had worked for decades and go looking for the ‘right now stocks’.

Netflix Inc. Stocks a buy?

Netflix, Inc. [NASDAQ:NFLX] is a good example of a ‘right now stock’.

The market looks at Netflix and sees a rising share price, rising subscriber numbers and a recent US subscription price hike.

All these factors scream buy right now.

No time to think about the long-term. No time to think about a revaluation in the multiple (price-to-earnings ratio). Fundies are stocking up on Netflix because it’s a buy right now.

There’s also a bit of monkey see monkey do at play here.

Managers are not just competing with the market after all. They’re also competing with other fundies for client money.

The fundies that have jumped into Netflix towards the start of the year are already up more than 30% for the month.

Any fund that isn’t holding Netflix is likely lagging the leaders. And to catch up, they pile in and hope Netflix’s momentum will continue pushing the stock upwards.

So, the game becomes how to pick the ‘right now stocks’ early, ride it up and jump out when momentum reverses.

The strategy works…on paper

That’s not to say this strategy doesn’t work. It does work out on average. Take a look at the long-term returns of a momentum strategy…

MoneyMorning 07-11-18

Source: AAII

[Click to open in a new window]

Yet it’s incredibly hard to produce these academic results in real life.

No matter how smart individual fundies are, most if not all have trouble predicting the future.

Yet most hedge funds and asset managers continue to try and do it anyway.

Sure, they look at earnings and balance sheets.

But what they’re really looking for is a trend continuation. They want to know whether quarterly earnings will beat prior figures rather than asking what standalone earnings are worth.

It’s a herculean task (to predict the near future with consistency) for even the brightest investment minds. It’s why most often fail at beating the market average over time.

From the AFR:

Hedge funds run by GAM, Schroders and BlackRock delivered significant losses in 2018 as declines for stock markets globally and rising US interest rates led to widespread difficulties for alternative managers.

Many large hedge funds failed to protect their clients from substantial losses, raising more questions about the performance claims made by some of the investment industry’s best-paid managers.

Only 16 hedge funds were able to deliver positive returns before fees in 2018 from a universe of 450 monitored by HSBC’s alternative investment group.

One fundie said it was just plain hard in 2018…

Trend-centric strategies expect to be hurt at points of price reversal, and the pay-off to bearing this risk is the ability to perform positively in sustained risk-off or bear market environments.

One trend I’m confident of is the continuing move towards short-termism and momentum strategies in 2019. I think there will be more investors than ever trying to guess next quarter and next year’s figures.

If you’ve got a bit of cash and some time up your sleeve, this is great news for you.

Rather than join the bandwagon and bet on prices, why not delve deeper into the market. Look for opportunities that make sense. The businesses you buy should be buys whether the stock is going up or down.

And unlike a momentum investor, you won’t need to constantly check the market to see if the trend has gone against you.

The trend is your friend (in the short-term),

Harje Ronngard,
Editor, Money Morning

PS: The growing Chinese middle class could translate into a massive investment opportunity for Australians. Get the details here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia