Momentum investors are casting off high-flying tech shares like unwanted winter overcoats. Owain Bennallack asks Mark Rogers and Nate Weisshaar if this is a buying opportunity? The team also discuss how a change in the Office of National Statistics’ official bean counting will boost UK GDP, and explore allegations that high-frequency traders have rigged the market. All that, and a look at three companies that have caught their eye.
The following is an unedited transcript of this podcast
Owain Bennallack: Welcome to Money Talk, the investing roundtable from The Motley Fool. I’m Owain Bennallack, and with me in the studio I have Nate Weisshaar and Mark Rogers from The Motley Fool’s Champion Shares Pro and Share Advisor services. Happy springtime, guys.
Nate Weisshaar: It’s looking nice and sunny out there these days.
Mark Rogers: Hey, Owain, great to be here.
Bennallack: It is weirdly sunny. Nate, I know spring break is a big tradition for you young bucks in America. Off to Miami you go, to party until 3:00 a.m. in your swimsuits, drinking cocktails. Mark and I, of course, are familiar with U.K. Easter bank holiday traditions.
Rogers: That’s right.
Bennallack: We will be going to a garden centre, where we will be looking at some damp lettuces in the rain.
Weisshaar: That sounds almost as exciting as Miami vacations.
Bennallack: Maybe you could go. There is a garden centre on the way to Heathrow, so as you go back to America, you could stop in, look at a few old, wet, soggy carrots, and then fly to the party.
Is it like that? Is it like those videos — like the rapping videos? I’ve seen videos on the Internet …
Rogers: What videos have you seen, Owain?
Bennallack: Not those videos. Safe search videos, which have a lot of people partying by a pool …
Weisshaar: Remarkably, it is very much like that.
Bennallack: Why do you like drinking beer that’s been floating? What does that do to the beer?
Weisshaar: It immensely improves the flavour.
Bennallack: I bet it does. Okay, well, let’s move on from Nate’s holiday plans!
In a moment we’ll talk about some recent turmoil in the markets, especially the fall from grace of high-flying tech shares, which momentum investors are casting off like their winter overcoats. Is this the chance to buy the overpriced, blue sky, hope-and-pray, jam tomorrow stocks you’ve always wanted? We’ll discuss. That wasn’t a biased question — we will genuinely discuss it!
Then we’ll discuss the Office of National Statistics. It’s changing how it accounts for the British economy, with some surprising results. Nate will make it all very interesting, won’t you, Nate?
Weisshaar: I’ll do my best.
Bennallack: We’ll see if he can actually pull that off.
Finally, high frequency trading — it’s been in the news frequently, but what is it, and should Foolish investors be worried?
Then we’ll conclude, as ever, with three companies that we’ve been looking at. Sounds good?
Weisshaar: Let’s get started.
Rogers: Sounds great.
Bennallack: Let’s start with the tech share route. Over the past few years, we’ve seen investors dismiss their doubts about buying into exciting predictions for 3D printing, the future of cloud computing, big data, and no doubt somewhere time machines and faster than light speed travel — I think someone’s trying to float TARDIS.com at the moment.
Recently, they’ve had second thoughts. The benchmark U.S. NASDAQ index has fallen about 8%, as I record this, in the last few weeks. Floats — we’ve seen all these dodgy floats come to market and now some of them are being postponed — and some of the shares have really taken a bit of a pummelling, haven’t they, Mark?
Rogers: Yes, it’s been really brutal out there for the last few weeks — few months, really — for some of these high-flying tech stocks. Amazon.com is down 20% for the year, Twitter has dropped 36% so far in 2014, and a few others. The 3D printing stocks; 3D Systems is down 50% and Stratasys is down 28% in 2014, so some pretty startling numbers there.
Bennallack: The jingoistic Brit in me thinks, “Ha, ha! Unlucky Americans who get spring break, but you also get plunging share prices.” But is it just a U.S. phenomenon? Do we have technology shares here that we can get scared of and dump in a panic?
Rogers: We might not have as many, but there are certainly some real high-flying shares, especially some of the ones that have recently floated.
Just-Eat, which we were talking about quite recently, is down 20%. Boohoo.com — we were talking about that one on the podcast — that’s down 30% since it floated.
Bennallack: It is a hostage to fortune, with that name, isn’t it?
Rogers: Even ASOS, which has always been a very highly-rated stock here, is down 40%, so it’s been brutal here in some cases, too.
Bennallack: I saw AO online, the online dishwasher vendor which floated a few weeks ago, is now back below its float price. From memory — you’ll want to check this if you think about investing — but from memory it came out in the high 200s, went up to 400, and has now gone back below the float price, which is a pretty incredible run.
Weisshaar: That’s a good round-trip for you.
Rogers: That’s common of just about all of these really highly rated ones that we were doing the “Hot or Not” review of, quite recently. It’s been pretty brutal out there, like I say.
Bennallack: Okay, so what do we think is behind this? A lot of these shares have been expensive on the standard, traditional metrics — like making money, profit, profit to earning ratios — but they have been for ages.
In most cases, to be fair, they have been growing pretty quickly and, unlike the dot-com days — much as I quipped a second ago — they have actually been producing some cash. On the whole, they’ve been reinvesting most of it.
That was the reason for owning the shares; what’s changed in a month?
Rogers: I don’t think there’s a single reason why it’s happened, but whenever you have a situation where these big momentum stocks, these big growth companies, have a very strong run — when that gets exhausted, it seems almost inevitable that the results can be quite sour for investors if the reason for owning it isn’t necessarily because, “This is a great company, I’m going to invest in it for the long term and take part in that growth.”
If you’re actually just holding it because it’s gone up — “I think it’s going to carry on going up,” and you’re getting on board — then that’s not the most stable reason for owning the shares in the first place.
Bennallack: Nate, we know some people that like to invest in companies like this, and are proper investors, and co-founded The Motley Fool; David Gardner would say he was investing for the long term. I take Mark’s point, that others do pile in.
To look at an investor who isn’t particularly growth-orientated — Warren Buffett — he says, “Be greedy when others are fearful.” People are clearly scared. Is this a good time for us to get greedy?
Weisshaar: I think some of these shares have sold off quite a bit, but a lot of their valuations are still very lofty and aspirational. The problem with those momentum type of shares, where people keep buying because they keep going up, is when they start going down, people keep selling because they keep going down!
Bennallack: But that does imply that at some point they’ll overshoot.
Weisshaar: Oh, yes. I think that’s probably the safest bet we can have, is that the market is going to overshoot in both directions.
As I say, these aren’t exactly cheap companies right now, but they do become a lot more interesting after selloffs like these, so I think investors who might have been interested in the stories around these companies should take a closer look at what the company actually has to offer, now that the shares are selling off, because they could keep going and offer a legitimate value opportunity.
Bennallack: Essentially, look for the companies that you think you’d like to own, and then see if you can get them at a sensible price.
Weisshaar: Yes.
Bennallack: Okay, well let’s move on from the fantastical predictions of certain tech investors to fantastical numbers from the bean counters. As the Sunday Times put it this weekend, there are lies, damned lies, and the Office of National Statistics.
Nate, it seems like the ONS is about to turn us into a fast-growing economy populated by a nation of savers, simply by changing how it adds up the figures.
Weisshaar: That’s a good way to do it, isn’t it?
Bennallack: It certainly saves saving money.
Weisshaar: Always change your point of view, and then things will look better — I think Mary Poppins taught me that.
Bennallack: You’re saying Mary Poppins is now …
Rogers: That wouldn’t surprise me at all.
Weisshaar: I think the government is looking for help wherever it can find it.
Bennallack: I will just say that when we were talking about this story before the podcast, you suggested certain media outlets were over-egging things, but you’ve already said that Mary Poppins is officially running the ONS, so I think you need to row back a bit.
Weisshaar: Yes, I’ll bring it back in a little bit. I think people are making a bit of a deal out of this. In reality, it looks to me like the ONS is updating its methodology in an appropriate way. Some people — some of the marginal commentators — might be calling conspiracy into play here, but it really does look like a legitimate move.
One of the big moves is the way they account for R&D spending, which up until now has been considered a cost. They’re now going to consider it more of an investment, and that should boost GDP by about 1%.
Bennallack: Which is really significant.
Weisshaar: Well, especially given the growth numbers we’ve been seeing. This isn’t really a growth boost — it’s raising the base, really. The U.K. GDP is estimated to be 1.4 trillion, right around now, and they think that the results of all of their updates to their methodology could boost the base number 2.5-5.0% which, given what we’re talking about, is an appropriately large range.
Bennallack: I guess, from what you’re saying, that even if it boosts it, they’d have to go back and look at the old numbers and change those as well, so it’s not like it will suddenly leap up.
Weisshaar: Yes. GDP growth won’t be 5% next quarter. It will just be off of a larger base, and the numbers are intended to more accurately reflect what’s happening in the economy.
Bennallack: How does this make us into a nation of savers?
Weisshaar: Well, we’re going to now start counting pensions as part of your savings. Previously, they were considered a liability for the company, and not an asset necessarily, for you.
This change I have a bit of an issue with, because you don’t really have access to your pension, so it’s not part of your disposable income — and savings is reported as a percentage of disposable income. So, I think this is a bit confusing to people, perhaps. The savings are there; they’re just not accessible.
Bennallack: Nate, I’ll stop you there. The red light is flashing — that warns me that listeners are turning off, because they’re worried that you’re about to get deep into the weeds on the pension changes.
Weisshaar: Well, I apologise to all of them.
Bennallack: We’re going to cut you off there, and we’re just going to basically cast aspersions some more, because what I worry about here is that, if the ONS is changing the numbers, I can’t tell whether I should take them more seriously because now they’ve got good numbers, or whether it means I should take them less seriously, because they’ve just changed the numbers on me.
Isn’t this kind of thing, the sort of thing we’re more used to from perhaps less transparent countries — dare I say China?
Weisshaar: Well, yes, China is famous for having dubious economic numbers and economic reports, but I don’t think this is anywhere near that level. I think this is more an improvement in the methodology, so you’re getting numbers that, while not exact or perfect, are better reflecting what’s happening.
That’s really all you can ask for from economic statisticians, because what they’re looking at is a constantly-moving target.
Bennallack: Does this bring us more into line with other countries, or less so?
Weisshaar: This adjustment will meet the newly-issued international standards. The U.S. has adopted this accounting process about six months ago; Australia and Canada have done the same thing. All these changes will be widely applied, so it pretty much brings the U.K. in line with everybody else.
Bennallack: Okay, so we’re making up the figures the same way as everyone else!
Weisshaar: Yes, we’re all guessing the same way.
Bennallack: We’re all in it together.
Mark, do you think this macro data is really of much use to an investor? I know you tend to get quite excited about the Purchasing Managers’ Index. What about GDP? Does that float your boat?
Rogers: Yes, the problem from an investor’s standpoint with GDP is that it tends to be a lagging economic indicator, so you really only get the numbers several quarters after that quarter has already past. It’s delayed for several months, so it’s very difficult for an investor who’s looking forward, to try and use that to try and make good decisions.
But, personally, I have an interest in economics and the economy, just generally, and I think it’s good to have context of what’s going on in the underlying economy, on the front line, and PMI tends to be a pretty good bellwether for that.
Bennallack: I tend to think that companies themselves are the closest to the front line, so if you’re reading a lot of company reports — which we are, because we don’t have any friends — you do get a better heads-up anyway.
Like, sometimes … was it the double-dip, maybe 18 months ago, where they were saying GDP had dipped, and yet companies were starting to report pretty nice numbers — particularly construction firms, that kind of thing?
Weisshaar: Yes, I think relying on the government for this GDP number, which we all know gets adjusted as time goes on, seems a bit silly to me, as an investor. The companies that you’re watching, they have their finger on the pulse of customer demand, and they have orders coming in — or not. They’ve got a much better view as to what they’re facing than a government office.
Bennallack: Another bunch of number crunchers that are currently in the news a lot are the high frequency trading hedge funds, dubbed “the flash boys” by bestselling author, Michael Lewis, in his latest book, of the name Flash Boys.
The allegation is the market is “rigged” by these firms, because they make effectively riskless profits — to our detriment, is the further allegation. Nate, do they do this? Is the market rigged?
Weisshaar: I think calling the market “rigged” is a bit extreme, but he’s trying to sell books, so that’s what you do. I think that high frequency trading does indeed give those doing it a riskless profit, but I’m not sure it’s to the rest of our — especially long-term investing — detriment.
For those who don’t know, high frequency trading is the act of placing essentially fake trades, in order to beat a trade — so if Owain was going to buy some shares and I happened to be located much closer to where he was buying those shares …
Bennallack: When you say “located,” you mean literally the computer server is in, say, the Wall Street Stock Exchange floor?
Weisshaar: Yes, they’re in the exchange building, actually. The exchanges will rent out space to these investment bankers, so they’re obviously a cosy group of people here. You front-run that trade, bidding up the shares a penny or two.
Bennallack: So, you basically see what I’m going to buy, then you go, “Right, I’m going to get some of that,” because you know that I’m coming in with my deep pockets. Then you can sell them a bit higher, because you knew that I was coming in with the money.
Weisshaar: Yes.
Bennallack: That sounds bad.
Weisshaar: Well, and it’s not great. But in reality, the difference is a penny or two. While that adds up for the investment bank, for you as an investor the ding is minimal, and as a long-term investor like we like to be, a penny or two on the day you purchase something and then hold for 10 years is almost meaningless.
Bennallack: Then the other thing, of course, is this wonderful word that we got — I think we imported it from America — “counterfactual.” The counterfactual here is that, yes, you might pay a little bit more because of this high frequency trading activity, but because there’s all this electronic, digital goings-on, that has over time brought down spreads in the first place, so you might pay a penny more, but maybe your spread would have been several pennies, 20 years ago.
I remember Bank of England did a report into this, and I seem to remember they found that liquidity and spreads had indeed been improved.
Weisshaar: Yes, this is the big argument from high frequency traders, is they provide the market with liquidity, and the evidence seems to indicate that they do do this. According to the Bank of England, from 2004 to 2011, bid-ask spreads — the difference between what a buyer will pay for your shares, versus what you would have to pay them to buy from — has dropped by a factor of 10.
Bennallack: A factor of 10.
Weisshaar: Yes, so say from 22/100 of a pence to 2/100 of a pence.
Bennallack: That’s massive, isn’t it? If somebody’s coming and getting 20% skimmed off the market, you’ve got to put it in the context of that massive collapse in the spread.
Weisshaar: Yes. There’s definitely a supporting argument for the increased liquidity being beneficial to shareholders.
Bennallack: Mark, as an ultra-low-frequency trader — which I know you will wear as a badge of pride …
Rogers: Absolutely!
Bennallack: Buying shares once a year or so, ideally never selling, do you care at all about whether high frequency traders are skimming a little bit off the market, especially if you’re getting tighter spreads as a result?
Rogers: Yes, this is an argument that’s been raging for years, long before Michael Lewis’ book came out. I’m personally not massively swayed in either direction on this. I see the pros and cons, but I’m yet to see a conclusive argument that it’s definitely detrimental to a long term investor who’s looking to buy shares to hold for the long term.
Whether or not the tiny change in spread is a massive bonus, compared to the ding that you take on … I just don’t see a massive argument one way or the other for me, personally.
Bennallack: We were talking about this before we came on air and you pointed out, quite rightly I think, that perhaps the one downside is some of the cleverest minds of their generation are playing cowboys in the London and New York stock exchanges, rather than inventing faster than light travel.
Rogers: Absolutely. I think if there’s one major externality that I don’t like to come out of this, it would be that, like you say, some of the smartest minds — mathematicians, physicists, etcetera — are being recruited by investment banks.
Quite rightly so; they’re offering the money to come in and be well-paid to write algorithms, but the net economic benefit is very small as a result of that, compared to what they could be doing.
Bennallack: Nate, some of the shares we look at are, in the U.K., quite small, quite illiquid, big spreads. Should we invite some of these high frequency guys to come over? I guess they only operate in the most liquid markets, because that’s where they can get in and out.
Weisshaar: Yes, I don’t think you want to invite these types of players into your game, if you didn’t have to. I think the spreads on very small, very illiquid shares are an annoyance, but I think if you’re investing in a good company for the long term, they’re something that you accept, and I’m not sure you’d want to open that Pandora’s box.
Bennallack: Okay, let’s look at a few shares that we might be thinking of buying in our old fashioned, dinosaur way — obviously, we’d be laughed at by the high frequency traders who probably set up a business and go bust before we get to the end of this section of the podcast!
Mark, what has caught your eye?
Rogers: With us talking about high frequency trading, I thought for a change I’d try and find a company that’s maybe in a position to benefit from the move towards the more electronic, software-based approach to financial markets.
Bennallack: This is the “can’t beat them, let’s join them” hypothesis.
Rogers: Right, a little bit of that. I think it’s a good company in its own right. It’s called First Derivatives (LSE: FDP). It’s an Irish-based financial software company, and what they do is they supply big banks like J.P. Morgan and Goldman Sachs with risk management and data analysis software for their traders and investment bankers.
They’ve been a phenomenal growth story in terms of sales over the last 5-10 years, especially since the crisis, as you can imagine. A lot of new regulations have come in, and they’re really benefitting from that.
The company is founder-led. The CEO, Brian Conlon, still owns 40% of the shares, and I think it’s an interesting story as regulation becomes more stringent. I think that analysis of data is just something that’s going to become increasingly important.
Bennallack: How are they different from Fidessa, which maybe some listeners have heard of?
Rogers: Fidessa is more focused on — for the traders themselves — executing trades, etcetera. This is more on the back-end side of things; risk management and figuring out exactly how much risk a book is exposed to.
It’s more back-end than the front end, but it’s there where there’s really a wealth of data coming in that needs to be analysed just to make sure the company’s carrying enough cash, etcetera.
Weisshaar: They’ve had wonderful growth, obviously — at least on the top line. But we have seen their margins get pummelled over the past five years or so.
Rogers: Yes, that’s right. What’s effectively happened is, as the company has grown dramatically in terms of sales, it’s won new business, won new contracts.
They’ve effectively tried to reinvest as much of the money that’s come in as possible, back into building up sales teams in foreign companies — in Singapore, in New York, where you can imagine they wouldn’t have had much in the way of contacts before, but as a result of spending the money and bringing in new sales teams and people to research and program software, they’ve been able to keep that ball rolling, and then win more business.
They’ve just won another new contract as well, which caused the share price to almost double, earlier this year. Since then, the shares have pulled back by about 30%, so a little bit cheaper than it was.
Bennallack: They’re speculating to accumulate, in short.
Nate, I suppose that the last week has seen you dumpster diving high-tech castoffs.
Weisshaar: Well, I don’t know if I’d go quite that far, but I have seen a few companies that have piqued my interest. One — which I already own — LinkedIn (NYSE: LNKD.US) is getting cheaper, and I may consider topping up my position.
The shares have fallen by a third since they reached their highs last autumn, and in this most recent round of tech chaos, the shares have fallen another 15%. It’s an interesting company; one of what I consider a bit more mature version of the social networks that are ever so popular these days.
The company’s got 277 million users, or members, an essentially they connect people who are willing to post their CVs and work experience on the web, with recruiters. It’s a modern disruption of the old hiring system.
Bennallack: I like LinkedIn as well. I own the shares myself, I should declare. I bought them a bit cheaper, Nate, after the plunge!
But what I would say about them, though, is you’ve described them as “disruptive,” and for people who are sceptical that this business will ever make money — you’re wrong, because it’s already making lots of money; it makes billions.
But it’s also a $24 billion company already — well, I think it’s probably $20 billion now, after the fall. Really, hasn’t it already done its disrupting?
Weisshaar: I think it has started to do its disrupting. Just take a look through the London Stock Exchange and you’ll see plenty of recruitment firms still listed, and still making decent money.
I think all of these are threatened by LinkedIn, and I think 277 million members is a big number, but the world population is significantly larger — and presumably most of those people would like to work at the best job possible — so I think there’s a lot of disrupting that remains to be done.
There are several ways that LinkedIn monetises its members, and they’ve just demonstrated a great ability to turn information into cash.
Bennallack: Yes, they’re doing things with sales leads now, for selling products, which is different again to recruitment. It could be a whole new avenue, really.
I’ll share my share, which is Diageo (LSE: DGE) (NYSE: DEO.US) — a much more familiar share — a £48 billion spirits maker, the biggest in the world. It’s in the news, actually, as we record, because it’s tilting for India’s United Spirits, which I think is the second-biggest spirits maker in the world, by volume.
The reason that I thought I’d mention it is because it’s getting into bed with David Beckham — calm down, ladies! I know, who hasn’t wanted to get into bed with David Beckham? But it’s getting into bed with him to produce a whiskey called “Haig Club,” which apparently comes from the venerable House of Haig, which is apparently 400 years old.
I’ve had trouble researching the House of Haig — possibly that’s just my lack of knowledge about whiskeys — but I just think this is a very interesting deal, because the company’s huge already.
If you want to basically get exposure to premium spirits around the world and sales into the emerging market, we all know the story; you buy Diageo — great emerging market growth, a big chunk of the business, but still plenty to come.
You’d kind of think, “Maybe they’ll just sit back and act as cash cows,” but I think this is a reminder that they don’t do that. They invest about 12% of their revenues in marketing every year, to make sure that people still want those premium brands — the Guinnesses and the Johnnie Walkers of the world.
And they’ve also done a similar deal in the U.S. with — Mark will correct me, I’m sure — but Puff Diddley, or Diddley Daddy, or whatever he’s called now.
Rogers: Bo Diddley?
Bennallack: Bo Diddley … Nate will correct me, I’m sure.
Weisshaar: I believe it’s Puff Daddy these days.
Bennallack: Puff Daddy at the moment. Sean Combs, is it?
Weisshaar: That’s what the government knows him as.
Bennallack: Mr Combs, we will call him. They’ve done a similar deal with him, to promote a high-end tequila. I don’t think these deals are going to revolutionise the world, but it shows that the company is staying alert, and continuing to invest in its brands.
Rogers: That’s what I was going to ask about this Beckham deal, Owain, is whether or not it can really move the needle for someone like Diageo over the long term? Is this something that becomes, for them, like a £2 billion brand, 10 years from now, or is it just a small bet that’s going to be a small part of the business?
Bennallack: Obviously, you never really know, do you, what’s going to become a £2 billion brand? There’s a brand Nate is familiar with in the U.S. called Knob Creek.
Weisshaar: Yes.
Bennallack: That sounds different in the U.S. I don’t know if the manufacturers of Knob Creek ever thought that would be a huge brand, but there it is, on the shelf!
So, it’s possible that the Beckham’s whiskey could become very popular, but I think more what it tells you is that Diageo is constantly looking at its portfolio of brands, seeing where there are gaps, seeing where it needs to stop other people getting on the shelf, because there are a lot of people — is it Gray Goose vodka, which is only about 15-20 years old, maybe even less?
Entrepreneurial characters can come in and try and squeeze these guys out, so if they’re not doing it, someone else will do it. I think it shows you that your company is looking after your cash and its position in the market.
Weisshaar: I think it also demonstrates Diageo’s moat. They have the millions and millions of pounds to throw at the marketing, because when it comes down to it, vodka with a Gray Goose label and vodka with a Ciroc label is really the same thing — it’s just distilled spirits.
Bennallack: Yes. I think whiskey is a little bit different, because there’s some mud involved, as I understand it, or peat or something.
Weisshaar: In the end, though, it’s relatively a commodity business, and they have the distribution and marketing power to allow people to pay up for this stuff.
Bennallack: That’s the incredible thing. When I first read that they spent 12% on marketing, I saw that as a negative because I thought, “Where’s their moat?” But then you realise that their moat is that you go and order the name you’ve heard of, and you remember drinking when you were 18.
Actually, for me, I think it was Diageo — Bell’s Whiskey — it put me off whiskey for quite some time! But in general you might have happy memories, and that’s what they’re trying to maintain.
Rogers: Sounds good.
Bennallack: Right, well if you’d like to hear more Motley Fool wisdom in the next fortnight, then head to our free site, or you can go straight to the good stuff by downloading our special free report on becoming a millionaire the slow and Foolish way. You can get that by just going to fool.co.uk/millionaire — there you go.
Mark’s eyes have perked up at that. I won’t delay his race to riches any longer, so at this point we’ll say goodbye.
Rogers: See you guys.
Weisshaar: See you.
Bennallack: Cheers.
