When markets reach extremes, we get to see further and further examples of looniness. Those willing to hold the ever-rising stocks take leave of their senses, drunk with the profits. Exhibiting an extreme form of confirmation bias, and drunk with gains, they start to dismiss any piece of data no matter how solid, while grabbing hold of any positive irrelevancy to justify their positions.
So, how loony is it getting out there today? I've seen many examples, but three were particularly powerful. I'll write about those episodes in this article.
You FUDster! Consumer Reports Loves Tesla (NASDAQ:TSLA)!
The first example comes from a recent conversation regarding Tesla. In this conversation I introduced the fact that Consumer Reports was not seeing Tesla's reliability in a good light, and might actually downgrade the Model S reliability rating from its present "average" reading to "below average". All of this was factual, it was based on an article posted by Consumer Reports itself, titled "Consumer Reports' Tesla Model S has more than its share of problems" and including this paragraph:
Given the number of bits and pieces Tesla has replaced on our car, it might be tempting to guess that its reliability score will go down. The reality is, it might-depending on the frequency and severity of problems reported by our subscribers and whether they show that reliability is below average.
What kind of reactions did me posting these facts generate? It was like I had awoken the devil himself. I was now a FUDster (spreading FUD - Fear, Uncertainty, Doubt). I was misrepresenting the headline. And that was the funniest of all, I couldn't read and needed to go to the proper source (remember, I linked to Consumer Reports directly!).
These kinds of blind reactions can only be attributed to extreme confirmation bias that's able to ignore any kind of data that's unfavorable to the positive thesis. You can bet that if Consumer Reports was positive overall, then it would suddenly be the most important data in the world.
EBITDA ex-player compensation
Another huge red flag came with a Bank of America (NYSE:BAC) presentation. Bank of America was evaluating a sports franchise (Claret), and what measure did it decide on creating? EBITDA ex-payroll! On a services business no less, on a sports team no less.
Naturally, removing the biggest and most obvious cost in the business yields magnificent margins. EBITDA margin goes from 12% to 60% or even 75-80% with further adjustments.
But how stupid can it get? This is removing a giant cash cost that's never going to go away - it's not like you can have a team without players.
So what about this new, brilliant, measure, FCF ex-capex? Oh My God, we finally found something that's going up, let's adopt that! Here's an example (Source: Enders Analysis)
Needless to say, this is as loony as they come. FCF is usually defined as operating cash flow minus capex. If one takes out capex, then obviously one is no longer looking at FCF and indeed, has removed all the "costs" FCF is subjected to. Come to think of it, not much different from doing EBITDA minus player compensation!
People are getting both tremendously creative in their valuations, and extremely exposed to confirmation bias. Everyone seems to want to believe, no matter what the facts are. This is even more evident in stocks that are incredibly stretched, like Amazon.com or Tesla.
Disclosure: The author is short AMZN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.