Trump SPAC |
What if fundamental analysis of stock prices was a temporary phenomenon? I have previously written my half-joking history of stock markets in three eras:
- For hundreds of years, stock markets existed, you could buy and sell stocks, but you had limited access to high-quality public financial information, and no access at all to Microsoft Excel, so it was pretty hard to estimate a company’s future cash flows and discount them back to present value. Stock-market speculation was a psychological gambling game. “The actual, private object of the most skilled investment today,” wrote Keynes, is “to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.”
- Then, starting in about the late 1930s, a favorable set of conditions came together for the rise of fundamental analysis. Public companies were required to publish audited financial statements, so you could analyze their cash flows. Books were written explaining how to do so. There were lots of fairly stable industrial companies, so you could predict their cash flows. Eventually, computer technology made it possible to do this more quickly and reliably. Mutual funds grew up with professional investors who did this analysis. Later, the development of leveraged buyout technology made it possible for you to realize the value of a company’s cash flows: If your fundamental analysis of a company said that it was worth more than its stock price, you could buy all the stock and take the cash flows for yourself. The result is that it was possible to do fundamental analysis, and there was a clear plausible link between that fundamental analysis and the value of the stock.
- But eventually — like, three years ago? — people realized that there was a flaw in that reasoning. While the value of a company’s cash flows probably does set a real floor under its stock price — if the stock is worth less than the cash flows, someone can buy the company and take the cash flows — it does not put a ceiling on the price. If the stock has cash flows worth $10, and you want to pay $20 for it, I can’t stop you, and I cannot directly monetize the difference: I can’t, like, sell all the stock for $20 and then buy it back for $10; I can’t force the price down to the fundamental value. If everyone just collectively decides to pay $20 for a thing with cash flows of $10, or $0, then it’s worth $20, isn’t it? There is no law of nature requiring that a stock’s price has to equal the present value of its future cash flows, or even that it has to equal the market’s collective estimate of its future cash flows. That’s just a matter of tradition, and the tradition is only like 80 years old. But the tradition could always change. Now maybe stocks will trade based on … I don’t know, something else, collective attention, online sentiment, the desire to “outwit the crowd.” Stocks can once again be pure tokens in a psychological gambling game.
I said that the third era started “like three years ago,” because that’s when GameStop Corp.’s stock went to the moon and inaugurated the era of meme stocks, stocks that trade purely on sentiment and attention rather than anyone’s views about fundamental value. But really I think the third era started a bit earlier, with cryptocurrency. I once wrote:
Before the rise of Bitcoin, the conventional thing to say about a share of stock was that its price represented the market’s expectation of the present value of the future cash flows of the business. But Bitcoin has no cash flows; its price represents what people are willing to pay for it. Still, it has a high and fluctuating market price; people have gotten rich buying Bitcoin. So people copied that model, and the creation of and speculation on pure, abstract, scarce electronic tokens became a big business.
A share of stock is a scarce electronic token. It’s also something else! A claim on cash flows or whatever. But one thing that it is is an electronic token that’s in more or less limited supply. If you and your friends online want to make jokes and invest based on those jokes, then, depending on your sense of humor and which online chat group you’re in, you might buy either Dogecoin or GameStop Corp. stock, and for your purposes those things are not that different.
I don’t know, I don’t entirely mean any of this? A week into the GameStop thing in 2021, I wrote:
I don’t think, however many days we are into this nonsense, that GameStop is a particularly important story (though of course it’s a fun one!), or that it points to any deep problems in the financial markets. There have been bubbles, and corners, and short squeezes, and pump-and-dumps before. It happens; stuff goes up and then it goes down; prices are irrational for a while; financial capitalism survives.
But I tell you what, if we are still here in a month I will absolutely freak out. Stock prices can get totally disconnected from fundamental value for a while, it’s fine, we all have a good laugh. But if they stay that way forever, if everyone decides that cash flows are irrelevant and that the important factor in any stock is how much fun it is to trade, then … what are we all doing here?
We were still there in a month, and people kept emailing me to be like “are you freaking out yet,” and I kind of was, though now GameStop is down about 86% from its highs of January 2021. Meanwhile the market capitalization of Dogecoin has been higher than $7 billion for about three years now. Much higher for much of that time, and about $30 billion today, but consistently above $7 billion. With no cash flows at all. People just like that dog.
With time, I have become more comfortable with the answer to “what are we all doing here?” The answer is “not fundamental analysis.” Maybe it is “having fun online.” Maybe it is “playing a complex game of mass psychology.” Maybe it is “using our investments as a form of self-expression, buying stocks and cryptocurrencies we identify with and feeling better about ourselves if they go up.” The third era is new, and we do not understand the mechanisms here as well as we understand discounted cash flow analysis, but maybe there are mechanisms to discover; maybe in 10 years there will be textbooks on Meme Stock Analysis.
And maybe there will be a first-year M.B.A. course in Meme Stock Analysis. And maybe it will have a final exam question — really a first-week pop quiz question — like: “Donald Trump has a publicly traded company with the ticker symbol DJT (his initials), he owns more than half of the stock, its business model is to ‘fight back against the big tech companies … that it believes collude to curtail debate in America and censor voices that contradict their woke ideology,’ and last year it had a net loss of $58.2 million on $4.1 million of revenue.[1] How much is that company worth?” And if you write “well Meta Platforms Inc. trades at like 9.3 times revenues so maybe $40 million?” you will fail.
I don’t know what you should write! The textbook is not yet written. But it does seem — as an empirical matter, but also just intuitively — like a lot of people would want to buy shares of an electronic token called “DJT” that represents their fondness for Donald Trump, that marks them out as members of a Donald Trump-supporting club, and that actually makes Trump himself richer and supports him in his endeavors. And so they might pay money for that token. And the cash flows just don’t enter into it at all.
Again, I don’t think I’m all that serious about any of this, or at least I hope I’m not. But Bloomberg’s Bailey Lipschultz reports today:
Trump Media & Technology Group Corp.’s stock fell as much as 22% on Monday to as low as $48.03 per share, below the $49.95 level where the blank-check vehicle it merged with was trading a week ago. The company has still delivered a meteoric gain this year to date, with its market value sitting at about $6.6 billion after it became a meme stock and captivated retail traders.
The company generated just $4.1 million in revenue for the full year, results reported in a filing Monday morning show, underscoring how richly valued Trump Media is relative to its peers. …
The discrepancy between where Trump Media’s shares trade and how the underlying business performs indicates that investors use it as a way to bet on Trump’s push for re-election. The stock, which has been trading since 2021 under the SPAC’s ticker, has tripled this year as the retail-trading crowd pumps it with posts across Stocktwits and Reddit’s WallStreetBets forum.
“Use it as a way to bet on Trump’s push for re-election.” If he’s elected, will that make the company’s business more lucrative? Oh, quite possibly; maybe he’ll sign an executive order requiring companies to advertise on Truth Social. But I don’t think you have to posit a mechanism like that. You can just say “people want to bet on Trump, so they buy Trump Media.”
Or Dan Primack writes today that “it’s not possible to even pretend that the equity value has any relation to the underlying business. At this point, owning TMTG is basically an in-kind donation to Donald Trump. Both financially and reputationally.” Yes! A lot of people want to associate themselves with Donald Trump, and also for some reason want to make him richer, and Trump Media’s stock is a quite straightforward way to do that.[2] Why does it have to have any relation to the underlying business?
Back when the Trump Media special purpose acquisition company deal was first announced in 2021, the stock jumped, and I pointed out that there was not a single dollar sign in the investor presentation. I said:
I think that a more realistic valuation method here is not to worry about cash flows at all — as Trump SPAC clearly does not — and treat the stock simply as a token of public interest in Donald Trump. My guess is that the price of Trump SPAC stock will not, for instance, be much affected by its earnings announcements, unless Trump himself does the earnings calls in which case it will go up no matter what he says. … My guess is that each day that goes by without Trump news, the stock will go down a bit. My guess is that the stock is essentially a bet on Trump’s personal newsiness, on Trump-news volatility.
I suppose that was wrong, specifically, in that the stock was down 22% today on spectacularly bad earnings, but I do think it was right in spirit. After those earnings, Trump Media is trading at only like 1,500 times revenues. It’s just not about the earnings!
One other important point from Lipschultz’s article:
The heightened valuation has made it costly and risky to bet against with short sellers facing annual financing costs of 500% to borrow, according to brokerages. That makes it the most expensive US company to bet against with over $100 million of short interest by a large margin, data from financial analytics firm S3 Partners show.
Again, fundamental value is a floor on stock price, but not a ceiling. If you think that a stock is overvalued, you can’t do anything to force it down to fair value. You can’t just short unlimited shares: You have to borrow them, and pay 500% per year to do so, and not many shares are available to borrow. But even if you could short all you wanted for free, people could keep buying them! The price could keep going up. It’s possible that the old rules of fundamental value still apply. But are you sure?
No comments:
Post a Comment