The comments sections of S.A. articles are always a fascinating foray into human psychology and (in many instances) a reflection of the number of informed and intelligent individuals who are involved in market activities. On more than one occasion I have obtained useful insight into an investment thesis on the basis of an investors comment at the bottom of my own (or others) articles.
They are also a place where intransigent attitudes meet up with emotional outbursts, which blend an odd mixture of moralizing with the day to day of financial activities: there are responses that treat a counter position on a stock as tantamount to a violent blow. In other words, a counter position on a financial equity is not merely a disagreement over the interpretation of the evidence, but rather a reason to declare war.
This all goes with publishing articles of any sort in the internet-comment era. You need not even lick a stamp for the author to hear your voice; just type whatever comes from the top of your head and hit enter (sometimes with great contemplation, sometimes with the whim of emotionality, usually somewhere in-between).
What this has to do with Sprint
I wrote an article last week related to the Sprint (NYSE:S) share run up, and an ongoing thesis that the fundamentals did not support the significant increase in valuation of the beleaguered telecom. Prices initially went down in support of my short thesis, but after what can only be termed as an unremarkable Q1 result (pretty much in line with expectations) the shares have once again spiked (quite dramatically) to over $6 a share.
I suppose that I should have a bit of egg on my face for my short position at $5 a share, but so goes the attempt to telecast the inherently unstable volatility of stocks that trade largely on secular and forward looking concerns. I am still quite skeptical on the short-term prospects for Sprint (even more so at $6 a share than $5) but the comments (and I received a tremendous volume of them) have incited me to focus on Sprint in the broader market context: what part of an individual's portfolio that ought to be made up of volatile stocks.
The comments section in particular (you can read all 120+ of them here) revealed to me that at least a few of S.A. readers following Sprint have what seems to be an overabundance of the shares in their portfolio. Further, I received a well intentioned private correspondence with an individual who told me that his father had questioned exiting the position after my article; this individual went on to caution me (really, reprimand me - albeit politely) that my words may inhibit individual investors ability to beat the market.
I thank him for his response, but also suggest that holding volatile-speculative stock should be very carefully done, and really should only be done in any meaningful volume (I'm talking here maximum 5% of your total portfolio) by individuals who have many years to make up the deficits that such activity can easily produce (you will not always guess right).
Why Volatility is Everything
After more than a century of established stock market activities, one thing has been established quite firmly: the long term returns on portfolios that primarily focus on dividend growth stocks (with reasonably low volatility) outperforms speculative portfolios to an extremely high degree of confidence.
One recent study by Malcolm Baker of Harvard Business School and colleagues found dramatic results: from 1968 to 2012 a dollar invested in the 20% of U.S. stocks with the lowest volatility grew to $81.66, while a dollar invested in the 20% with the highest volatility grew to only $9.76.
It should be noted (in the example above) that backwards looking data is inevitably skewed: you never know with total certainty which equities will have low volatility going forward; when looking at them from the future you have total confidence which ones had low volatility in the past. And low volatility itself generally attests to the stability and reasonable returns that the company provides to investors (which makes the outperforming result unsurprising).
What it does suggest is that investors ought to take the time to seriously consider volatility as a negative component of the future return potentials, as opposed to an opportunity to get rich quick. On a thirty-five year investment, the above data states that your returns will be 9x higher between the lowest and highest volatility stocks. Sprint (I would strongly suggest) is far in the upper half of forward stock market volatility.
The Cost of Beating the Market
The Cost of Price Discovery can be defined as the amount of money (in terms of research, human capital by individual investors, electronic, regulatory, and trading costs) that is spent as a part of total market cap. The Cost of Price Discovery is focused on determining the most efficient prices for the various asset classes. The process of price discovery is a floating concept that is prone to vary on the basis of secular attitudes, fundamental business cycles, randomness, et al.
And while the previous several decades have fundamentally altered how we trade (in particular, electronic trading platforms have significantly decreased trading costs, while the advent of Mutual Funds and ETF's have provided an increasing share in market ownership), it is interesting to note that the last 30-years have seen a rather stable Cost of Price Discovery of around 0.7% of NYSE, Amex, and NASDAQ market cap. Furthermore:
Direct holdings by individuals decline a lot over time. Individuals hold 47.9% of the market in 1980 and only 21.5% in 2007...The shift from direct holdings to [professionally managed] funds has an important implication. Some argue that mistakes by retail investors are a reliable source of trading gains for other investors. If so, competition for these gains must be fierce later in the sample as an expanding group of professional investors fights for a shrinking pool of mistakes.
What individual investors should take from this is that beating the market by foretelling the future business prospects of individual companies, is a bit like trying to outguess the weatherman on the chances for rain tomorrow: the professionals have a vast array of time, tools, and experience to identify mispriced equities and to respond in market-making moves.
This does not mean that a well informed and educated individual investor cannot beat the market, only that there is a fundamental cap to the degree to which you can: if you gain a percent and a half on the market at large, you have performed quite admirably (and, though it does not seem like much, that 1.5% over decades will amount to a significant amount of additional capital). If, however, you get it in your head that you can beat the market by a great deal more, not only are you succumbing to a form of hubris (that professional investors are inept enough to leave you room for such profit-making) but you inevitably will overextend yourself on some combination of leverage, volatility, and risk - all of which ultimately detract from lifetime portfolio performance.
Sprint against Apple
As it relates to Sprint, we have an interesting comparison between the debt-laden telecom (as the encapsulation of the idea of wildly beating the market) and Apple (as the encapsulation of how to value-bet on a potential dividend grower).
Sprint, I have been informed by the bulls, has the potential to be $10-stock within the next year (as a comparison, at $10 a share Sprint would have a Market Cap of $40B, or 8% greater than T-Mobile (NASDAQ:TMUS). From the $5 a share price 10-days ago, this would amount to a yearly return of 100% on investment. The first thing to insist on here is that the market - though 100% returns do in fact occur YoY at times - generally does not miss out on such opportunities that have anything more than a fairly low chance of actually occurring. Of course Trump could get elected, the next chief of the FCC can be all-in on mergers, and Sprint could make that 100% jump. But how much are you willing to bet on it?
Because, on the other side, Sprint ran their deficit up another $300M on their net loss for Q1, while the nice gains in liquidity is the result of a bit of smoke screen from off balance sheet debt swaps. And while Sprint has certainly gained ground on the postpaid subscriber rolls, they have done so on revenue slashing promotional deals. Added to this is increasing cost savings via slashing capital expenditures, in an industry that requires capital expenditures to keep up with the growing consumer desire for wireless data.
Against Apple (NASDAQ:AAPL) you have a stark comparison of companies with a great deal of skin in the cellular game, which are (to varying degrees) out of favor in the market. While Sprint's woes have largely been fundamentally-based (and related to continuing cash losses) Apple's largely have to do with the market cycle on their iPhone brand. And while you cannot avoid some speculative conclusions relating to the forward ability of Apple to regain iPhone sales when the new model handset is released, that speculative aspect is far less important to long-term Apple holders than the speculative component relating to the Sprint turnaround (and potential M&A).
Apple currently has a market cap of $530B on a diluted EPS of $8.98. In addition, Apple offers a dividend yield of 2.3% (and recent history suggests that the behemoth is intent on growing their dividend). Apple has levered free cash flow of $50B, and a clearly engaged following of consumers. Added to this Apple has been expanding their reach into various connectivity platforms, and has a clear path into a more diversified income stream in the future.
While Apple has a 52-week range between $89.47-123.91, Sprint is between $2.18 and today's (July 26th) high of $6.28. In a nutshell, Sprint is up 188% on the year, while Apple went down 27% from their high (they are currently 22% down from their high). The ultimate question for investors is whether the likelihood is greater long-term for Sprint to continue the run-up (against a sustained history of losses) or for Apple to rebound in the coming year from their post iPhone 6 sales slump.
I would strongly suggest that the overall market history of rewarding dividend growth stocks (particularly those in a normal business cycle slump) makes Apple (or a correlate) much more satisfying than a speculative stock on high (Sprint) that has not yet demonstrated the ability to produce positive cash flow, and who is leveraging their assets and network (with lowered Capital Expenditures) in an effort to turn around in a hyper-competitive cellular landscape.
Click follow above (or on my homepage at godofgametheory.com) in order to follow my next series focused on dividend growth/low forward volatility investments to beat the market.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.