Well duh, Nelson. This is more obvious than Olympic athletes having them some sex after their events are over. (TOPICAL!)
Last week, friend of the blog Joe from Timeless Finance wrote about how he bought a stock, Liquor Stores North America. It’s North America’s largest liquor store chain, having stores in Kentucky, Alaska, B.C., and Alberta, the latter of which is where the majority of their stores are located. He bought it a couple of weeks ago, right before the stock dropped 20% on news that the B.C. government would allow alcohol sales in grocery stores, at some point.
Interestingly enough, I took a look at Liquor Stores right around the same time Joe decided to buy, and I hated it. The balance sheet is stuffed with intangible assets. All their real estate is leased, the only real asset on the balance sheet is inventory. They have too much debt for a company that doesn’t have such secure cash flow. Same store sales are starting to decline. Yes, people will always continue to drink, but as the population gets older, they start to drink less. And finally, in Alberta, they have to compete with stand-alone liquor stores under grocery store brands, where they’re more concerned with drawing people to the store than they are with margins. I think they might even have to cut the dividend at some point later on in 2014.
Now this isn’t a knock on Joe. Unlike a lot of retail investors, he did his research and came up with solid reasons why he’s bullish. I don’t necessarily agree with him, but at least there’s a thesis behind his decision. He didn’t just go on Twitter one day and stumble upon people talking about the stock and bought it blindly.
I hereby bet him one beverage of his choice that Liquor Stores will be lower one year from now. That’s putting my money where my mouth is. Get it? Because it’s a beverage bet? I’m here all week. Mostly because I’m too lazy to leave.
During his post, Joe also said he doesn’t buy stocks that trade under five bucks. His reasoning is that anything under that level is firmly in penny stock territory, and penny stocks are the land of quacks, stock pumpers, and maroons named Nelson, which are all things nobody wants to be associated with.
He’s kinda right, but with a few caveats. First of all, the five buck level is arbitrary, and somewhat pulled out of his ass. Certain institutions won’t own stocks that are under five dollars per share, but there are enough hedge funds out there that this rule is mostly moot. The five dollar rule has more to do with liquidity issues and less to do with share prices.
It also has more to do with institutional investors dumping stock that falls below a certain level than it does with buying. Most mutual fund managers aren’t rewarded for thinking outside the box at all. If they make a big bet on a certain stock and they’re wrong, returns will suffer. Fickle investors will leave the fund because their returns sucked, and so on. Because it pays to not stick their necks out, mutual fund managers will punt any stock once it falls, even though logic would dictate that might be the best time to buy.
This usually happens at the end of the year, so their current holding lists won’t show the latest dog stock. For an astute investor, this can be a good time to pick up the latest company in the doghouse.
The five dollar rule also ignores the positive action that can happen once the stock gets above five bucks. Everything I just talked about with mutual funds dumping crappy stocks? It happens in reverse when a former high flying stock begins to show signs of a real turnaround. As long as you get in while it looks the bleakest (and don’t worry about timing that exactly right, since that period is usually months or years in length) then you get to participate when mutual funds start loving the name again.
Essentially, share prices are meaningless. Imagine two stocks, one is $100 per share and one is $1 per share. Stock A makes $10 per share and has a book value of $70. Stock B has a book value of 70 cents per share and makes 10 cents. Hence, value is exactly the same. The only difference is stock A is probably a well known blue chip, and stock B is a smaller company. You could make the argument that you’d rather own stock A because of goodwill, but stock B undoubtedly has the greater potential because of growth in both their business and growth in their exposure to investors.
Blue chip stocks are generally considered to be safer, but some of that comes from what I call recognition bias. We value companies higher when we recognize them and regularly use their products. Why do you think dividend growth investing is so popular? Safer is all fine and good, but studies have shown that it’s actually small-cap value stocks that outperform the market. You’re paying a big price for the safety of blue chips.
Anyway, you’re probably getting bored of me constantly pushing small-cap stocks, so I’ll wrap this up. You’re not going to outperform the market if you load up on shares of McDonald’s and Coca-Cola. Nothing against those mega-cap companies, but there’s no way a retail investor can outsmart Wall Street guys on those stocks. So why even try? Find some nice small-caps that represent good value, and invest in those. And don’t worry if they’re under five bucks per share. If you’ve picked the right ones, they’ll soon be worth more.