Front Page News a Terrible Place for Investment Research

Charlie Munger passed away last year, but he left behind a wealth of wisdom.

A famous quote of his was, “invert, always invert.” By which he meant it’s often beneficial to think about things backwards. When it appears conventional wisdom is well established, attempt to think differently.

This is a useful mental framework to utilize as the stock market swings between optimism and pessimism.

At periods of extreme optimism, stocks are often expensive. If investors hope to profit from expensive stocks, the most effective strategy is to go short, or bet against them.

But that’s easier said than done.

Enron went bankrupt in December 2001, but prior to Chapter 11, Fortune magazine named Enron "America's Most Innovative Company" for six consecutive years. Enron was among the top-performing stocks in the market during that time.

Put simply, shorting stocks is hard. Even if you’re right, there’s potential to lose significant money along the way.

The other side of the coin is extreme pessimism. This often presents a backdrop where stocks can become cheap, a scenario that is often more compelling. 

Pessimism can potentially lay a foundation for future success.

Why? The world gets better over time. And when market prices begin to reflect too much negativity, that’s fertile ground for investors.

But the caveat is: You must be willing to think differently. Stocks don’t go on sale without a reason; it typically occurs due to a company-specific event, an asset class falling out of favor, or a crisis of some variety.

There are few examples across companies and industries that we’ll use to illustrate this concept.

Example 1: Facebook

Facebook (now Meta Platforms) went public in 2012 and ascended to become one of the world’s largest companies. 

But it hasn’t all been smooth sailing.

Since going public, Facebook’s stock has had:

• 7 separate drawdowns of more than 20%

• 4 of those drawdowns turned into 30% declines

• 3 turned into 40% declines

• And the peak to trough max drawdown has been 76%

Each drawdown included a story suggesting that the company’s best days were behind them, often pointing to competition or regulation as the culprit.

Facebook’s best days will eventually be in the rearview mirror—like every company inevitably—but that’s not what these past drawdowns reflected.

The most recent drawdown came in 2022. In September 2021, the stock was at all-time highs. By November 2022, the stock had fallen 76%. 

This period represented a massive shift in its business, and a time when the company renamed itself to Meta. 

Many headlines made it appear obvious that the company had peaked. One analyst wrote, “I’m not sure there’s a core business that works anymore at Facebook.”

The company was falling out of favor with investors as they invested billions into its metaverse strategy. Capital expenditures—purchases of property and equipment—jumped nearly 70% to $32 billion in 2022.

The running joke was, “What are they building, the Death Star?”

In short, spending was out of control.

What happened next? While oversimplified, management found Jesus on spending and Meta’s shares have since increased by more than 400%, outpacing the S&P 500 nearly tenfold.

Example 2: Energy Stocks

The 2010s was one of the greatest bull markets ever for US stocks. For energy stocks, it was a lost decade.

Energy stocks returned -7% from 2010 through 2020, while the S&P 500 compounded at 13.7% annually for a total return of more than 300%.

At the end of 2020, energy stocks made up around 2% of the S&P 500’s market cap, down from nearly 30% in 1980.

Investors had essentially left energy stocks for dead. Returns had been terrible, bankruptcies were common, and oil was a commodity in secular decline.

Things looked bad, and then they got worse. In a historic move, oil prices briefly went negative in 2020, and as the New York Times pointed out, a barrel of oil was worth less than nothing.

The market cap of Zoom—a company founded in 2011—surpassed that of Exxon Mobil, the largest US oil company with a history that dates to 1866.

And Jim Cramer was DONE with oil stocks!

But none of this served as a final verdict on oil’s future. Rather, it planted the seeds for improvement.

Companies build muscle during hard times. The energy industry is very different today than it was a decade ago. There is less debt, capital is being returned to shareholders (buybacks and dividends) instead of pursuing more oil production, and valuations are undemanding given many investors gave up on the asset class.

And now returns are catching up. Energy is the best performing sector over the past three years.

And Exxon Mobil’s market cap is now 23 times larger than Zoom.

Another interesting anecdote, though not a factor in returns, is that the largest energy companies are also some of the biggest investors in energy projects of the future. Burgeoning industries like carbon capture, hydrogen production, and sustainable aviation fuel are being pushed forward through capital commitments made by traditional oil companies.

Whatever your prediction for when the last drop of oil is used—and opinions on that subject span from years to millenniums—these companies are investing to ensure their long-term viability.

Which is something the market may not fully appreciate, leading to a potential opportunity for investors.

Example 3: Banks

Obituaries were being written for the banking sector last March.

From initial rumors to total demise, Silicon Valley Bank only lasted a couple days. It was a stark reminder that risk happens fast, and you don’t realize how precious confidence is until it evaporates.  

An index of regional bank stocks fell more than 40% from March 1 through mid-May.

The headlines were ugly.  

Conventional wisdom indicated that the entire banking sector was in trouble. However, the reality was quite different.

As regional banks tried to contain the fire, depositors sought safer havens for their money, leading many to turn to the largest, most durable franchises in banking like JPMorgan, Wells Fargo, and Bank of America. JPMorgan even acquired First Republic Bank at a bargain price, effectively capitalizing on the crisis.

And a year later, it’s clear that too much negativity might have seeped in. All the banks mentioned outperformed the S&P 500 over the past year.

For investors willing to think differently, the banking crisis presented an opportunity rather than a major risk event.

Going Beyond the Headlines

The common theme in each example is that headlines can easily mislead.

Former Fidelity fund manager Peter Lynch was fond of saying the front page of the newspaper carried the negative stories intended to capture the widest readership.

Facebook’s demise, the fall of oil stocks, and a banking crisis all fit the bill.

But Lynch’s quote went on to add that while the front page carries the salacious stories, “The back pages have all the facts. And that's where you need to be focusing your attention.”

Lynch’s point is that the stories others are ignoring—or afraid to touch because of overwhelming negativity—are often a great place for investors to focus attention.

If you look at the past 50 years in the stock market, the average intra-year decline for stocks—on average—is about 14%. But if you look at individual stocks, the average fluctuation between the 52-week high and 52-week low is closer to 50%.

Point being, every year there will be opportunities that investors can potentially use to their advantage.

As Charlie Munger said, opportunity comes to the prepared mind.