Anthony Davian's  Instablog

By: Dasan

The fourth element of the monthly Dasan Stock Digest is the Dasan Focus Report. In this report, I cover whatever I find interesting at the time. In this particular issue, I will cover what has to be the story of the week for any stock investor - the trading in Amazon shares in 2009, culminating in Friday’s 25% move.

Many value investors worship at the feet of Ben Graham, who literally wrote the book on Value Investing. He came of age during the Great Crash in the 1930s and was the first person to put in writing a method of stock market investing that relied on buying cheap stocks. In his seminal work, he made a strong point that stock investors should always invest with a Margin of Safety by buying a stock that is trading for below asset value. This is where most Value Investors stop. They keep repeating “Margin of Safety” as if it were a mantra.

I will make a controversial statement (I like to do this often) and say that Margin of Safety is as real as the Tooth Fairy. There is no such thing as a Margin of Safety, because even tangible assets (such as printing presses or semiconductor fabs) can become almost worthless if they don’t produce earnings.

The most important, brilliant, massively valuable insight that Ben Graham had to offer was his metaphor of “Mr. Market.” He said the best way to think about the market was it was like a business partner with emotional problems. You own half of, say, an online bookstore. Your partner owns the other half. When his hemorrhoids are flaring up, he goes a little nuts and offers to sell you his half of the business for only $50. You have the chance to either buy him out or do nothing. Then, if the moon crosses Jupiter a certain way, he offers to buy you out of your half for $118, even though yesterday he would have paid only $88 for the same business. Warren Buffett, the richest man in the world, often says understanding this fact about the stock market is the most important key to investing.

Ladies and Gentlemen, I will take the metaphor even further. Mr. Market does not just have emotional problems, but he has Tourette’s Syndrome, Clinical Depression, and a bad Crystal Meth habit all at once! If you don’t believe me, take a look at what has happened to the trading of Amazon (AMZN) stock over the last year.

On Friday, after reporting good earnings, the stock jumped 26% in one day. This means about $10 billion of market value was created out of thin air in one day! Take that, efficient market theorists!

Let me start by taking a look back a few months.

In the beginning of 2009, the chorus of naysayers on Wall Street was saying how terrible Amazon was. It was too expensive, the P/E was too high, the consumer was dead, and so on. What you really had was the set-up of a lifetime to buy quality stocks.

How did Wall Street analysts handle things? Look at the chart below. On Jan 4th, 2009, when AMZN was only trading at $54.46 per share, the average of all analysts ratings was 3.51, implying about 2/3s had “hold” ratings and only 1/3 were “buy” ratings. Look at the craziness at the far right of the chart - once the stock jumped to $118, the average of all ratings was 4.05, a record high on the same day the stock hit all-time highs! The chart of analyst ratings is rather flat, since most analysts on wall street just put a “hold” when they mean “sell” or “I don’t have any idea what I’m talking about .” But it’s clear that there is little value from following these analysts, and in fact, it may be smart to do the exact opposite.

OK, I’ll admit being long stocks in the first quarter of 2009 was too scary for most people. So forget about that. How about waiting for the smoke to clear a bit? How about waiting until Amazon had already gone up from $52 to $79?

Here’s my commentary from my blog on May 25, 2009, when I reviewed my portfolio decisions in Q109:

“My idea was to stick with “Triple A Tech” through this storm. By Triple A Tech I mean AAPL, ADBE, AMZN. Three companies with rock-solid defenses and enormous moats. I was told by many that “shorting AMZN is a no-brainer – the consumer is dead.” My thought was the world’s most efficient e-tailer becomes even more valuable as high costs and collapsing sales put their competition out of business.

Independent thinking wins out again. Notice- contrarian thinking – simply buying the stock that was down the most didn’t work – nor did avoiding AMZN because it had a high multiple.” weblink

Ok, fine, you’ll say - this is ancient history. What do we do with Amazon stock now? That is the question I hope to help answer in the next few pages. Dasan's letter is a premium product at davianletter.com. Please visit the subscribe page to learn more about Dasan's premium product.

Disclosure: long AAPL, AMZN, ADBE