How to spot a comedian, and protect your investment judgement

by admin on October 23, 2012

This post has nothing to do with Japanese stocks. It is about keeping nonsense out of your life for a healthier investing mind.

Occasionally I lapse from my value investor vows and look at websites such as Seeking Alpha (few gems, much junk), and very occasionally CNBC – as healthy for your mind as fried cheese is for your body. To be fair, they sometimes can stimulate you into coming up with a good idea, especially on the short side.

But there is so much trash out there on the Internet. Beginner investors especially need to be careful.

So, the other day I happened to notice that a stock I am short of (MLNX) was written up by two different authors on Seeking Alpha:

Two articles - one long, one short Two articles – one long, one short

One article was a good in depth review of the short thesis, while the other one was such incredible nonsense that I almost chocked on my croissant.

Let me first tell you what kind of a mangy unwashed dog this stock was…

This stock was widely known all over the Internet as a prime short candidate. The company basically makes widget for computers. These widgets are needed for computers to talk to one another real fast.  The company has really clever management who made themselves the only supplier of the latest version of this widget, giving them super-human margins, for the time being.

Now, not only is the product cycle very short (as excellently written up by Kerrisdale Capital), but also Intel went out and bought another firm for the specific reason of muscling in on the market for next version of this widget. The punchline for me was the fact that the market cap was bigger than their own estimate of the total addressable market. Management had been abandoning the stock as if it smelled of farts for some time. The stock was such a well-known lemon that the put options were extremely expensive (I borrowed the stock).

And yet…a contributor to Seeking Alpha ranked No. 3 for the Dividends category came up with such a howler that I just needed to share this. If we ever get information police, then this would be a good place to start.

Here goes – put down any pastry products you may be eating right now, and just imagine you are getting pitched this ridiculously-valued one-hit wonder rocket-launched price stock:

The company has a stellar earnings and revenue story. Mellanox shares trade at a 49.3% operating earnings growth rate. …. I expect the company will beat earnings. This view is based upon the company’s leading product line, technology partners, and top-tier customer clientele.

Mellanox also has top-tier partner and channel relationships that help it capitalize on major market opportunities.

Financially, Mellanox has strong cash flow, a solid, debt free balance sheet and a business model that is working very well. Mellanox has proven that it can develop and deliver industry leading products and stay ahead of its competitors.

The important thing is that all of these things were mostly true.

The fact that it was idiotic was not because it was false, but because the author lacked the minutest amount of judgement. This person is, mentally, a carbon copy of people who bought at the top of the property bubble by only looking at the shininess of the doorknobs, and not the affordability of housing.

You see, folks, it is not what a company says about itself that gives you a license to put about views on the stock (or any speculation or investment, really). You must have a sound judgement on the gap between current perception and actual reality (of future earnings power, mostly).

This judgement must be tailored to the specific stock. When you see fast-growing sales, you need to have a sound grip on the basis for that growth in order to extrapolate it into the future.

Unfortunately, this is not limited to contributors to Seeking Alpha. Famously, Goldman Sachs has been predicting for many years that China will overtake the US as the world’s largest economy in a few short years by, get this… a. exporting to the US and b. overinvesting in things that produce no return within China.

I’m not sure whether they have gotten with the program yet, but you can see that extrapolation is of rapid growth are bonkers if you do not take into account why the growth is happening.

Guard your good judgment and protect yourself from nonsense (rookies – I’m talking to you) – you are nothing as an investor without it.

MLNX earnings - ouch MLNX sh/p following earnings – ouch

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