Clint Oppermann, portfolio manager of Thompson Plumb Select, strikes me as an incredibly thoughtful investor. And someone who can credibly claim that he is "fully aware of the Generalized Autoregressive Conditional Heteroscedasticity (GARCH) models used to estimate time-varying covariance matrices" is obviously at least one standard deviation above the norm in knowledge of asset valuation theory.
He's also more than likely a smartypants. When I had some questions about IMS Health (NYSE:RX), a company I featured in Motley Fool Hidden Gem predecessor Motley Fool Select, I went directly to him for answers, and they were more cogent than those I received from the company itself.
And yet Oppermann's fund took it on the chin severely when it bought into Qwest Communications (NYSE:Q) in early 2002. Oppermann made public statements that he was perfectly aware of the, er, ethical shortcomings of the company's management, but thought that the USWest assets that Qwest had acquired were worth substantially higher than the market had assigned them.
Having in prior months decided that my own investment in Qwest was the worst place for my money, I didn't share Oppermann's optimism for the company's valuation, but I found his public statements rigorous and thoughtful. Wrong, in that he only discounted Qwest's fiber optic network down to zero instead of giving it the negative valuation indicative of a cash suck, but thoughtful nonetheless.
I do not mention this to pick on Clint Oppermann. Quite the opposite -- it was the error made here that was noteworthy, because the methodology from whence it came seems to me to be very sound. But there's a question that's gnawing at me a little bit: Had Qwest not dropped in price, would it still have been a mistake to buy it?
This isn't a question posed just for navel-gazing. In the past week, I've gotten a nose full of emails from people who were a little torqued that I'd dare mention that Internet Capital Group (NASDAQ:ICGE) and CMGI (NASDAQ:CMGI) as being potentially overvalued due to the fact that neither has much in the way of cash flows. Of the more convincing rebuttals, there has been a pretty consistent theme: "These smart people disagree with you," followed by a list of, well, purportedly smart people who either own or like one of the two.
In the first place, even if people are smart, it doesn't mean that they are right. In the second place, this objection in the investing forum misses something basic: Your end results are not dependent upon people agreeing with you. Remember, when Lucent (NYSE:LU) first blew up, almost every analyst who covered it had it at "strong buy." Their opinions could not trump reality.
But it occurred to me that the market doesn't really discern whether you have used good logic or not in its rewards. Someone who bought Krispy Kreme (NYSE:KKD) in 2000, having done hour upon hour of a 15-point analysis like the one practiced by Phil Fisher, would be in the exact same boat as one who walked into a Krispy Kreme, said "These doughnuts are good," and bought the stock. Their rewards were in no way scaled based on each shareholder's understanding of the company. If the stock doubles, both the guy who can state his investment case with borg-like efficiency and the one who knows little more than "there's one on Richmond Highway" receive the identical benefit.
Not only this, but empirically speaking, I submit that someone who has invested based upon the premise that "these doughnuts taste good" has made a monumental mistake, even if the market bails him out. He has no idea what he bought or any idea whether the company has made money in the past or will ever make money, and he certainly cannot rely upon his own knowledge to make critical decisions. And yet, had this guy bought Krispy Kreme in 2000, he'd have doubled to tripled his money, in a time that the stock market has done far, far worse. It's also possible that this guy might feel like a genius for his stock-picking acumen.
He's no more a genius than the person who manages to flip "heads" 20 times in a row in a contest. But you contrast this event with what took place with Oppermann's Qwest investment, and there should be no question: In many cases, the stock market rewards people for really poor decisions. It is incumbent upon each person -- as a steward of her own money -- to figure out whether she is making good decisions or not.
There are instances when the market will not give you that feedback. I believe that 2003 was one of those times. The only feedback people have gotten was that if they buy stocks, the stocks go up, and the poorer the quality of the underlying company, the more the stock rose. Matt Richey quoted a money manager friend to me the other day who said that success in 2003 was predicated on exactly four decisions:
- Buy stocks.
- Cover your shorts.
- Don't sell.
- Don't sell short.
Mark Sellers at Morningstar culled some data that underlines how true this was: Of 5,999 companies that were traded on the major exchanges for the entire year, 87% increased in stock price, by an average of 90%, a median of 38%. This means that almost every stock listed went up, many of them by a great deal.
There is a pretty good chance that almost everyone reading this had a missile or two in his portfolio, one that went up several hundred percent in the course of the last year. Lots of people who have barely a clue of how to value the companies they own nonetheless had spectacular years in 2003. And as I've hinted in the past few weeks, my email inbox suggests something we haven't seen in a while: Lots of these folks feel pretty darn smart, and they don't look kindly on those who doubt the validity of their gains.
That's fine. It could be that all the underwear sniffing going on right now is fully justified, that this time it's different, that 2003 was really the beginning of the rise of companies that currently do little better than destroy capital. In some selective cases, I'm willing to believe that this is true. But it's not true for all of the companies that surged higher last year, and when the tide goes out, some folks will once again look somewhat silly without their swimsuits on, looking for someone else to blame.
It's also why, in the comparison of returns between Clint Oppermann and doughnut guy, or satellite radio guy, or "they're buying in China" guy, I'll take Oppermann's long-term returns every single time. There is an inverse relationship between the level of knowledge you possess about a company (and its finances!) and the level of risk you've assumed in owning its securities. Bad things can happen, because knowledge doesn't alleviate risk. But knowing what you own remains an excellent hedge to the bouts of euphoria and despair that grip the market. I suspect that, maybe not in 2004 but sometime in the future, many who bought low-quality securities in 2003 will look back and say, "How could I have been so stupid?" Others will have been both stupid and lucky, and will remain forever oblivious to the risk they actually took. That's what makes markets fascinating.
A word before I close. As is usually the case, such examples as given above are prone to misinterpretation. I do not believe that the person who does the hours and hours of research is ipso facto a better investor. In fact, there is a certain subset of folks who will so rigidly attempt to quantify everything that they'll miss the fact that our two-second investor picked up instantly: These companies are living, breathing organisms that produce stuff that people buy or don't buy. "I like their doughnuts" may not be a sufficient ground for buying a company's stock, but it's still a valuable piece of research, one that quantitative investors are prone to forget.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
Bill Mann is the editor of Stocks 2004. He actually thought the title "Stocks in the Year of the Monkey" would have been better. As of press time, he held no positions in any company mentioned. The Motley Fool is investors writing for investors.
