Friday, September 16, 2011

Theme Investing, Good Idea?

When you have been in the investment world for a long time, you realize that every era, people get caught up in all sorts of 'themes' and 'stories'.  Back in the early 80s, it was technology.  There was a technology boom that ended in a bust.  This happened in the 60s too, with many companies coming out with names that ended in '-tech' or '-tron' or some such indicative thing.

Of course this happened in the late 90s too with the internet; many companies coming out with names ending in ".com".  The early 90s saw biotech stocks boom on the promise of biotechnology.  The Japan bubble was partly based on the limited supply of land in the tiny island nation, and those 'hidden' assets the Tokyo Stock Exchange-listed companies owned.

Oftentimes, the 'story' or 'theme' will prove to be correct.  But the accuracy, or correctness of the story does not often lead to good investment results.  In the 1800s, British investors rushed to buy into hundreds of railway companies starting up in the U.S.  The story was that railways across America will change the country.  It did.  But how many of those British investors made money?  Of the hundreds of railway companies that were started, only a few were left by 1900.

The same happened with automobiles early this century.  Autos was the future.  It will change the country.  Every household will own their own car at some point etc...  Sure, it was a big thing.  But there too, many automobile companies were started.  How many survived?  As far as I know, only GM, Ford and Chrysler survived and the rest went under.

This is the same story that we repeated back in the early 1980s.  Computers will change the world!  But out of the hot computer stocks back in the early 1980s, how many are still around today?  Disk drive makers?

The internet bubble.  The story was that the internet will change the world.  Yes, it did change the world.  Those prediction came true, pretty much as people expected.  But how many people made money by buying internet stocks back in 1999/2000?  How many picked the winners, and were smart enough to get out at the top?  Not many.

A similar thing may be happening in natural resource and commodity stocks.  China's growth is deemed inevitable, and that means more demand for just about everything.  

Another 'theme' these days is green energy, solar and things like that.

I think these predictions will come true, about the growth of China and the increase in use of renewable energy sources. 

But as usual, I am highly skeptical of people's ability to pick the winners.

This doesn't mean, of course, that people shouldn't invest in the area.  It's just that it is a hard game to play, to invest in themes/stories as I showed above with historical examples.

One great example of green energy is Pacific Ethanol.  Pacific Ethanol was a great story. They were a pure play on ethanol, which was a bio-fuel to help reduce our dependence on imported crude oil.  The government supported this industry with incentives.  The stock price soared to $300 or so (actually more like $40 or so since there was a recent 1:7 reverse split).

Corn was cheap and abundant in the U.S., and crude oil was expensive.  What's not to like about turning cheap, abundant corn into something you can put into your gas tank? And it burns cleaner than gasoline too, and the government is offering incentives.  This is a layup.  How can you lose money?  It kills two birds with one stone (reduce dependence on foreign oil and help the environment at the same time!)

And then on top of that, you had Bill Gates' investment company owning a large stake.  This is the richest and smartest guy in the world with an investment in Pacific Ethanol. 

What a really great story.  If I was a retail broker pushing stocks, this would have been an easy one to sell for sure.  What's not to like?  How can you not understand it?

So what happened?  From a high of $300 or so (I'm just eyeballing the chart on Yahoo Finance; ticker symbol is PEIX), it is now trading at $0.38.  That's not a typo.  It is trading for less than one dollar.  And they didn't even make subprime loans or buy CDO squareds!    (see chart here)

Another one is Ballard Power Sources.   Check out this chart.  This too is an alternative energy play.  For as long as I have been in the business, Ballard has occasionally been promoted as the answer to the country's energy problem.  They develop and manufacture batteries, and will presumably be suppying many of the batteries that will go into the future electric cars. 

I have been hearing this story over and over for many years, particularly when oil prices go up and people start talking about electric cars. 

Nobody really knows who will dominate the electric vehicle battery market.  Nissan, Toyota and many other companies are putting a lot of money into R&D to develop a good battery that would work well in an electric car.

Here too, I think the 'prediction' will come true.  Some day, most of our cars, buses and maybe trucks will run on electricity.  But who will profit from that?  That's a very different and very difficult question to answer.

My guess is that the winners will be a complete surprise.

So what matters, then?
At the end of the day, all investments come right back to the two simple questions: 

1. Is it a good business?
2. Is it priced reasonably?

If the answer to the above two is yes, then it's a good buy and if the answer is no for either one of them, then it's not a good buy.

If someone can find a good business with a good story, that is great too.  But the above two questions should come before the story or theme.

If people asked these two questions, most of the losses caused by my examples above would not have happened.


  1. I agree with you, kk. That's why if you had commentary about specific companies it would be very interesting.

    You mentioned the solar stocks. Without knowing anything about the business itself, how do we learn to look at a balance sheet? First of all where is the data available? How do we slice / dice / aggregate? The big players are FLSR, SPWRA (and SPWRB, just a different seniority), against a plethora of chinese companies led by YGE, LDK, STP, JASO. Could you pick SPWRA and YGE and compare them (all other business factors being equal)? That would be a great post to me. I know I like SPWRA and don't like the chinese companies,

    For another example with chinese against western companies, look at the rare earths. The big players are MCP, GMO, Lynas against a plethora of chinese companies. Chinese control 95% of the world's production. The rare earths are key for many manufacturing processes, incl. the solars. But let's forget about the geopolitical and look at the company sheet. Is MCP really wayyyy overvalued like some of my trader friends are saying? Can we give a value to MCP based purely on current business results as a function of (unknown and unpredictable) future rare earths prices? If so, then I could take that and make my own decisions based on whether I believe chinese will exercise their monopoly and drive prices up, or whether the new Lynas plant in Malaysia or the new production facilities by MCP will increase non-chinese production of some of those elements.

  2. Hi LB,

    I will take a quick look at some of the above names, but I have to say that it is highly unlikely they will be attractive for the same reason that it would have been highly unlikely for anyone to find a good value opportunity in internet stocks in 1999, biotech stocks in 1993, computer stocks in 1982, oil company stocks in 2007, Japanese stocks in 1989, Chinese/Asian stocks in 1997 etc... on and on...

    When the story is compelling and everyone is talking about it, beware. The rare earth story is just such a story. It is highly unlikely that there is a good value play in that area right now.

    But in any case, if I have time I will take a look.

    kk (this comes out as anonymous because i still haven't figured out how to post a comment as kk, lol...)

  3. Oops, forgot to answer the other part of the question: in order to learn about the company, it's business/balance sheet etc, you should start first by reading the annual report. This is available, usually, at the company website under "investor relations". For a more detailed discussion of the business, risks involved etc... you should read the form 10-k, which is an annual report that has to be filed by the company to the SEC every year. This is usually filled with a lot of interesting details that are not included in the regular annual report to shareholders.

    I will look at one of the above companies and look at these documents and walk you through what I see. That would certainly be an interesting post.


  4. For these kind of great technological changes, Buffett says it is easier to know the losers than winners. For ex. cars in 1900s vs. horsecarts. So these are more like negative signals for what to not buy than what to buy signals..
    thanks for the post.


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