My Worst Investment was My Best Investment
By Brian J. Regan, CFA
The best investment I made this year and the worst investment I made this year were the same stock.
I typically buy stocks where I believe the stock price is below the company’s intrinsic value. On any given day the intrinsic value does not have any impact on the price of the stock. There are a number of reasons why a market participant would buy or sell a stock that has nothing to do with the business, here are a few: delta hedging, liquidity need, index participation, day trading, algorithmic trading, investor sentiment, investor politics, margin calls, and technical analysis. Market liquidity and volatility are inevitable outcomes of auction markets.
Typically, with time, stocks cannot help but trend around intrinsic value due to current and future buybacks and dividends. Ultimately, future cash flows and interest rates will determine the direction of a stock. In the short term, the excessive volatility caused by all the other things can leave you “holding the bag” and given opportunities.
In 2022, I am holding a bag. I also took advantage of a huge opportunity. Both trades were in Netflix ( (NFLX) – Get Free Report).
When I first initiate a position, it typically is not a ‘whole’ position, meaning that if the stock were to get cheaper vs. its intrinsic value, I would likely buy a bigger percentage. Additionally, if a stock falls more than other stocks in your portfolio there is mathematically room to buy to get back to the original target percentage.
My initial buy was around $380. As you can see, that has not worked out for me. I “tried to catch a falling knife.” Although I bought the stock when it was nearly 50% lower than its high, as of today, I am still down 32% on that lot.
Netflix trades at a little less than 6x EBITDA. I use EBITDA rather than Net Income because amortization of content is a huge non-cash charge with a longer tail than the accounting treatment (See Stop Relying on P/E Ratios). This multiple is inarguably cheap for a company that has grown gross margins by 10% in the last ten years while continuing to grow revenue. A multiple consistent with the YoY (year-over-year) growth rate would be very conservative, but a guidepost for a back-of-the-envelope intrinsic value (similar to PEG). A 10x multiple would lead to a stock price of nearly $450 or a 28% premium to my initial buy.
In the spring, Netflix stock was crushed as they lost users. To me, there were two good reasons why the user base hit a blip. One, they cut off all their Russian subscribers following the invasion of Ukraine. Two, they continued to raise price. Revenue continued to grow. None of this mattered to a market that assumed the best days were behind a stock that had already fallen precipitously from its lofty high. Queue the delta hedging of puts, technical analysts declaring “the chart looks bad,” and retail investors losing any confidence they had left.
Follow us on Instagram and Twitter!
The market started to price in declining growth. The company traded at lower than 5x EBITDA. EPS and P/E ratios began to be cited around the clock. Hit pieces came out daily about the abundance of competition and the cost of content. ALL these articles were accurate when the stock was at $170. They were also accurate when the stock was at $700.
Management becomes very important during hard times for a company. Netflix’s Reed Hastings had proven his ability to pivot in the past. He beat out brick and mortar video. Then he took down Blockbuster as they tried to compete on DVD mailings. He was first to market with a successful streaming platform, intelligently licensing classic content for pennies from competitors showing that content has a longer tail on streaming (making amortization less important).
Reed Hastings and Ted Sarandos most importantly had some obvious levers to pull to initiate further growth. Netflix had always been a subscriber-based platform without advertising. They have an estimated 100 million users that are sharing passwords. They could start an advertising option and try to monetize the password sharing community. Furthermore, in the longer term, they have what I call the “Disney Option.” The Disney Option is the shameless monetization of all the intellectual property that they have been developing to the tune of $20 billion a year. What is stopping them from licensing Stranger Things to Six Flags for an amazing new ride? Walt Disney was a pioneer in creating evergreen intellectual property. My two-year-old was Minnie Mouse for Halloween. Minnie was created in 1928 – I am not sure that four-year accelerated amortization schedule makes so much sense.
I have a stock that I believe is conservatively worth $450. They have a proven and tested management team. They have successfully been growing margins and revenue for many years. They obviously have near-term and long-term opportunities to keep growing at a substantial clip. The stock is trading at $215, $190, $171. To me, I was handed an opportunity. I bought where there was room in portfolios. I started adding incrementally continually as the stock fell.
Today, the stock has recovered some to $282. I am holding a loss from that initial lot, but because of those incremental buys I am also holding lots in substantial gains. In one year, one of my worst investments and one of my best investments were the exact same stock.
About the author: Brian J. Regan
Brian J. Regan, CFA®, MBA, is the chief investment officer for Asset Management Resources, LLC. His responsibilities within the firm relate to investment research, portfolio design and implementation. He has education and experience in portfolio risk management, asset allocation, fixed income security selection, equity security selection, and macro-economic analysis.
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax, or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.
Asset Management Resources or one or more of its officers or employees may have a position in the security presented and may purchase or sell such security from time to time. The security presented may also be bought and sold in client accounts on a discretionary basis.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website. Past performance is not a guarantee of future results.