Albert Bridge Capital’s Drew Dickson has been putting out some insightful pieces and this one should rank right up there. It might sound familiar to readers of Marcellus’ newsletters where we keep banging on about fundamentals. In this piece, whilst Drew rants about why in the long run fundamentals matter, he raises three aspects why the market, especially in the US can remain delinked from fundamentals for much longer than historically.

First, the rise of passive funds (something that we wrote about in our recent blog) which drives inefficiency in the market. As a stock goes up relative to the market, its weight in the index goes up forcing index funds to buy more of the stock which in turn drives stock prices further up.

“Many of us probably remember when it was announced that Tesla was entering the S&P 500. Rumors started circulating in September of 2020, with the stock as low as $110. By the time the announcement was made on November 17, the stock was trading at $136. And when it was actually included in the index on December 21, it had surged to $231, and it continued up to $300 by the end of January.

Now, sure, there were other dynamics affecting the stock, and other dynamics that affect all stocks. We will discuss some of them below. But there is no doubt that inclusion in the S&P 500 Index mattered for Tesla. It mattered so much that my former professor Merton Miller is probably rolling in his grave.”

However, index funds are not yet significant in India and indeed India has gone the other way in terms of market being more broad based with small caps outperforming the large caps. That raises Drew’s other point.

“And that brings us to the impact of the retail investor. The punter.  And, more specifically, what the impact of social media means for price discovery.

I haven’t done any empirical work at all, but suspect that companies where retail investors are more prevalent, either in ownership or in the percentage of daily trade flows, also have an impact on volatility. And, more specifically, an impact on our definition of “the short term.”

We of course all saw that with the meme stock frenzy during COVID, from the behavior of stocks like Peloton and Carvana to the surreal craze that surrounded Gamestop and AMC.”

India is seeing a surge in retail participation like never before, as Axis Mutual Fund’s Ashish Gupta writes in this blog.

Drew then drives home why eventually fundamentals matter.

“Eventually, the market is a weighing machine. If you want some evidence – even from some of the most iconic, well-followed, index-heavy, retail-engaged, pod-owned, successful companies, it is still, eventually, about the fundies.

Let’s take some of the winners as an example. And by winners, I mean game-changing, world-dominating winners.

You’ve surely noticed what has happen to Nvidia lately. We used to just call these winners FANGs, and then FAANGs and then FAMANGs, but Nvidia has insisted on joining the league table. It now has a $1.7 trillion market cap. And in the last five years, the stock is up about 1,700%. Guess what else is up about 1,700%?

Nvidia’s earnings estimates.

How about Facebook, aka Meta, which goes through periods of hatred and love with equal vigor? Well, over the past seven years it has bounced around a lot but still has generated nearly 260% returns. And forward earnings projections? They’re up 280%.

We can stretch things further back, and look at Google over the past 14 years (earnings up 885%, stock up 980%); or Amazon during the same period (earnings up nearly 2,500%, stock up about 2,800%).

Or we can go waaay back and analyze Microsoft over the past 22 years. Forward earnings projections have increased from $0.93 in February of 2002 to $11.57 today. That’s nearly 1,150%. The stock is up just over 1,200%.

And finally, from one of my favorite former-CEOs Reed Hastings, we have good old Netflix. About 18 years ago, analysts were forecasting that Netflix would generate 11 cents of earnings in the coming 2006 year. Here in 2024, they are forecasting a whopping $17 of earnings in the coming year. That is a whopping EPS increase of 14,889%.

And how about the stock? We’ll it is up a whopping 14,882%.

Fundamentals matter, sports fans. Fundamentals matter.”

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