"The mark of an educated man is to look for precision in each class of things." — Aristotle
Sadly, Wall Street pays little attention to Aristotle, even when his wisdom fits in the 140-character limits of a tweet. The ancient Greek philosopher would quickly notice our modern inability to distinguish between a company's business and its stock price.
We believe an excellent stock must represent an excellent business, and a lousy stock must be a lousy business. In reality, we more often see lousy stock performance from excellent businesses and excellent stock performance from lousy businesses.
Two companies in last week's news are excellent examples: Twitter (TWTR) and Tesla Motors (TSLA).
The Twitter initial public offering (IPO) was a major success by any definition. Underwriters reportedly received 30 requests for each of the 70 million shares available. The $26 IPO price far exceeded even optimistic projections just a few weeks ago. Those same shares then traded up to $50 on opening day.
Those able to buy Twitter at $26 clearly bought a great stock, especially if they sold immediately. Whether they bought into a great company is an entirely different question.
According to Twitter's own filings, it lost money in each of the last three years. It lost even more money in the first nine months of 2013, a period during which sales totaled $422 million.
At the $26 IPO share price, Wall Street valued Twitter's business at $18.3 billion. The wider public gave it a secondary market value closer to $25 billion.
Twitter may someday be able to justify these valuations, but at $40, buyers clearly fail to distinguish between Twitter's business and its shares.
A day earlier, we saw the opposite situation in Tesla. The luxury electric car manufacturer reported $603 million in quarterly revenue and adjusted earnings of 12 cents per share. The company had previously estimated 5,000 vehicles deliveries for the quarter. They beat the goal by 10 percent with 5,500 cars sold.
Tesla is an actual business that successfully sells real products to real people. Instead of rejoicing, investors punished Tesla. Its shares dropped 14.3 percent in a single day.
The Tesla selling made more sense in context. The widely hyped stock had more than quadrupled in recent months. Tesla's future is arguably better than Twitter's is, but the stock was not worth $170. The earnings report gave speculators a convenient excuse to bail out.
As a logical matter, it is very difficult to argue that Tesla is overvalued and Twitter is undervalued. Neither stock is trading in line with any realistic view of their underlying business prospects.
Investment success depends on such distinctions. A stock's market price is the sum of many individual decisions. Sometimes people make bad decisions — and sometimes a stock's price will reflect it.
Making those distinctions is the mark of an educated investor.
More Posts by Patrick Watson
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