I am constantly asked two questions by Clients and Friends and they are:
- Why are the markets roller coasters and why do they act the way they do?
- Why has Microsoft (NASDAQ:MSFT) been dead money since 1999?
Here is my attempt to answer both questions.
So why do the markets act like they do? The answer = Herd Mentality!
When humans operate in a herd mentality they tend to be greedy and rush in where angels fear to tread. The herd has no clue what they are doing and thus buy at extreme prices and thus tend to raise the total market for stocks to the point where they create bubbles. From this overbuying, unfortunately gravity gets introduced into the equation and then crashes unfortunately show up, which causes the herd to do panic selling.
The first thing you need to learn as an investor is that there is a big difference between what your shares do on the stock market and how the company actually performs on Main Street. Microsoft, for example, has grown its book value per share from $.02 in 1986, when it went public, to $7.50 a share in 2012. Its stock price was $.08 when it went public on March 13, 1986 (split adjusted) and it closed 2011 at $25.96. So in the end Microsoft has grown its business on Main Street on average by +25.60% per year over the last 26 years. And as an owner on Main Street (like Bill Gates is) one has been overjoyed by the results, as their numbers on Main Street are some of the best ever achieved in corporate history.
The problem is that because the herd tends to go crazy when a stock like Microsoft goes public, they basically discount all future gains in the stock ahead and move it up way before this performance is ever achieved. For example Microsoft stock went up from $.08 in 1986 to a split adjusted high of $46.46 on December 27, 1999. At the same time the business on Main Street went up from a book value per share of $.02 to a book value of $2.69 during the same period. Therefore the stock price went up 57,975% while the business on Main Street went up 13,350% during its first 13 years. So as you can see the herd panicked on the stock to the upside 4.34 times faster than what the actual business was growing on Main Street. Since 1999 Microsoft has returned -44% to investors, but it’s not Microsoft’s fault, but the fault of the herd. From 1999 to today Microsoft on Main Street has increased the size of their business 178.81%, but this fact has totally gone unnoticed as most investors have no clue of what they are doing.
So if we now do a total analysis of all the years in question 1986-2012, Microsoft on Main Street has grown their business by +37,400% and its stock price has grown by +32,350%. So by the herd hating the stock so much it has actually reversed the trend that we saw up to the year 2000. Microsoft when it went public on day one had a price to book value of 400% and today it has a price to book value of 341%. On December 27, 1999 it had a price to book value of 1,727%. I have had many people ask me why Microsoft has done nothing for an investor since 1999 and it is basically because the herd was so enamored with the stock that this same herd brought it up to a point where the stock was an overinflated bubble waiting to pop. That bubble continued to rise and eventually gravity entered the equation and the bubble eventually popped. When the bubble popped the stock went down like rock falling off a cliff in the months that followed as the herd went from infatuation to extreme hatred overnight and where previously no price was too high to pay for Microsoft stock, the herd wanted nothing to do with it. Unfortunately the stock has taken 13 years to finally trade at a discount to its Main Street valuation. So the lesson here is to wait patiently for amazing companies to shed themselves of the herd and then buy them when they are no longer loved and are totally ignored by the herd.
The herd is alive and well and never will die, so as a group they are constantly creating opportunities for the patient investor, due to their irrational behavior (which can be extreme at times). I have spent my life trying to understand these behavioral patterns and have attempted for the past 30 years to design a system that will not only track their behavior, but more importantly attempt to take advantage of it, by doing the opposite of the herd and thus profiting from the herds mistakes. By using the herd and not following it one can not only sleep well at night but can consistently outperform the markets as well. Warren Buffett and Charlie Munger of Berkshire Hathaway (NYSE:BRK.B) are living proof that this is possible.
What has happened to Microsoft has also been mirrored by stocks like Intel (NASDAQ:INTC), Cisco Systems (NASDAQ:CSCO), and most recently by Netflix (NASDAQ:NFLX). All great companies making tons of free cash flow but were so overbought by the herd in the dot.com days of boom and bust that they have yet to recover. When the Nasdaq or the Nikkei (NYSEARCA:NKY) in Japan will ever hit new highs again is a something that your grandchildren might see someday but you definitely won't anytime soon.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: Always remember that these are the results of our research based on the methodology that I have outlined above and in other articles previously published. This research is provided as an educational tool and should not be considered investment advice, but just the results of our research. There are many ways to analyze a stock and you should never blindly follow anyone’s work without doing your own due diligence or by seeking the help of an investment advisor, if you so need one. As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.