Every year, I am surprised how suddenly summer switches to The Holiday Season here in L.A. And with The Holiday Season comes shopping and shopping fads. This year it’s all about Frozen (if you have toddlers). For Halloween, even my forklift-obsessed 3-year-old son wanted to be Frozenâ€˜s star, Queen Elsa. Then he changed his mind to Anna, then Elsa again, then Anna again, and so on and so on. He eventually settled on being an astronaut after seeing a video on YouTube of Neil Armstrong’s lunar landing. Go figure. But the Frozen fandom remains alive and well at our house.
Since my wife works at Disney, I shouldn’t be so hard on Frozen and its plethora of merchandising (from Elsa-Anna-Olaf branded Listerine to Elsa-Anna branded Campbell’s soup). In terms of brand strategy, they clearly got something right. But I do hold unusual disdain for fads. They illustrate our tendencies toward blind enthusiasm and herd mentality over rational thought. Sometimes we see this in investor behavior as well.
The Euro-Bashing Bandwagon
Right now for the retail investor, it seems to be all about bashing Europe’s economy and the euro currency while calling for a wholesale retreat from European stocks. Admittedly, Europe’s been struggling for years on a variety of levels. But I have often wondered if the very fad chasers who ditched their European stocks are the same people who love their BMWs, enjoy an occasional Kit Kat (NestlÃ©) and take an Excedrin (Novartis) after stressing about their investment portfolios. I think far too many people have dumped their European” stocks (often with capital gain tax consequences) before acknowledging the sources for those underlying companies’ profitability and growth.
Many European stock funds are dominated by truly global companies with a sizable amount of sales coming from outside of Europe. Often, those companies are in industries such as pharmaceuticals that stand to benefit from an aging population and a rising middle class in emerging economies. Many investors are understandably concerned about the future value of the euro, but if the European currency devalues further (as it seems poised to do), European companies should be in an even stronger competitive position to grow exports, so the increase in profitability is likely to at least partially balance out the depreciation of the euro.
Perhaps those hopping on the Europe-bashing bandwagon should also pay attention to a more insidious fad happening here in the good ole US of A: leveraged share repurchases (also known as stock buybacks). According to The Wall Street Journal, in mid-August, around 25% of non-electronic trades executed at Goldman Sachs group (excluding small automated rapid-fire trades) involved companies buying back their own shares.
When I was in business school, we learned about the merits of share repurchases as a relatively tax-efficient way of returning capital to shareholders. It goes like this: When a corporation has excess cash, it can either distribute the cash via dividends or buy back its own shares, taking them off the market. Simple math dictates that with fewer shares in circulation and earnings constant, earnings per share instantly increase, which tends to bump up the stock price, effectively distributing tax-deferred wealth to shareholders (rather than taxable dividends to shareholders). Share repurchases aren’t bad in and of themselves and are often pointed to as an indication of the insiders’ confidence in their business. But the fad proliferating among many public company CFOs is to borrow money in order to buy back shares, increasing earnings per share in concert with more debt. That creates the illusion of a more profitable company, but it is really one that is just more leveraged.
I am not sure either of these fads has gotten out of hand. European stocks are not so cheap as to reflect a mass exodus. At the same time, corporate balance sheets in the U.S. are not so leveraged as to reflect an imminent danger of mass defaults. I also remember a time not too long ago when everybody seemed to be certain that America’s rising debt threatened the U.S. currency’s reserve statusâ€”there were calls for oil to be priced in the more reliable euros, for example. It sure seems hard to imagine that these days. Moreover, it sheds light on the fact that it can be very hard to capitalize on these fads or trends as you don’t know when the irrationality will rationalize. Investors jump on the bandwagon only to watch the market move on to something new.
The Danger of Following Trends
Consumer products companies like Disney do well by driving trends, which increase demand and do a good job of convincing the consumer (or their tired parents) that they absolutely must have something they don’t really need. While trends are arguably innocuous when talking about Frozen merchandise, long-term investors do themselves a serious disservice when they are distracted by short-term trends. While it’s interesting to watch fads unfold, it pays to be honest about your present motivations and your financial planning needs the next time you are tempted to short the euro, gather your bitcoin and peruse earnings announcements with a NescafÃ© in hand.