Ball Don't Lie
Owning stocks means owning small percentages of other people's businesses.
It's the opportunity to leverage the entrepreneurial ingenuity and hard work of global citizens you'll never even meet.
And from complex, multinational corporations, to tiny lemonade stands, we know the profile of a successful business:
The ability to earn money, and the ability to keep the money earned.
You can't succeed without revenue, and you can't succeed if you spend all your revenue on expenses.
Just last Wednesday, investors valued Facebook at $880B.
By last Thursday, investors had reassessed: Facebook was only worth $650B.
$230B in value went down the drain.
Elsewhere, on that same painful Thursday for Facebook shareholders, investors valued Amazon at $1.4T. By the next morning when the market reopened, investors reassessed that to $1.6T, appreciating $200B in value.
The moves resulted after each company respectively announced their business metrics from the previous quarter...metrics like revenue, and profitability. These earnings calls force public companies to provide the public with updated, transparent details.
These events are incredibly useful, as they provide information to investors who can then update their assessment on the future prospects of the business. But should companies announcing information about the previous quarter's performance really take such gigantic swings in their value in just one day?
The short answer is yes.
Yes, but it actually doesn't take place over the course of just one day.
It takes place in fractions of a second. While corporate announcements occur after the market closes, there are after-hour markets that trade, and prices don't wait. On the next morning, stock prices open up already having adjusted for yesterday's new information.
This post is about events, and determining which types of events actually give us valuable information, and how to determine what that valuable information is.
And this post is about Rasheed Wallace.
Some events do not provide us information about previous events.
Rasheed played in the NBA for 16 seasons. He was fabulously talented, and was known to be a bit hotheaded on the court. During the 2000-2001 season, he averaged one technical foul for every two games...an NBA record that still stands. And for better or worse, this jeering phrase is as memorable as his hustle:
Ball don't lie.
There's a petulant authenticity that is deeply relatable (at various times, we've all felt incorrectly penalized) – which makes watching Rasheed's ball don't lie rails both comical, and cringeworthy, at the same time.
And what Rasheed meant, earnestly or not, was simply that the outcome of a free throw somehow provides information about a previous event. If the ball doesn't go in, then I was incorrectly whistled for a foul.
Of course we know that an opponent having missed a free throw didn't mean Rasheed should, or should not, have been called for a previous foul. It just means the opponent missed a free throw.
Subsequent events can result from previous events, but subsequent events don't necessarily provide information about previous events.
The truth is that Rasheed wasn't wrong. The ball doesn't lie. It's just that the ball doesn't truth-tell either. The ball is just the ball.
Other events do provide us with useful information, but uncovering that information – and knowing what to do with it –isn't always obvious.
What information can we glean from Facebook's value dropping 25% in just seconds after an earnings call?
The easy answer is that the stock market is a casino. How can anyone invest in anything that can steal our money so quickly?
Another easy answer is that the game is rigged. How can investors win when the bottom can fall out so ruthlessly?
We should avoid the urge to assume that these are appropriate takeaways.
Here's the gist of what Facebook announced last week:
People aren't spending as much time on our platforms anymore
Apple has made it harder for us to sell ads if someone is using an Apple device
We are losing 1,000,000 users every day, globally
There aren't many new signups from U.S. and Canada, our most profitable markets
When your business relies on people spending time on your platform so you can sell them ads, and markets are expecting you to grow over time...this is a sobering announcement.
And details like these allow investors to reassess. That can be manifested in brutish volatility following surprising news. Of course, for Amazon, it was to the upside. Here is what they announced:
Profits doubled this holiday season compared to last
We've learned how to better control the costs of running our business lines
Our cloud-computing (Amazon Web Services) and ad-sales are strong and growing
Prices adjusting quickly to new information is exactly what you'd expect from a well-functioning market.
Institutional investors, like hedge funds, have algorithms designed to place large trades based on words and phrases said in the earnings call. For example, ad sales were very strong might trigger a flurry of inputs to buy. So not only does new information impact prices, but it happens essentially instantaneously.
The overarching takeaway is how prices behave. It is not a casino. Prices move because of new information, and they move quickly because there's no reason for investors to wait.
And as my friend Conor Feldmann says:
It’s not good or bad [news] that matters, it’s better or worse.
Markets have an expectation, like for quarterly earnings reports. Dozens of really smart analysts have already publicly shared how Facebook and Amazon likely performed last quarter, and the assumption of a data-driven investor is that the average of those analysts' informed opinions are already incorporated into the price. It is deviations away from those opinions that will cause prices to change meaningfully.
On Facebook's call, they announced that they made profits of $10B last quarter.
Unfortunately, the average analyst opinion was for $11B.
It shouldn't be lost on us how unique a world is where a company announces they make $10B in a quarter and it's a disappointment. But this isn't a world where we are trying to figure out if $10B in profits is a good thing (sure sounds good)…but rather, is it better or worse than we expected?
I personally believe that flying first class to the Maldives and staying at the Ritz-Carlton sounds awesome.
It doesn't mean I've ever been...because the prospects of this vacation are reflected in the price-tag. We can't just say things are good or bad – those are not investment theses, nor reasons to buy things.
What you pay matters. It is the same with stocks.
Investors should be empowered that current stock prices reflect the average opinions of other market participants – otherwise, the prices would already be higher or lower. Any imbalance gets solved by the pricing mechanism.
And further empowered that what will drive upcoming changes in prices is new information, and those are currently unknown to the public.
It's because of this mechanism that some investors (like myself) choose to do zero research on individual companies. I buy thousands of stocks, from all around the globe, without doing any research on what I'm buying. I don't know their business model, where their headquarters are, who their CEO is, and likely can't spell nor pronounce the name of many of them. I don't care.
I've just designed a system where I can leverage other systems:
The entrepreneurial ingenuity and hard work of other global citizens
The pricing mechanism where other traders have set reasonable stock prices
And so I get to buy the expression of this ingenuity at a fair price, without much effort.
We can mistake events for providing information, like Rasheed's ball don't lie. Truth is...sometimes the ball really is just the ball.
Other times, the ball is telling us something useful, but we're misidentifying what that is. Like us assuming that volatility from corporate earnings announcements makes stocks riskier to own, that the system must be broken, or that investing is like a casino.
And still other times, the ball is telling us something useful, and we discover exactly what that is.
On weeks like last week, I'm grateful to be an evidence-based investor. The ball is telling us that other people didn't know the news ahead of time. It's telling us that investors are on an even playing field. The volatility reinforces my trust in prices.
There is no casino...there is just owning small percentages in other people's businesses.
The longer I stay in this industry, the more beautiful is this picture of millions of people trading billions of dollars of stocks everyday. These trades create an equilibrium, which is just the price itself, that reflects the aggregate opinions of smart people around the globe.
Accepting these prices, and buying a little bit of every stock across the world because of it, is a much more elegant and thoughtful approach than it may seem.
If we'd invested $1 this way, back in 1975, it would be worth $193 today.