Stonks, Stocks, Traders and Owners
February 2021
If you owned two businesses, one profitable and growing and the other chronically losing money and languishing, to which would you allocate additional resources? Business owners are tasked with making successful capital allocation decisions that will propel their companies forward for the long-term benefit of their shareholders, their employees, and their customers. Why, as an investor in a stock, would anyone want to think otherwise? Much of the frenzy around meme “stonks” and short-term trading recently has caused some to lose sight of what stocks truly represent: the opportunity to own part of a business.
Index mutual funds and ETFs can serve an excellent purpose, giving investors a low cost, tax efficient means to owning various segments of the market. Usually, these funds also offer the benefit of diversification, offering investors small or large the ability to spread risk across hundreds of portfolio companies. But the recent trading in GameStop and other heavily shorted stocks reveals a significant problem with these indexes, particularly those investing in small cap companies. According to Carson Block of Muddy Waters Capital, approximately 25% of GameStop shares were owned by passive funds. As short sellers were forced to cover, share price rose and passive index funds with inflows from investors were buying more at higher prices. Some small cap index funds had greater than 10% positions in GameStop in late January 2021 as a result of the rise in share price. Suppose you bought one of these index funds as a long-term investment, considering yourself an owner, not a trader. Is a company like GameStop where you, as an owner, would allocate additional capital? Would it be prudent to turn your back on company fundamentals and valuation?
Legendary investor Charlie Munger is credited with the statement that “a great business at a fair price is superior to a fair business at a great price.” This is the way that we see value at QSV Equity Investors. We do not buy cheap stocks or make short term bets in pursuit of quick gains. We seek out great businesses with competitive advantages that enable them to persistently deliver high returns on invested capital. We have found that the irrational behavior of investors combined with patience will eventually provide us with the opportunity to purchase these quality businesses at a fair price. We make these decisions supported by extensive valuation work to determine our view of the company’s true value. Risks abound in the stock market and it is our job at QSV to manage these hazards while seeking out businesses that can compound wealth for our clients over time. We believe this approach is a better form of ownership than the possibility of a hidden “stonk” inside an index fund.
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[1] The ‘stonk’ bubble poses significant global risks | Financial Times (ft.com)
[2] BoardIQ – GameStop Roils Index Funds’ ETF Weightings
Stonks, Stocks, Traders and Owners
February 2021
If you owned two businesses, one profitable and growing and the other chronically losing money and languishing, to which would you allocate additional resources? Business owners are tasked with making successful capital allocation decisions that will propel their companies forward for the long-term benefit of their shareholders, their employees, and their customers. Why, as an investor in a stock, would anyone want to think otherwise? Much of the frenzy around meme “stonks” and short-term trading recently has caused some to lose sight of what stocks truly represent: the opportunity to own part of a business.
Index mutual funds and ETFs can serve an excellent purpose, giving investors a low cost, tax efficient means to owning various segments of the market. Usually, these funds also offer the benefit of diversification, offering investors small or large the ability to spread risk across hundreds of portfolio companies. But the recent trading in GameStop and other heavily shorted stocks reveals a significant problem with these indexes, particularly those investing in small cap companies. According to Carson Block of Muddy Waters Capital, approximately 25% of GameStop shares were owned by passive funds. As short sellers were forced to cover, share price rose and passive index funds with inflows from investors were buying more at higher prices. Some small cap index funds had greater than 10% positions in GameStop in late January 2021 as a result of the rise in share price. Suppose you bought one of these index funds as a long-term investment, considering yourself an owner, not a trader. Is a company like GameStop where you, as an owner, would allocate additional capital? Would it be prudent to turn your back on company fundamentals and valuation?
Legendary investor Charlie Munger is credited with the statement that “a great business at a fair price is superior to a fair business at a great price.” This is the way that we see value at QSV Equity Investors. We do not buy cheap stocks or make short term bets in pursuit of quick gains. We seek out great businesses with competitive advantages that enable them to persistently deliver high returns on invested capital. We have found that the irrational behavior of investors combined with patience will eventually provide us with the opportunity to purchase these quality businesses at a fair price. We make these decisions supported by extensive valuation work to determine our view of the company’s true value. Risks abound in the stock market and it is our job at QSV to manage these hazards while seeking out businesses that can compound wealth for our clients over time. We believe this approach is a better form of ownership than the possibility of a hidden “stonk” inside an index fund.
____________________________________________
[1] The ‘stonk’ bubble poses significant global risks | Financial Times (ft.com)
[2] BoardIQ – GameStop Roils Index Funds’ ETF Weightings