I Am Shocked, SHOCKED, To Find Gambling Is Going On Here...

This past few weeks we've seen some impressive 'misses' and subsequent stock declines. I often get asked about these 'fad' stocks, so I thought I'd put some of my past thoughts down.

Snap (NYSE:SNAP) and Twilio (NYSE:TWLO) have quickly put the game of ridicule, bubbles, and the associated denial back in full focus. Every time these events happen the market seems to shift between an 'told you so it's a bubble' narrative vs. 'this is part of the long term process of how growth stocks work' rationalization. But are either right? I'd argue not necessarily (certainly not the latter), but rather a process we see of 'valuation, investing, and overall gambling' that just confirms the nature of fad stock chasers. These common mistakes likely happen more in bullish/bubble climates, but overall these mistakes are easily recognizable. Let's first look at the carnage...

1. Value vs. Valuation

TWLO came out and rung everyone's bell by not only significantly disappointing 'investors' but putting real fear in the viability of any moat they may or may not have.

See the chart below, the entire process of 'selling' an IPO. Note the original hype article titled, 'One IPO that proves Silicon Valley unicorns have value'. This is where a lot of the logical flaws begins. Value vs. valuation. We've all heard the a good company doesn't necessarily mean a good stock, however in these cases it's often neither.

At fusion point we've had members steer clear of these issues if not outright short them [GoPro (NASDAQ:GPRO) and TWLO]. Beyond the logical flaws, there are massive valuation concerns, and most importantly stock based comp issues (most recently seen at SNAP but TWTR probably being the worst long run offender).

GPRO and Shake Shack (NYSE:SHAK)

Starting at the lowest hanging fruit, let's just peek what happened with GPRO and SHAK. Here's one of the most simple ways to think about it, and why I shorted GPRO in the 90's. At its most simple analysis, it was trading at nearly 11X sales, but the more complex setup came in the technical chart (not shown). The key point here is though that at best GRPO had 240M in cash, 1B in sales, why pay 11B for it?

Now let' look just how much 'valuation' the market ascribed to so many of these so very 'valuable' names. Please note the market narrative to each, being the 'best of its type'. You can see in every instance, there eventually was competitive products and or simply re-ratings to something more reasonable.

2. Lose Lose Stocks

There are usually 3 things I am often told about these stocks by bulls.

1. It's the only game in town (best ever!)
2. I just don't understand the technology (do tell)
3. It will grow into it (no)

To simplify the discussion, let's use SHAK with respect to these 3 points. With SHAK 1 and 2 are thrown out the window. Obviously anyone can make a burger, and there's hardly any technology to understand. Having said that I am choosing this purposefully because the 3rd concern is the most important regardless of the technology. By now investors should know this, but I am SHOCKED to find out otherwise. Further I'd argue the technology plays that sport these dynamics are even more risky as there are significantly faster ways to be disrupted in technology [front and center SNAP and TWLO vs. Facebook (NASDAQ:FB) and Uber (NYSE:UBER)]. 

At its peak SHAK traded at 3.36B, in return for 152M sales and approx CFO of 12M. In terms of scale the business needed about 4+M of that to maintain and grow so even this number is a bit inflated. What are you doing in this case other than gambling.

But, it will grow into it right? In SHAK's case sales did grow. In fact fairly rapidly at 60+% quarterly and nearly 175+% in the last 2-3 years. The problem is you can now buy that higher run rate (250M+) for just over 1B.

Now you can argue above the lack of scaleablity as SHAK has essentially less CFO than back at the 150M run rate, but that is beyond the scope of what I am doing here. In every scenario there is 'something' that could have or was different. I call the above a 'lose lose' stock. That is to say if they execute, you at best get your money back at where you paid, any slight miss and it's curtains.

But most importantly, let's just cut to the chase on 'growing into it'. Every single one of these names saw major sales growth since their IPO's ad since their peak stock price. Take a look at the relationship between the two.

Here is how the market tends to looks at things and why we can profit from this silliness. I call this the 4-step process. Here you can see how markets pay zero attention to the above, simply chase the stock around based on price performance.

1. Initial IPO RAMP
2. Preliminary Crash
3. See all is better phase (most dangerous for those following charts only)
4. Game over

3. Mass Media Psychology

Shifting gears to market psychology with respect to fad stocks, I want to point to two articles that really sum up the times. This was an article written prior to the SNAP IPO. I call the following chart the 4 ways to know you are in a bubble.

1. # of users as the new 'eyeballs' or 'website views'
2. Benchmarking against other overvalued models
3. Authors having no clue what they are talking about (more below in GPRO)
4. No fundamental basis for valuation based on sales in particular

Continuing on, what has always impressed me is the power of denial. This can be best seen in the following article. As GPRO got crushed, check out the following article, a tiny bounce in the shares and the author literally argues that the CEO buying a yacht is, wait for it, yes…BULLISH! Furthermore and perhaps the most disturbing aspect of the story is the insinuation that Apple is rumoring to buy GPRO. Even the author admits, 'who knows'. Curious why bring it up.

The bottom line? The fad stocks craze continues. It's unfortunate to see investors get hurt by chasing these however it is also what makes a market.