the perfect company

We have entered the Age of Speculation — when the possible is valued more than the practical, the whimsical is desired more than the useful, and when belief is all that matters.

Evidence is everywhere.

Special Purpose Acquisition Companies (SPACs) are out-pacing IPOs 2-to-1 this year with 145 SPACs raising $44 billion versus 55 IPOs raising $22 billion. SPACs raise money behind the names of investors including former house speaker Paul Ryan, quarterback Colin Kaepernick, and human rights advocate Martin Luther King III. To their credit, SPACs are transparent about their brazenness: They refer to themselves as “blank check” companies.

The SPACs take your money and compete with all the other SPACs to find great private companies to buy. This drives up the price of the few good private companies that have already been picked over by private equity, and the deal flow is likely to become increasingly bizarre.

For instance, if you’ve been thinking, “How can I get in on the dog walking craze?” you’re in luck: A SPAC with the symbol NEBC has announced a deal with Rover.com, which will give Rover a valuation of just $1.3 billion. NEBC went public a year ago at $10.75. Today, it sells for $10.10.

Many stocks are valued beyond all rational possibility. Let’s start with the idea that value is proportionate to the reward or the joy that it produces. If your bird lays golden eggs every day, you’ll want a great sum for that bird. If you open your eyes every day to the original painting, “Flaming June” — now hanging in a museum in Puerto Rico — you might think, “Wow, that’s awesome — I want a lot for that painting.”

What if you could buy a company that put funny ears on faces and made pictures disappear after someone looks at them? The company has sales of $2.5 billion and loses $926 million annually. You can pick up this company (SNAP) for only $97 billion ($106 billion last week) — just two times Ford Motor (F) and 3.4 times Discover Card (DFS), which earned $1.1 billion in a bad year.

Or you could buy another company that offers taxi rides and food delivery, but whose real value is its ability to convince jobless car owners to trade future car repair bills for cash today. UBER sales declined from $14 billion in 2019 to $11 billion in 2020. UBER’s loss declined to $6.7 billion, and its market cap increased to $100 billion ($108 billion last week.)

Two years ago I recommended puts on UBER that I cashed out at the beginning of the pandemic. Two surprises: (1) UBER is higher priced than ever, and (2) most people with whom I speak assume that UBER is wildly profitable. The exact opposite is true.

Then there is GameStop (GME), a company with 5,500 retail leases when massive multiplayer online games give away their services to millions of gamers who make in-game purchases. A Yahoo Finance / Harris Poll found that 28 percent of Americans bought GME or other viral stocks in January. While a majority of Americans have some investment in stocks, only about 15 percent hold two individual stocks, so if 28 percent bought viral stocks in January, we’re into a whole new frenzy.

This isn’t a craze for a new technology that will change the world: this is somebody-told-me-this-will-take-off buying. At one point, my son’s friend said he held $1 million of GME. “I’m going to wait until it’s worth $11 million,” he said. I suggested that, if GME went up another 11 times, it would be one of the largest market caps in the world. He eventually accepted a much lower price. He could have been a contender.

The Age of Speculation encourages every kind of wager. If you still see commercials, you may have noticed that about half of them encourage you to bet on sports or online casinos. This is the most cynical of all speculations because it is designed to systematically rob its customers. Yet online gambling is growing by 11.5 percent a year. DraftKings (DKNG) is spiking upward, but it loses prodigious amounts of money: Trailing Twelve Months revenue is $423 million with an operating loss of $606 million. Insiders have sold millions of shares.

Even art is packaged for speculation. When I tried to join Masterworks.io, “the first platform for buying and selling shares representing an investment in iconic artworks,” I was 32,000+ on the wait list. Somehow, my number came up the next day.

The one thing that people understand even less than Uber’s profitability is art. Recall that the day of the Lehman Brothers bankruptcy — September 15, 2008 — Damien Hirst sold $200 million worth of sharks, zebras, and cows in formaldehyde along with other conceptual art. Hirst’s bounty was the high-water mark for art excess until his 2017 Venice auction that reportedly raked in $330 million. He called his mockumentary on the exhibit “Treasures from the Wreck of the Unbelievable.”

The King and Queen of the Age of Speculation are Elon Musk and Cathie Wood. They supply belief that good things can — and will — happen. Musk applies physics to the business world, whether he is boring tunnels, designing hyperloops, optimizing batteries, or winning the space race in his spare time.

One must stand amazed: as Boeing’s planes drill into the ground and drop their engines, Musk tosses cars into space and lands rockets on ships. That said, Musk fuels the Age of Speculation by feeding the attention economy. One week, he tweets for Bitcoin; the next, he says Bitcoin is overvalued. Slow week? Musk introduces the Cybertruck that takes deposits and stalls future truck competition. He’s got flamethrowers. He’s taking the company private — no, he’s not. He’s moved to Texas. He’s the world’s richest person — no, he’s not. He’s connecting computers directly to the brain. He’s launched an OpenAI platform. A day does not pass when we are reminded that Elon Musk is the chief architect of our future, and that, someday, he will leave us for Mars.

Cathie Wood is Musk’s biggest cheerleader and the most effective promoter of new technology. The first time I saw her, I thought, “Wow, someone on CNBC has something to say.” Guests usually hawk a thin story or hedge every statement they make. Cathie Wood declares her vision for disruptive innovation, and she has packaged companies into market-beating ETFs such as Ark Innovation (ARKK), Ark Technology and Robotics (ARKQ), and Ark Genomic Revolution (ARKG).

Wood’s picks become a self-fulfilling prophecy: She anoints them, and prices are driven, if not to Mars, then to the moon. Tesla, with a market cap of $676 billion, is worth more than the combined value of all the world’s other large car companies. On February 23, when ARKK and TSLA both slid, ARK funds bought an additional 240,548 TSLA shares.

Why Are We Speculating Now? A convergence of motives and factors has ushered in this Age of Speculation:

To keep the economy and voters afloat, the government flooded the market with cash. I have spoken with business people who ended up with a surprising amount of cash that, instead of spending on operations, they happily invested.

During the pandemic, employment options have been limited, and speculation provides a new entertainment — especially when Robinhood advertises free commissions. Add to this the excitement of wild swings and bragging rights for taking down a hedge fund, and you’ve got some real fun.

Then there is bundling — a kind of willful ignorance. Financial marketers bundle up stocks, loans, and other investments so that buyers cannot rationally evaluate the purchase. Investors find themselves sitting at conference tables looking at lists of historic performance and trying to appear intelligent. You can consider (1) the name of fund and (2) the historic performance, though a note emphasizes, “Past performance is not indicative of future performance.”

You buy the bundle and hope for the best because it’s easy, and, one hopes, safer because risk is distributed. However, bundling has led to disasters like the bad loans bundled in the mortgage crisis: no one really knew what was in the packages. Cathie Wood’s ARK bundles are more transparent, but they encourage betting on “disruption” that, at some valuation, become more speculative than investable.

The biggest speculative driver is the fear of missing out, which has its own acronym: FOMO. Who can sit on the sidelines when others are getting rich? Isaac Newton sold his South Sea shares in 1720 for 100 percent gain of £7,000 — only to jump back in at the top to lose £20,000 — about $4.2 million in today’s money.

He said he “could calculate the motions of the heavenly bodies, but not the madness of the people.” Neither can any of us afford to “miss out.” With interest rates still near invisible and inflation looming, keeping up is important.

What No One Tells You About Speculation. I know a few people who gamble in Atlantic City. They all say: “I always make enough to pay my expenses — dinner, parking — it’s just fun.” Sometimes, they win big and tell the tale, but no one ever talks about their losses. Losing is embarrassing, so you never hear about the ceaseless, accruing losses.

We don’t know their names, but someone bought GameStop at the top. At that time, I looked at other heavily shorted companies, and thought that ESPR might have a real business that could take off if the horde decided to squeeze the shorts. I bought at $34.62 and closed out my loss at $30.04. It was pure speculation. ESPR is at $28 today. Imagine the pain of people who bought GameStop at $325. It plunged to $38, and, after a big rally, went to $150, settled back at $107, but as of March 9 was up to $237. You’ll never hear from the people who bought at $325, but some lost big. It could be you.

There is the game, and there is gaming the game. The game is to spot opportunity before others spot it. Gaming the game is employing technology to spot crowd behavior before others do — or employing massively expensive technologies not available to others. (See the film “The Hummingbird Project” for a dramatic treatment.) Many of the most successful hedge funds game the game: They hardly care about the business, and they don’t hire business analysts or MBAs.

They quantify sentiment by screening messages in chat rooms and mentions in the press. They were surprised by GameStop, but they will not be surprised again because they will defensively monitor the new behavior.

The people who game the game are very smart and have virtually unlimited resources. They are hard to beat at speculation. At the end of the night, they will take your money. The small investors in GameStop who believe that the market has been democratized are like the young men on the barricades in “Les Misérables”: They are surrounded, and they don’t know it. “Can you hear the people buy? Buying the stocks of angry men? It is the buying of the people who will not be slaves again!” Would that it were true.

Strategies for the Age of Speculation. Consider selling a stock if you would not buy it today. If you don’t have the confidence to buy your investment today, you are speculating that someone else is willing to pay a higher price than you are. You have no confidence in the investment, though you may have a “feeling” that you can recoup some loss or eke out a higher gain. Sell today, and put your money into an investment you believe in.

I speculated in NTES because it’s a game company that hedge funds were buying for value. Net­Ease is a Chinese company with a $75 billion market cap. I don’t trust Chinese companies, and I don’t know much about games, so I sold NTES for a 24 percent gain. NTES was pure speculation for me.

On the other hand, I have a 373 percent gain in NDCVF, which makes chips for the Internet of Things. NDCVF has a $3.7 billion market cap with room to grow. It will go up and down, but I think NDCVF will continue to grow and could be acquired by a larger company.

Consider buying Puts on SPACs. Owning a SPAC is like the first days of a romance: You hardly know each other, and anything is possible. Then one day, the SPAC does its deal and romance flies out the window. You’re the proud owner of an overpriced dog-walking service. In the case of a SPAC called Churchill Capital IV (CCIV), shares dropped 25 percent after its merger with Lucid Motors was announced. A handful of SPACs have skyrocketed, but, with so many vying for deals, the later deals are likely to be weak.

Consider buying long-term Puts on over-valued companies. As Isaac Newton discovered, you cannot calculate “the madness of people,” so it is good to buy longer term puts out-of-the-money that are relatively cheap. You will lose on most of these, but, when you win they are great paydays. At about $100 billion each, SNAP and UBER are good candidates.

If you have a company or an idea, consider selling shares or raising money now. The time to sell is when people are buying. When winter comes (think 2009), no one invests. The best companies and the most brilliant ideas sell at remarkable discounts. You have reached rock bottom when you find companies selling for a discount to their liquidation value — that is, you can buy stock for less than their cash per share. When buyers are paying a multiple of sales — as they are today — sell, sell, sell!

If you have a really great private company, arrange for SPACs to bid for your business. For the right idea, story, or growth path, public valuations can be monstrously higher than private equity.

QuantumScape Corporation (QS), a pre-revenue battery company, is now valued at $21 billion. Even dog-walking apps are worth over a billion dollars. Imagine the price your company could command.

Become a disrupter. Add a potentially disruptive feature to your business, or use your small public stock like a SPAC. In an extreme example, flooring distributor Tesoro Enterprises merged with mobile wallet company Humbl (symbol: HUMBL), and increased the market cap to $5.4 billion.

Look for special situations. Curiously, one of the biggest returns since March, 2020, is from a prosaic retailer called Kirkland’s (KIRK). I had recommended Kirkland’s in 2019, and then sold out at a loss when it tanked. However, in March, 2020, you could have bought KIRK for 56 cents; it sold for $28 as of March 1 — an increase of 4,900 percent. Sales are down, and the company still loses money, but their online business was up 35 percent in the fourth quarter, which is probably driving the price.

It’s impossible to know exactly what is going at a company, but you can check on the behavior of insiders toward the company. In the case of KIRK, directors were buying the stock.

Sometimes you can spot a situation that looks promising. You’ll never get the full story, but I had a positive trade with KSPN, a company that serves as an on-ramp for e-commerce. The company sold its FYE stores at the beginning of the pandemic, changed its name to Kaspien, and focused on helping manufacturers sell their wares online. Since the entire world was transitioning to online sales, KSPN seemed like a better bet than Amazon (AMZN), which is already in the public eye. KSPN had a market cap of about $8 million when I bought it at $6; the stock touched $52 briefly, and I sold at $32 for a 433 percent gain.

If there is a lesson here, it is that, in the Age of Speculation, a historically good management can sometimes make a hard turn and create outsized gains. Since all the facts are never at hand — if they were, others would be bidding up the price — you have to buy multiple tickets to get one good rocket ride, but that more than pays for the duds.

Know when you are investing and when you are speculating. Some companies will probably continue to grow. TREX, for instance, continues to gain in popularity, and, as lumber prices soar, TREX products are more competitive.

I am surprised by how few people in New Jersey, where Universal Display (OLED) is headquartered in Ewing, have heard of the company; I think OLED will continue to grow into lighting, TVs, and phones.

NDCVF will continue to sell chips for the Internet of Things. ZBRA, a computer ID and printer company, will keep growing. AlphaMax (MAX) is a publisher and customer acquisition service in the insurance space that was self-funded and profitable years before its public offering. These are relevant companies that do a great job in their industries.

Finally, consider the trajectory of a true disrupter, Amazon (AMZN). During the period from 1998 to 2003 Amazon shot up and fell back to earth. The pattern is common for exciting stocks: after the public offering, buyers pile in, reality sets in, and the price dives. Then the company deploys cash and starts to grow. That is the moment to buy: when everyone else has left the scene, and the company is building the business. You could have bought Amazon at $6 in 2001. You did, right?

Then examine Amazon’s price from 1998 to today. The disastrous decline of 2000 is barely a blip. If you plan to live another 20 years, consider buying companies that are true disrupters — or wait for the bubble to burst, and buy them when no one else will.

Send feedback to gpaul@perfectcompany.com. Investment recommendations are solely those of the columnist, and are presented for discussion purposes. Investors are advised to conduct their own research and that past stock performance is no guarantee of future price.