Differentiating Business Performance from Stock Performance

Ian Cassel Blog, Educational 6 Comments

“If I’d had the slightest idea of what lay ahead of me when I joined up with Chrysler, I wouldn’t have gone over there for all the money in the world. It’s a good thing God doesn’t let you look at a year or two into the future, or you might be sorely tempted to shoot yourself. But He’s a charitable Lord: He only lets you see one day at a time. When times get tough, there’s no choice except to take a deep breath, carry on, and do the best you can.” – Lee Iacocca

Wouldn’t it be great to have the ability to see into the future? This ability would most certainly provide instant success. It sure would save us a lot of pain and frustration. You would never have to face any of life’s challenges. You would always choose the least restrictive path to success. But would escaping life’s obstacles really be living? No, it probably wouldn’t. Like Iacocca said above, it’s good we have a charitable Lord, that doesn’t let us see the future. It forces us to work our hardest today, in hopes that tomorrow will be better.

If you’ve read other articles I’ve written you know I like to ask thought provoking questions. Sometimes the questions are meant to test the quality of a business, and sometimes it’s just meant for preparation. Let me ask you another question. It’s a question that is a great one to ask at some nerdy stock value investing dinner or cocktail reception.

If you knew a stock you owned today wasn’t going to go up for the next 12 months, would you still own it today?

For many investors or traders this might seem like a completely asinine question. Why would anyone choose to hold something they knew wouldn’t go up for 12-months? The answer is because the long-term reward is worth the short-term pain and frustration.

In, The Art of Holding, I mentioned that great long-term investors can disconnect emotion from investment decisions and can differentiate business performance from stock performance. The ability to differentiate or disconnect business performance from stock performance is extremely difficult because it’s our human nature to focus on the thing that is moving. We anchor ourselves to stock prices instead of the business.

In late 2001, Neogen (NEOG) was a $100 million market cap microcap company. From 2001 to 2007, the company grew revenues from $35 million to $86 million and earnings from $3 million to $9 million. Even though the fundamentals of the business were strong, the stock was extremely volatile. The stock price had three drawdowns of close to 50% over this time period. No Pain No Gain. And it would take six years for the stock to make a sustainable move higher. Only if you were focused on the business and believed in the intelligent fanatic vision of the co-founder James Herbert, who founded the company in 1981 by way of a $50,000 investment from Michigan State University, would you have made it through this period.

Today, Neogen is a $2.4 billion market cap company. Its shares have appreciated 25x since 2001 (24% CAGR), and 100x since 1990 (19% CAGR). The cool thing is it’s still a relatively small company by public company standards.

There are hundreds of other public companies which had similar multi-year periods where stock performance didn’t align with business performance. Most multi-baggers will have long periods of stagnation as fundamentals backfill, old shareholders get bored, and new shareholders enter. Naysayers to stock picking will say it would have been impossible to hold Neogen or one of these other companies through a multi-year period of ill performance and volatility. I think it would be impossible too if you focus on the wrong thing….the stock price. It is achievable if you focus on the business.

During periods of stock price consolidation and volatility an investor is forced to dig deep, form conviction, and really understand the business. If the business continues to perform, this conviction will come in handy when the stock ultimately ascends. Many financial professionals love to point to “luck” or “naivety” on how someone could actually hold something that goes up 5-10-20-50x or more. It’s easier for them to rationalize that someone was just lucky or too dumb to know any better to sell earlier. Yes, there are certainly those that fall into this camp, but there is an equal or greater portion of successful investors that hold on because they know what they own.

If you knew a stock you owned today wasn’t going to go up for the next 12 months, would you still own it today?

The correct answer: If it’s still a great business that is growing and the story hasn’t changed… Absolutely. I’m willing to wait for my pot of gold.

“I don’t want to spend my time trying to earn a lot of little profits. I want very, very big profits that I’m ready to wait for.” – Phil Fisher

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Comments 6

  1. Ian,

    As always, I enjoy your thoughts and articles in relation to microcap investing. We tend to see very little logic applied in the microcap world as it tends to be dominated by emotion and “stories”. Keep banging the drum.
    – Grant Howard

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  2. I took a personal finance class my final year at Purdue quite a few years back. The teacher, who was not a business professor but rather a local Morgan Stanley broker, explained a way to value a company. Project the earnings for the next five years and then guess a P/E the stock would trade at on that fifth year of earnings. Discount the cash flows and the terminal value back to present value. Add up the present values and there you go.

    I thought this was madness. Why not just guess the P/E now? I was more inclined to value the company on the future cash flows forever all discounted back to the present value. So I asked the guy, if you could buy IBM now for $1 a share (it was trading in the $80’s or something) but you new the stock would never go up, would you be interested? He was befuddled by the question but eventually answered “no, why would I buy a stock that would never go up”. It was hopeless so I didn’t press him any further.
    Investors don’t want to own a business, they want to guess what other people will pay for their shares next year, or for some investors, next month.

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  3. Good one Ian, I think all of your posts are related to each other..in a sense 🙂 It is a trail of thought.

    You have been covering some of the most important aspects in investing, thank you!!

    It is an excellent question to ask. I’m thankful that “there is an equal or greater portion of successful investors that hold on because they know what they own.” It is frustrating at times but who said it was easy. 🙂 Like Munger says “”It’s not supposed to be easy………”

  4. This post makes me think of a certain verification business that is very well covered in the club. The core business continues to perform and management continues to add value through strategic acquisitions.

    All this and the stock has traded in a very thin range for the past 30+ months with very little capital appreciation.

    This feels like exactly like the situation Ian outlines in the article where the stock market will wake up one day and current shareholders will be rewarded handsomely for their patience.

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