Mad Catz: The Difference Between Investing and Gambling

Mad Catz Interactive, Inc. (MCZ) closed today Thursday at $1.17, off about 20% from when I took profits at $1.42. I say this not too boast, as I am not a short term trader and admit ignorance as to all but the most basic technical signals as to what makes a stock go up and down in the short term, absent of news. I do, however, find it fascinating to watch investor psychology play out as stocks rapidly appreciate and depreciate in value absent of any fundamental change in the business.

As a value investor, I try to be agnostic to short term price moves and keep my eye on my fundamental investing thesis, which I outlined in my original post. The general gist of my thesis is that if gross margins continue to improve--driven by increased sales of higher margin products--then MCZ is likely to see stellar FY08 earnings--upwards of $.12--which should result in a revaluation upwards at some point within the next year. As the next year unfolds, we will get clues to the validity of my thesis, through earnings releases, conversations with management, industry trends, and future news releases. So far, the announcement of the Halo deal in particular has increased my confidence that my thesis will play out as I expect it to. Nothing has changed in the past two days, yet the market has decided that the company is worth about 20% less than it was two days ago. For those believers in efficient market theory, I would really like someone to explain to me how this is possible.

I have seen this behavior firsthand countless times. It is all around us--a cursory glance of the yahoo message boards of any momentum stock will show this. Just a few days ago, investors reacted somewhat mutely to the first announcement of the Halo deal, before sending MCZ up about 50% in the proceeding days and causing people on yahoo to shout all sorts of silly things. Two days later, with the sharp downward move, the momentum crowd sings a much different tune. Through all of this, though--from the day after the run until now--nothing has changed with the business. The company is the same as it was seven days ago, or two days ago. It is always helpful to keep this in perspective.

My family and friends are also great examples of people who react strongly to price moves (or lack thereof). I have recommended the Hussman Fund to many people--they loved it in 2000-2002, but want to get rid of it because of its recent under-performance. Because I understand and am confident in the effectiveness of Hussman's long-term strategy, I am not worried about his short term underperformance, but without this knowledge I too would likely unload it for a high flying fund (at my own peril). I do not expect everyone to be an expert in securities analysis (even many of the experts are pretty bad), but I do believe that it is our responsibility to recognize this ignorance within ourselves, and to make wise financial decisions accordingly--most notably, remove ourselves from the day to day price fluctuations of our investments and protect our portfolios from ourselves.

There are many short term traders that know what they are doing (Charles Kirk of The Kirk Report, one of my favorite blogs, is a good example of one). I do, however, worry for people who trade on no basis at all--who watch the rapid upward and downward
movement in stocks with excitement and anxiety, but without any disciplined approach as to when to buy, when to sell, and what actually causes the stock to move up and down. This is also why I previously wrote people not trained in investing or finance should not invest a significant portion of their own money in individual securities until they get a better feel for what they are doing. Investing in stocks without understanding what causes price movements is not investing or even trading--it is gambling, pure and simple, which has its place, but not at the core of a disciplined long term investing strategy.

Buying and selling stocks can be fun, profitable activity--and cheaper than a trip to Vegas--but its always important for us to be honest with ourselves as to when we are investing and when we are gambling.

Disclosure: Author is long shares of MCZ.

MCZ 1-yr chart: