Back to Drew's Views
July 4, 2021
Previous
Next

Rumpelstiltskin and Meme Stock Investing

Markets
Stock Picking
Valuation

Let’s say a company is ex growth, perhaps even deteriorating a bit year‐on‐year, but still doing about $5 billion of revenues annually. The business model is under severe duress, it is heavily indebted (say $4.5 billion of net debt), and the cost structure is rendering it unprofitable. They do 8% operating margins in the good times, and they’re now down to half that, and after the interest expenses from their big debt‐load, they are losing money.

But there is a contingent of investors out there who see some value down the road, and another faction that see optionality of a pivot. These marginal investors in the aggregate decide that the equity should trade at $500 million or so (which works out to an Enterprise Value of $5 billion).

But then imagine the stock inexplicably (at least to the value investors) starts rallying. For some reason it starts trending on r/wsb and a meme battalion starts launching TikToks stating how owning shares is sticking it to the man.

So the stock rips without any fundamental justification. Vinnie Value says “good, yours” and sells his shares at what he thinks is a silly price, and moves on. But meanwhile, Mo Horshack and many others join the “battle”, and the meme battalion becomes a meme brigade. Things get sillier.

Meanwhile, company CEO (Boom Boom Washington) is no fool, and starts issuing as much stock as he thinks he can. But as he does it, instead of the shares selling off, more troops join the battle! And before we know it, the meme battalion has become a meme Army.

The logic goes a little something like this. As the share price increases, the management can sell shares at higher and higher prices to embark upon new projects, transitioning it into a digital age. Meanwhile, the shares that were pressured severely by the mountain of debt dominating the Enterprise Value are now released.

This eliminates much of the cyclicality of the business, and effectively removes the short, intermediate, and probably even the long‐term risk of zero (a risk that Mr. Market believed was incredibly likely just a year ago). Finally, the strength of the stock price and the burgeoning cash coffers (and money‐spinning share sales) simultaneously lure the best and the brightest to join the ranks; not of the Army Brigade, per se, but of the actual company itself!

So the story goes that the exploding share price isn’t just a bunch of random craziness, the exploding share price is actually making the company more investible. It is making its sustainability more likely. It is increasing the value of the pivot option. The share price itself is changing the fundamentals of the company. The tail is wagging the dog.

As they say on Twitter, “What sort of sorcery is this?” Is this financial alchemy powering a perpetual motion engine that will result in higher and higher share prices?

Not exactly.

Let’s take it to the extremes to visualize it. Forget about all the reflexivity stuff for a second (the ability to hire great people, the optionality of new projects). Heck, as a starting point, even forget about the debt and/or risk of zero.

Just imagine a company with no net debt, and a business (fairly) worth $100 million, and 100 million shares out, trading for $1 a share. Then imagine that without any change in fundamentals, the share price ten‐bags to $10, giving the firm an enterprise value of $1 billion.

Then imagine the company (wisely I might add) decides it wants to sell more stock to raise some cash at these wild levels. Now pretend (not hard these days) that the stock market doesn’t react negatively to a big placing. Then assume that the management has authorization to issue, and then commences with, selling another 100 million shares at $10/share, raising $1 billion of cold hard cash.

So, what do we have? We still have a company with a fundamental business worth $100 million, and we have $1 billion of excess cash in the bank, so an equity value of $1.1 billion.

We have 200 million shares now, too, so that works out to fair value of $5.50 per share!

Wow! Is this a Rumpelstiltskin stock?

Nope, it isn’t. There is no free lunch. Sure, the stock is worth $5.50 per share, but the buyers who participated in the placing at $10 basically handed over nearly half their money to the existing shareholders. It’s just a straight transfer, that’s all that happened.

There is no Rumpelstiltskin. You can’t turn straw, or lead, into gold.(1)

Okay, but what if we introduce the heavy debt load now? If this $100 million business was deeply cyclical, and its ability to finance itself was risky, and it had long ago taken $90 million in debt to keep it going, then it only had just $10 million of equity value. In that case, those initial 100 million shares weren’t worth $1, they were worth just $0.10.

And if the stock price surges to the point where the value of the enterprise (the business) is the same $1 billion mentioned above, that means the equity is worth $910 million (the $1 billion less the $90 million they owe). That’s $9.10 per share.

If they go out and do the same 100 million share sale at $9.10, that raises $910 million. After doing so, they have a business which is fundamentally worth the same $100 million, with $910 million of new cash, of which they pay off the $90 million of debt (leaving them with $820 million of excess cash). This leaves them with $920 million of equity value, divided by 200 million shares, and a share price of $4.60 per share.

Sure, the return for the initial shareholders is even better than in the first example (thank you leverage) but it is still the same transfer from new shareholders to old.

That’s all it is.

And before anyone says “well, what if they just keep on doing that?” the answer is you can’t. You can’t do this forever. It smells a bit like a Ponzi Scheme already, in fact. Eventually, you run out of marks.

Sure, the suddenly invincible management team could take that new money, hire a bunch of smart people, pivot hard, or embark upon an entirely new business. And yes, that could one day make the $10 or $9.10 per share capital raise a profitable trade for Mo Horshack, with high fives from Epstein and even Mr. Kotter.

But it would have been a lot more profitable for Horshack if it were just a new company – one where his new money didn’t have to pay a nearly 50% entry fee to join the party.

Welcome back, insanity.

FOOTNOTES

(1) Well, I guess if you have a handy particle accelerator you might be able to: https://www.scientificamerican.com/article/fact‐or‐fictionlead‐can‐be‐turned‐into‐gold/

Image Credit: “Rumpelstiltskin” by Paul O. Zelenzky, via Myth & Moor, Terry Windling

‍

Download PDF

Topics

Markets
Stock Picking
Valuation

DISCLAIMER

The views and opinions expressed in this post are those of the post’s author and do not necessarily reflect the views of Albert Bridge Capital, or its affiliates. This post has been provided solely for informational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The author makes no representations as to the accuracy or completeness of any information in this post or found by following any link in this post.‍

YOU MIGHT ALSO LIKE

Text Link

Heading

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Suspendisse varius enim in eros elementum tristique. Duis cursus, mi quis viverra ornare, eros dolor interdum nulla, ut commodo diam libero vitae erat. Aenean faucibus nibh et justo cursus id rutrum lorem imperdiet. Nunc ut sem vitae risus tristique posuere.

Text Link
Text Link

On the Relationship Between Gasoline Prices and Vehicle Demand

As it relates to demand for pickup trucks and SUVs, gasoline prices may not matter matter as much as they used to.

Stock Picking
Read More
Text Link

Sell in May and Go Away?

Turns out there may actually be something to the old Sell in May and Go Away adage - at least over the last 80+ years.

Markets
Asset Pricing
Read More
Text Link

If Growth Stocks Sell Off Will They Bring Value Stocks Down with Them?

Growth stocks crushed just about everything from 2017 through 2021. Not that they necessarily will, but if they do give back some or all of their gains, given their weightings, times will be tough for broader indices. But what about the value names within them, will they sell off in sympathy as well? Of course no one knows, including ourselves, but we take a quick look at behavior of value names as the tech bubble sold off from 2000 through 2002. This example may be worth some consideration.

Markets
Factors
Read More
Text Link

Stock Market History, Illuminated

Some year-end charts and tables asking some big questions about what comes next.

Asset Pricing
Factors
Markets
Valuation
Read More
Text Link

Which One Are You?

So, if you are in the taxi, what is your first move (and you can’t say “do nothing”). Are you trimming or adding?

Markets
Stock Picking
Read More
Text Link

Was Ben Graham a Quant?

The short, and relatively unknown, paper is chock full of wonderful anecdotes and pearls of wisdom, but it was the interview portion that really caught my attention.

Stock Picking
Read More
Navigations
HomeTeamDrew's viewsPressContact
Disclaimers
Legal & regulatoryPrivacy policyCookies policy
How to get in Touch
info@albertbridgecapital.com

Subscribe to Drew's Views

No spam. Unsubscribe anytime.
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
© Albert Bridge Capital 2022
Website by SW10media.com
On the Relationship Between Gasoline Prices and Vehicle Demand
Sell in May and Go Away?
The Politics of Passive Investing
If Growth Stocks Sell Off Will They Bring Value Stocks Down with Them?
Stock Market History, Illuminated
Which One Are You?
Was Ben Graham a Quant?
Do Short Term Flows Permanently Affect Share Prices?
Just How Cheap is Europe vs. the US, and Should it Be?
Are American Companies Better than European Ones?
Rumpelstiltskin and Meme Stock Investing
Archegos, Disclosure, and Price Discovery
It's All About the Fundies
On Unlimited Upside
A Memo to Investors
Investors? Possibly you!
Avengers Assemble!
How Did This Even Happen?
Was “Value” Just a Hot Hand Thing?
The Hot-Hand Fallacy Fallacy Fallacy?
Cue the Camouflage
The Times that Try Stock-Pickers’ Souls
A Different Game?
Heads I Win
A New Ice Age?
Grandpa Stocks
Bubblicious?
On Negative Oil and Futures Prices
In Flew Enza
COVID-19 and Equity Markets
Regulators to the Rescue?
Perspective
We Don’t Make Pizzas
Ben Graham the Growth Investor?
Not a Bad Decade
On the Impact of the FAMANGs
Europe vs the US: Is it all about sector exposures?
Behavioural Finance is Finance
America’s Decade
Known Unknowns and Share Prices
Prediction, Publicity, and Paul the Octopus
Are Company Visits Good or Bad?
Everybody Was Kung Fu Fighting?
Voting Machines and Weighing Machines
The DCF is the Randy Watson of Valuation
The Sacrilegious Diaries: Measuring the Impact of Portfolio Turnover
Passively Irrational?
Imagine No Inflation
The Sacrilegious Diaries: The Benefits of Turnover
Stay in the Game
I’m Volatility?
Woody was Right
When You Can’t Wait For Tomorrow
James Harden and Alpha
Groundhog Day and Overnight Returns
Debiasing and Alpha
Peak “Peak Car” ?
The Right Way
The First Step to Regaining Credibility
The Futility of Market Timing
Visualizing the Arithmetic of Active Management
123 Years of the Dow
Sweet Emotion?
Share Buybacks, Bad Companies, and Bear Markets
Risk and Portfolio Theory
Keeping Calm and Carrying On
Reminiscences of a Stock Operator: The Volkswagen Chronicles, Ten Years Later
We’d Rather Not Sleep
Factor Timing, Should You Try?
The Mathematics of Maintaining Bet Size
The Grandfather of Behavioural Investing
On Sexual Chocolate and Semi-Annual Reporting
Island Economies and Risk
Build a Bear?
Data Science and Alpha
We’re all Value Investors
Hunting for Alpha
Career Risk, Alpha, and Contrarian Investing
Passive Flows and Wheelbarrows
God Bless the Shorts
Equilibrium Happens
Horses and Stocks
Peak Quality?
Bill Sharpe and Hank Aaron
Unwarrented
The Search for Excellence and the Loser’s Game
Fooled by Non-Randomness
Half Hearted Is Half Minded
Still Superman, but without the cape
122 year Dow Jones Histogram: Putting 2017 into context
Pegs, P/E'S and the Value Premium
Rick Barry and Lewis Carroll
Secular Winners and Value Investing
On Passive Flows, Smart Money, and Alpha
The Voting Machine
Prevous
Next
homeTeamdrew's viewspressCOntactDisclaimers