The financial media are obsessed with name-brand investing, especially at the worst moments. Here’s the standard logic: company XYZ has had a terrible turn of events. Hence, the stock price has been beaten down to a pulp. The big name is so cheap that it must be worth more. After all, it’s company XYZ – how can it go down any more? Forget about the disaster in the financial statements. Just focus on the name.
First of all, the proponents of this strategy are highly myopic. American corporate history is a graveyard of former big names. Take for example some of the first members of the Dow Jones Industrial Average, such as U.S. Leather or the National Lead Company. You’ve probably never heard of them. But once they were key Dow companies; now they are all but forgotten. In fact, almost the entire Dow Jones has been transformed over the decades. Large corporations come and go.
It won’t be long until our kids and grandkids will have no recollection of Wachovia, Bear Stearns, and Lehman Brothers, all once well-known names. The investors who thought that they were buying a great name cheap on a downward slide lost their shirts with these companies. Remember, no matter the company name; financial reality is impossible to escape. Perhaps, a brand name reassures a customer, but it can’t wipe bad liabilities and ill-advised management decisions off the books.
Despite historical precedence, the same advice gets repeated over and over again. BP was one of the latest poster boys for this speculation style. A company’s stock price is nothing more than the value of future expected cash flows – and the spill permanently altered those future cash flows.
Nonetheless, the news often treated the spill like the stock speculation of the century. But just recently, an even better buying opportunity had passed by. During the financial collapse, an investor could have bought BP low with much less risk than in the spill scenario. If an investor bought at the bottom of the spill, he would be up 51.5% now, 81 trading days later. In comparison, if an investor had purchased BP on March 3, 2009, he would have been up 38.4% in 81 trading days. But the stock didn’t stop there; it then peaked at $62.32, an 82.5% gain.
Not only was the post-market crash return greater, but the risk was lower too. With the spill, a stockholder held firm-specific risk. In 2009, the shareholder’s main concern was systematic market risk. Regardless the equity held at the time, investors primarily worried about the general market heading further down. During the spill, more dangerous company risk was the problem. Plus, the economy was still in bad shape. It was a much riskier situation for less return.
With earnings season at hand, the same name-brand investing advice will be applied to the big banks as usual. I can hear the mantras now, “Sure, their balance sheets are filled with deadweight, but don’t worry. They’re such big names.”
However, I ask myself the same question as I did about BP. I know the risk is high, but what’s the possible return compared to other investment alternatives and scenarios? A quick analysis of a few top banks from 2003-2007 shows their non-spectacular performance compared to the S&P 500 during the boom.
As the chart shows, these major banks clustered around the S&P 500. In fact, only JPMorgan Chase on average beat the S&P 500. The rest trailed a few points below it. Why hold enormous risk when the possible returns aren’t particularly high?
If you’re really looking for a market rally, buy the S&P 500 instead. Once again, you’d be dealing with market risk rather than market risk plus high firm-specific risk. Despite this, the news loves the “buy the troubled big name cheap” advice.
Once, you start investing based on a company’s name alone, it’s no longer investing at all. It’s actually gambling on the horse with the most appealing title. Sure, risk can be good if the return is worth it. For example, our mining picks in the International Speculator have high degrees of risk but possible returns can reach 100%, 200%, or more. If I must take a substantial risk, I want a return where the sky is the limit. And honestly, Citigroup and Bank of America are not going to produce those kinds of returns.
Don’t let the big names blind your judgment. Always be aware of firm-specific risk, the possibility of failure regardless of the company, and the risk/reward tradeoff. Does my opinion here mean that you should never invest in a big name? Of course not.
In the October issue of The Casey Report, we recommended a member of the Dow Jones Industrial Average. But our decision wasn’t based on the name. The financial statements were right, the corporate strategy was right, and the company’s direction in general was right for our portfolio and our perspective on the economy. The fact that the company is a household name was just a cherry on top of an already good deal. And that’s the way that you should look at investing in big names. Fundamentals first.