Powered by MOMENTUM MEDIA

Positive sentiment: A powerful market force

By Sinclair Currie
 — 1 minute read

In the story of Jack and the Beanstalk, Jack trades a cow for some magic beans. He has faith that the beans will deliver his fortune, and he is willing to give up the value of a reliable supply of dairy to acquire them.

Sinclair Currie

Fortunately for Jack, his positive outlook is rewarded with a golden goose. Similarly, in the stock market exchanging cash cows for growth options has delivered some golden eggs. 

There are numerous examples of nascent or unprofitable businesses that have delivered spectacular share price growth. In Australia, these have been the likes of buy now, pay later (BNPL) and software as a service (SaaS) businesses. 

Advertisement
Advertisement

It just takes a little faith
Propelled by positive sentiment, investors have been willing to abandon the anchors of conventional valuation metrics. Alternative yardsticks of growth potential are now as important as return on capital employed (ROCE), earnings per share (EPS) growth and cash flow. Examples of these include total addressable market (TAM), gross margin (GM) and customer acquisition cost (CAC).

These alternative ratios are good leading indicators of growth. The downside is that investors do not benefit from the audited accounts and assurances that underpin traditional valuation tools. Simply put, unaudited metrics can be more readily gamed. An investment rationale that is justified by unverifiable statistics requires faith. If enough of a crowd believes and adopts the faith, their positive thinking is richly rewarded. When money is readily available, the impact of the crowd is multiplied.

Fake it ‘til you make it’ as an investment strategy
Some companies have seen their share valuations rocket to dizzying heights. The power of positive thinking has driven their cost of capital so low that “mining the market” via equity issuance has become a viable growth strategy. With a high enough share price, aggressive growth plans and acquisitions, the new equity is gobbled up by cashed-up investors whose focus is on the potential future growth prospects of businesses rather than financial discipline. 

A high share price is a self-fulfilling means to value creation – basically the cost of growing a business (buying cash cows) is a relative bargain when a company enjoys an extravagantly valued share price (a cheap supply of magic beans). In this way, convincing investors to think positively about a stock’s future as important as delivering profits and dividends. There is not much new about this, although it seems more prevalent today. 

Social media is a new battleground
Positive sentiment has always been a powerful market force. Stock promoters nurtured it via market releases, investment research and traditional media. Today, social media provides a new arena to communicate positive narratives about stocks. 

A spectacular example of this was the recent surge in GameStop Corp. The powerful force social media can exert on markets was on full display. Two factors help explain this power. Firstly, there is less friction on social media. Stock promoters can communicate directly to the crowd without needing to convince intermediaries such as analysts or journalists to communicate narratives on their behalf. Secondly, the reach of social media is broader than broker research or specialist financial publications. Stock promoters can mobilise enormous crowds across the globe.

The higher volatility that results is also likely to impact valuation dispersion due to its negative impact on investor confidence in general. Volatility undermines investors’ confidence in their predictions. An investor’s willingness to buy a stock reflects confidence in their price predictions and the future, overall. Expensive stocks have baked in the most optimistic outlooks, and therefore have the most to lose from any decline in confidence. 

The best-performing stocks are generally companies that are sustainably building valuable businesses. However, if volatility has been mispriced as described, the best opportunities are likely to arise from contrarian viewpoints rather than pursuit of expensive momentum. To this end we continue to look for high-quality businesses where recent (positive) changes have not yet been recognised by the market. 

We believe the best antidote to volatility is to ensure that our investment process is balanced. Our approach is to construct diversified portfolio of quality businesses, anchored by fundamental conviction as well as a positive narrative. 

Sinclair Currie, principal, Novaport

 

Positive sentiment: A powerful market force
Sinclair Currie
ID logo

 

related articles

promoted stories

Website Notifications

Get notifications in real-time for staying up to date with content that matters to you.