If the definition of crazy is doing the same thing repeatedly and expecting different results, then Mr Market is undoubtedly crazy. Simon Shields, Principal at Monash Investors, says there are several behaviours that he observes that cause stock mispricings over and over again. He identifies three common ways that shares become mispriced:
- Underestimating the length of a company’s growth trajectory, particularly with regards to store rollouts
- Failing to understand changes in consumer trends
- Pre-IPO opportunities can often be mispriced due to a lack of pricing information.
Watch to video or read the transcript below to hear some recent examples of each type of stock mispricing.
There are lots and lots of sources of mispricing or patterns of behaviour or business situations that we see over and over.
Mispricing 1 – Underestimating earnings growth
One of the big ones is underestimating the returns that are going to come from a business, for a variety of reasons. One of the reasons is, for example, when there's a store rollout going on, people can get focused on the existing business and not think so much about how big the store rollout is. In the case of Lovisa, for example, the share price came back from $12 all the way to $6 because people were worried about like for like sales in Australia. Australia was about half of the business. Like for like sales ended up falling from about six percent per annum down, at the worst point, to maybe about minus two (percent). And that was because the whole of the Australian retail market came back. However, at the same time Lovisa was growing its top line by almost 20% per annum because it was rolling out to the United States, to Great Britain, to France and so forth. So that was a classic case of the market missing the wood for the trees really.
Mispricing 2 – Changing consumer preferences
Another thing the market often does is miss big changes in consumer preferences. Now Coca Cola, for example, is really suffering from that because people want to have less sugary drinks in their life. As a result, for 10 years its earnings have struggled, and the stock price has gone nowhere. It's traded between about $6 and $8, maybe up to $10 at the most. But it's really been within that range for the last 10 years or so. So, we've had a short on Coca Cola and that's really gone nowhere while the market's run ahead.
Mispricing 3 – Pre-IPOs
Another place we can get some easy wins sometimes is pre-IPOs - the market just seems to make the same mistake over and over. One recent example is a biotech company called Telix . It had some near-term earnings, we were able to buy it pre-IPO at about 16 or 17 cents, it listed around about the 60-cent mark. It's currently trading about 85 cents.
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