Stock Market Efficiency - The Shuts Down of SPO Partners Co. (Assessed Blog 1)

STOCK MARKET EFFIECIENCY

A top line news that was published by Bloomberg on 25^TH Oct 18 caught my attention while I was struggling to look for a topic that best suits in this blog. According to the news, a hedge fund which is worth $5billions is shutting down because it finds exceedingly difficult to deploy capital with an acceptable margin of safety in the recent challenging market environment. SPO Partners & Co., had been advocating in value investing for over almost 5 decades and posted an average annual return of 23 percent across its investments. However, good fortune won’t last forever, the strategy of value investing implemented by SPO Partners & Co. was not compatible with credit crunch that started since the year of 2015 which will be discuss later on this blog.

First and foremost, what is value investing? It is one of the popular investing strategy where investors look for the stocks that are appear to be undervalued. They analyse the value of the company by examining the price-earnings ratio, future prospects of the company, cash flow and etc. hence compare it to its current share price in order to determine whether the company the is undervalued or not. Warren Buffett, an investor with highest prestige globally had made a stunning fortune with this particular strategy over the years and I believe there is no further elaboration needed on his successful investments such as the Coca-cola case as well as the recent investment in Apple. Nevertheless, here comes the question, is the strategy of value investing used by SPO Partners & CO. over the years effective in stocks investment? Or it is what exactly causes SPO Partners & CO. to collapse?

In stock market efficiency hypothesis, there are three market levels of efficiency which consists of weak form, semi-strong form and strong form efficiency. Firstly, the updated public information is not spread freely and easily in an inefficient market (weak form), thus using fundamental analysis that based on public information about a company such as profit, assets, etc is able to predict share prices. This is because the information of the company is not acquired by everyone, therefore the “knowledgeable” people can use it to beat others who don’t know it.  However, technical analysis is not applicable because it is based on past share prices which are known by everyone. Looking into semi-strong market efficiency, the public information spread semi-quickly which is faster compare to weak form. Therefore, fundamental and technical analysis are not applicable because they are both based on public information. Nevertheless, some insiders like company officers have slight advantage over normal investors like us because they had information slightly in advance of the public. On the other hand, nobody can make profits by using any information to “analyse” and predict future share prices because everyone knows all relevant information of a stock at the same time in perfect market efficiency (strong form). In my opinion, perfect market efficiency is not realistic because public information does not spread quickly in a real world situation. This can easily explained by the many of insider trading cases all over the years and normal investors like you and me could only get the last-hand news. For examples, I’ve seen many stocks rises dramatically a few days before the quarterly report of the company is disclosed. It is obvious that some insiders had acquired the information before it was published and started to accumulate the stocks hence sell it after the information is published in order to make a huge profit.

Coming back to the case of SPO Partners & Co., the strategy of value investing might be effective because the stock market is inefficiency in a real-world situation. Thus, the hedge fund could analyse stocks using fundamental analysis and invest on stocks that are “undervalued”. However, the share prices are fluctuating in a random fashion and there is no systematic link between one price movement and subsequent ones according to Kendal Chartists. He also mentioned that it is impossible to predict future share prices without extraneous information and share prices changes when new news enters market. True that people tends to overreacting towards new news on companies and the share prices volatiles in the short-run, this is due to the human nature of greed and fear. I believe that share prices and the value created by companies are consistent in the long run because buying shares of a company means that investors own a part of that company and involve in the business with other shareholders. Therefore, if a company is doing well and generating higher value of itself, there will be more investors buying its stocks and eventually the share prices will rise.

Since year 2015, the FED started to implement contractionary monetary policy by raising interest rate to the current rate of 2.25%. Therefore, companies have to pay more interests for debts and the investments of companies will be reduced. This posted a disadvantage for value investors as well as hedge fund like SPO Partners & Co. because the stocks prices will only grow cheaper due to lesser investments and deleveraging. In contrasts, people are going for “growth stocks” with a fair price and causing the stock prices of “undervalue” stocks to stay cheaper for a long time. This happens when other investors did not discover the so called “cheap stocks” and no one is buying it thus lead to value investors like SPO Partners & Co. to fall into value trap and eventually shuts down.

Reflection on Dragon's Den

Well, I've never written a single blog in my life, if it's not assigned by Dr. David, I think that I will never write a blog for the rest of my life. The purpose of this blog is to reflect on an episode of “Dragon’s Den” of our choice. Wow! It’s sounds like a cool title right? At least for me it is, it sounds something like “Games of Thrones” or some other epic drama, but it turned out that it is reality television programme in which entrepreneurs get to pitch their business ideas to five “dragons”, the multimillionaires, yet the Dragons get to evaluate and make their decisions on whether to invest or not.  I randomly picked one episode to watch, which is season 15, episode 14 as I had no idea what was it about.

In this episode, the first entrepreneur introduced a business called “Playbrush”. It was basically a smart device that can transforms any normal toothbrush into gaming controller and later on connect to a device such as smartphone or tablet via Bluetooth, thus the kids are able to play video game while brushing their tooth. If I were one of the dragon, I would have a great interest in the business as this product was capable in solving the problems faced by parents. On top of that, children market is also very huge and profitable. However, the initial offer by the entrepreneur was a hundred thousand pounds for a 1% stake in the business. What the fuck? 1% stake? Seriously?! In addition, the business is currently making a loss of around 1million pounds, thus it made the deal less attractive. The dragons made counteroffers ranging from 5-10% stake in the business but eventually the entrepreneurs turned it down and left with nothing. I was surprised that the offers were turned down because 5-10% shares are not really a big portion and the investment is what the business really needed. It was not really a smart move, was it?

Looking into the second business pitched by the partners, a 20 years experienced therapist and a 30 years experienced in sports businesses. They had introduced a product called “Gravity” which is to cured the back pain effectively and aimed to raise 25,000 pounds for a 10% shares in return. In my opinion, there are quite a big amount of people who are actually suffering from the back illness and the product invented by the partners could be the saviour for them and eventually make a good fortune out of it. However, it was brought to my attention that the product does not possess any legit certificate or approval from the clinics. Moreover, it was only a pending patent and trials done by the therapist over the last three years to support the credibility of the product. It may sound convincing but it involved an immense risk if the dragon were to put their money into the business as the product was lack of proof.   As a result, all of the dragons had rejected the offer and it was reasonable for me because if I was in their position, I would have definitely done the same thing unless it was clinical proven.

Next, the third participant was a woman who was offering 50,000 pounds investment into her business for 20% shares, which produces modern cloth nappies and accessories. I believe the main selling point of the business is that the designed nappies are environmental friendly as it could be reuse for many times, thus it could beat the market shares of disposable nappies. Judging by the look and design of the products, the quality itself is commendable and there are many patterns hence it could attract the new generation parents. However, the business is really small which on captured a total of 23,000 pounds sales in year 2017 and it requires a large amount of time in order for the business to grow. Therefore, the pitch was turned down by 4 dragons and only one dragon made an offer to the businesswoman. The offer was to acquire half of the business and it was 30% more compare to the initial offer. Wow, a huge appetite there from the dragon, right? I mean, this is how the business world runs, it is cruel but the businesswoman had no other choice beside accepting the offer because she needed the fund and connection to build her start-up business.

The last participant was pitching the gins business that crafted by himself and currently making a turnover of 85,000 pounds. Nevertheless, his is working as a contracts engineer in oil and gas industry and he had been in that position for 17 years long. He only uses his spares time to run his business thus I was so concerned how the hell could he managed to do that? If I were to do the same thing I would be extremely exhausted and torn apart. Overall, the business itself is beautiful as the specially made gins have a good taste with a nice packaging and selling at a reasonable price. Of course I didn’t get to taste the gin but feedbacks were given by the dragons.

In short, Dragon’s Den is a really worth watching reality television programme as it shows the audience how does the businessman pitch their brand to the investors and there are a lot of critical points mentioned by the dragons. However, in my point of view, I wonder that would there be conflicts of interests or communication failure occur in the process of the investments? I mean, the dragons barely know the businessman so it is questioned whether they are trustful or the business itself might not be as sexy as it looks behind the scene?