Thursday, December 16, 2010

Trendy Stocks (why stock-picking is a bad idea)

This Syntroleum pilot plant is sitting idle until oil prices go up.


One problem with stock-picking is that most folks want to buy a stock "ahead of the curve" and "get in on a great deal".  So they try to look for the "next big thing" and gamble on some new technology or new company.  And in most cases, it is little more than gambling, as picking the "winner" in emerging technologies is difficult.

For example, during the early years of the PC, there were a number of PC makers, most using the CP/M operating system.  Apple had developed its Apple II machines, but these were viewed more as consumer-grade toys.  In most industries I worked in in the 1970's and early 1980's, the CP/M type machines dominated.  If I was to "bet" on a PC technology in 1980, I would have said a CP/M type system.

But things changed dramatically after the introduction of the IBM PC.  People flocked to that platform on the premise that "It was IBM" and at the time, IBM was the General Motors of computing (and General Motors was the GM of cars).  But oddly enough, IBM didn't "win" the technology race with its PC.  As it turned out, the software was the key component, and Bill Gates - a dark horse if ever there was one - came from behind and won.

And if you know the back story about Microsoft, you'll realize that it very well might not have been Gates that won, but the CP/M system, modified to work on the IBM platform.  But circumstance, luck, and some clever negotiation threw things Microsoft's way, and as they say, the rest is history.  Who could have foreseen that set of very unlikely circumstances?

Once the IBM PC platform started to dominate, other PC companies fell by the wayside in short order.

And few people would have seen this.  After all, back then, as I have noted time and again, people believed the money was in the hardware, not the software.  Software was something you hired some low-paid geek to custom code for you, not something you bought as an off-the-shelf package.  But software predominated, and the rest, as they say, is history.

Stock-picking based on the news of the day, therefore, can be tricky.  Unless you have some special insight into the industry or technology, you will likely pick one of the many losing horses.  The "dot com" era is another example of this - with many, many companies going bankrupt, and only a few emerging as going concerns.  Who would have guessed, back in the 1990's that companies like eBay, Amazon, Google, and Facebook would end up as Internet giants?  After all, all the "smart money" was on AOL/Time Warner, right?  And we know how that worked out.

It is tempting to try to look at current events and guess what will trend next, but in many cases, you are merely gambling and usually will lose your shirt.

For example, during the last gas crunch, I foolishly bought shares in Syntroleum, a company that makes synthetic fuels from natural gas and from biomass.  The company started out in the 2000's with huge government grants to develop a pilot plant.  But like with the electric car, cheap gas pretty much killed off the concept.  The plant is built, but is mothballed until the price of oil exceeds $100 a barrel or more, which doesn't look promising in the near future.  Simply stated, it is uneconomical to operate unless oil becomes staggeringly expensive.  A recent project with Tysons to make fuel from biomass might turn the company around, but then again, with oil cheap, maybe not.

My mistake in buying the stock (which has dropped 45% in value since I bought it) was to react to a news story and to the high price of gas at the time ($5 a gallon).  However, the high price of gas two years ago was due to refinery capacity shortage (a chronic problem in the US and worldwide) and some pipeline shutdowns.  In other words, it was a temporary market manipulation, not a long-term trend.  Even as gas topped $5 a gallon, oil prices remained low.  It was an odd conundrum - but not grounds to invest in alternative energy.

I completely misread that, even though experts at the time all noted that oil was cheap and the real causes of high gas prices were transitory.  I listened, instead, to the cry of consumers who all proclaimed the end of the world was nigh, and that cheap gas would never return.  Again, following the herd is always a bad idea.  They usually stampede off a cliff, or up the chute to the retained-bolt gun.

However, at least I didn't buy Syntroleum at the top of the market - when it was trading for $10 a share or more, but rather nearer to the bottom - for a couple of bucks a share.  So at least I am better off than the initial investors, who took a real bath.  And who knows?  Recent reports show that outside investors are pumping money into the company and with the new Tysons contract, it is possible that they may turn things around.  It could be a sleeper stock - all we need is one good oil embargo.

Another pick, CREE, was a better choice for the long term.  Congressional mandates to eliminate or at least reduce the use of incandescent bulbs in the next few years will mean that more and more people will switch to lower energy cost lighting.  Compact Fluorescent Bulbs, to me, are a stop-gap measure and don't represent future technology.  They have horrible lighting color, odd form factors, and toxic material issues.  LEDs, on the other hand, last decades and use far less energy than Compact Fluorescent Bulbs.

And slowly, LED bulbs are trickling into the marketplace.  And in the technology race between Compact Fluorescent Bulbs, Incandescent Bulbs, and LEDs, the LEDs will win, hands down, as they have better lighting characteristics (in theory, they could be adjusted to put out different light wavelengths and patterns), save more energy, and as costs come down due to mass production, will be far more cost-effective in the long run.

CREE seems like a winner, and the stock has jumped nearly 100% since I bought it.  But even here, I am just getting lucky rather than being smart.  While LEDs might be the wave of the future, which LED company will be the General Motors of LEDs, and which will be the Motors Liquidation Corporation of LEDs?  As a consumer, you can't tell in advance.  The first-to-market is often the loser in new technologies.  The Edison wax cylinder gave way to the flat phonograph record.  And companies can be looted from within, with phony profit reports pumping up stock prices until insiders can cash out.

The bottom line is, trying to pick stocks based on the day's headlines, is something that is fraught with peril.  What the pundits and news analysts often do is get things wrong - very wrong.   It is often not until years, or decades later, that the real truth emerges about any "story" reported on the news.  The news is not only sometimes wrong, it often is.  So using the nightly news as a source for inspiration for stock picks is generally a bad idea.

So if you are going to try your hand at trend-spotting, where do you go?  Well longer term data is a better source, and I think demographic data is a good start.  A lot of recent economic events, from the Real Estate Bubble to the economic downturn, can be traced to demographic trends.  Age and position in life determine a lot what people will do and buy, and as a result, you can predict some trends from demographics.  For example, as our youth market shrinks, we can expect to see stress in educational institutions, and in fact are starting to see this stress now.

Other long-term trends may seem harder to spot, but are readily apparent to anyone who bothers to look.  Larger display screens and the avalanche of people going online will mean that paper documents will become less and less important.  Many folks decry this prediction, saying silly things like "We'll always need hard copies!" when in fact, more and more people are paying bills, sending letters, and doing business without paper copies of anything.  And the decreased volume of US Mail, FedEx overnight packages, and the like, is proof of this.

Conversely, the increase in online shopping and spending means that these same shippers will do more business with online package delivery - which may more than make up for the loss in revenue due to less shuffling of papers.`

But again, if you listen to "people" you would get this trend wrong.  The average Joe will say he likes to write checks - or that going to a store to "feel the goods" is still critical in this day and age.  But the same average Joe will slowly realize that it is far easier to manage your finances online and pay bills online.  And the same average Joe will realize that saving 10-50% in costs by purchasing online (and getting a better selection to boot!) is better than going to a brick and mortar store.

And the same goes for telecommuting.  If you listen to "people" you'd think this was a dead-end.  Yet more and more people, such as myself, are working from home, online, and making money.  Even McDonald's is using telecommuting for order-takers for their Hawaiian stores.  And every year, more and more people are doing this.  And as "virtual presence" becomes commonplace, the urge to travel physically to other locations will diminish.  Not disappear, but perhaps become less casual.

And yet, the common man dismisses such predictions as fantasies.  After all, things have always been one way, why should they not stay that way?  And that is the interesting conundrum of the common man.  The average Joe believes in two opposite and contradictory scenarios - that no change will take place ("we've always done it this way!") and that a crises or sea change is at hand ("Gas is at $5 a gallon!  We'll all have to drive mopeds from now on!").

And actually, if you think about it, it makes sense.  Since the average Joe cannot see any possible change in the way we do things (e..g, we always drive 10 mpg cars) when conditions change (price of gas goes up) he cannot envision any possible way outThis explains why many people today think American is in " crises"  and that this crises cannot be solved - they simply cannot see their behavior or lifestyle changing, possibly for the better, in response to changes in conditions.  Everyone drives 30 miles each way to work - that's how it'd done.  You drive to the store to rent a DVD or buy a Book - that's how it's done.  The idea that you could use the Internet to do all of these things is, well, alien to them, so the idea of high gas costs frightens them considerably, as there are " no other alternatives"  in their primitive minds.


And over the last few decades, I have witnessed this first hand.  During the various gas crises, people have said "Well, that's it, a dollar a gallon, we can't drive anymore!" and yet life went on as before.  But at the same time, people invested great belief in the status quo - that General Motors, for example, would "never go out of business!".

Time has shown both propositions to be false.  While the economy and the world changes, it doesn't mean that each event of the day is a world-changing one.  And while some things remain static for long periods of time, that doesn't mean they are immortal.

In fact, thinking of this just now, you probably could do well, as a general rule, betting against trendy changes based on events of the day, and also betting against long-term static institutions, in the long run.  Both are probably bad bets, and you could profit greatly by betting against them - provided your timing is correct.

At this point, I'll hang on to my Syntroleum stock for another year.  Perhaps the investors buying in will boost the price above what I paid, and I can make a small profit.  But long-term, the declining demand for energy, and the large number of new exploration sites for traditional oil will probably mean that oil prices will remain relatively low, other than for occasional shocks.  When the price of oil goes up, people start looking for more of it - and then the price goes down.

The same is true of gold.  That bubble will burst any day now - with each piece of good economic news tolling its death-knell.

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