There is a fundamental misconception regarding public markets that our team recognizes and uses to its advantage. That misconception is: a rising (or falling) stock price equates to value creation (or destruction). While a public market with adequate liquidity provides an excellent mechanism for the discovery of a security’s value it is by no means a perfect process.
We meticulously review publicly available data for all of the companies we hold in client portfolios. Most days there is no news or change in financial data whatsoever. Despite that, a security can trade 10% or more in either direction. There are a few things that can explain price movement that occurs in the absence of a change in the issuing company’s fundamentals. First, liquidity needs of the stock owners may trump the owners’ desire to sell at the current price. This can happen when an investment fund receives a redemption request from a client and is forced to sell shares of a company to satisfy the request. Regardless of the current price of the stock, if the fund needs the cash immediately it will have to liquidate its position which may create downward pressure on the price of the security. Second, a company’s inclusion or exclusion from a market index, such as the S&P 500 or Russell 2000 Value, can lead to index-tracking funds to enter or exit an investment in the company. Depending on the size of the fund, this can create an imbalance in the order book and cause excessive price movement. Third, stock prices can be manipulated through sham trades or can be traded on insider information. There are too many varieties of improper transactions to discuss here, but they occur in the marketplace on a daily basis and we are mindful that we compete against them. Finally, prices can change when macroeconomic or industry news gets incorrectly attributed to the individual company. Admittedly, this gets closer to a change in fundamentals but differs where the news does not affect the company in question in the same way it does its competitors.
An example of this last situation recently occurred in the equities of regional banks. Between March 8 and March 13, the price of New York Community Bancorp, Inc. (NYCB) fell 24% on news that Signature Bank and Silicon Valley Bank (SVB) were failing and that other regional banks were at risk of the same fate. Despite this generalization of the state of all regional banks, NYCB maintained an appropriately managed balance sheet and our evaluation of the company showed no reason to be concerned about its ability to continue to operate profitably. If you used NYCB’s stock price as a direct indication of its value, you would think there had been a large change in the company’s asset base, liabilities, management, or other relevant components of its operations. In reality, nothing about the company changed during that period. That’s not to say that we ignore factors external to a company that may affect its future earnings power, but we don’t equate the failure of a competitor to a change in the company unless there is a compelling reason to do so. Here, and in contrast to market sentiment, NYCB acquired a significant amount of Signature Bank’s assets and as of the date of this letter the share price is 75% above its March 13 low.
Like NYCB, we continue to see pockets of opportunity to transact in portfolio companies whose price movements are disconnected from our appraised value based on thorough fundamental analysis. Our strategy of owning companies for long periods allows us to digest short-term price volatility and benefit from erratic pricing that creates opportunities to enter or exit positions. We continue to remain calm, alert, and opportunistic and look forward to continuing to show why active portfolio management can create substantial value for clients through all market cycles.
As always, feel free to reach out to MIAM if you would like to learn more or discuss a particular company or idea.
Sincerely,
The MIAM Research Team