Episode Transcript
The Finance Ghost: Welcome to episode 241 of Magic Markets. We've just finished recording our Premium show on Alibaba. If you are interested in Chinese big tech and cloud and AI and eCommerce and all of that good stuff, nice follow on as well from some of the recent discussions we've had about analysing retailers and omnichannel and all that good stuff. Go and check out Magic Markets Premium if you are interested in learning more about Alibaba.
And if you are interested in learning more about the catalysts for why stock prices move and especially move quite a lot, you are in the right place because that is what we will be covering on this show. Moe, welcome to your own show as usual and I look forward to this chat with you.
Mohammed Nalla: I love that. Welcome to my own show, Ghost. Always a pleasure doing this with you. This weekly Magic Markets podcast is great because we have a platform to reach out to our listeners. Thank you to all of you who loyally listen to us every single week.
And again, we want to bring you stuff that's relevant. I think at the moment there's a lot of stuff going on in the markets. And so we said: what should we look at when we're looking at catalysts in the market? Because Ghost, you and I both look at things quite differently. I do look at the fundamentals, I think that's where you're a lot more grounded. You do a lot more bottoms-up research than I do. I do some bottoms-up research, but I'm a macro guy. And so I look at the macro, I look at some of the technicals.
It's very important to say: what are some of those catalysts that we look at in terms of, can a stock move? Are we invested in something? Is this going sideways for a long time? Do we cut the position? Do we wait for that catalyst to actually emerge? And so what I'm expecting to get out of the show is a nice mix between some of the fundamental catalysts, some of the technical catalysts, and then other stuff that's also quite relevant because over the course of the last several months, we've seen this reemergence of meme stocks as a theme. One that's very relevant to me here is a stock called Opendoor. That's a stock that was put on my radar by someone I know and they said, go and have a look at the stock. And I generally don't dabble in meme stocks, but when I went to go and have a look at this, I was saying, what are some of the key catalysts that could propel the move in the stock?
For reference, it's actually gone from around $1.50 a share to currently sitting around $6 a share, now some of that is yes, meme stock sentiment that comes through, but there are also a number of underlying metrics that we don't traditionally cover, and I'm going to look to actually include some of that. So things like, for example, what's the short interest on a stock?
I'm not going to detract from our discussion on this Ghost. I'm actually going to hand over to you first to say what are some of the catalysts that you look at? Because when you're looking at fundamentals, sometimes it's a slow burn and you can wait a very long time for, for those catalysts to actually emerge.
The Finance Ghost: Yeah, sometimes it is a slow burn and sometimes it's not. It's actually quite funny because one of the classic catalysts is some kind of earnings surprise in one direction or another. Like the surprise I got just a few minutes ago when I realised that I had actually prepped the wrong thing for this podcast, which is quite fun. So Moe and I, or rather I just misunderstood Moe and what I thought we were going to cover. But the good news is, because we look at this all the time, we could pretty much record a show on just about anything, I think Moe and just chat through it.
So what causes stocks to move? What causes big moves specifically? At the end of the day, a stock price is really just the result of a whole lot of people expressing a view based on, in theory at least, working off the same information.
Now, in a well-functioning market, all information is public and it then comes down to the skill of people in interpreting that and how much they believe the management story versus not, what access to other research they have - this is all the mosaic theory stuff, anyone who's ever studied CFA will know that term.
But essentially what causes a share price to move in a big way would be just a huge difference in expectations now versus what the price was reflecting at the end of the day, right? And those expectations will ultimately come down to financial metrics because that is why you invest in a stock, is you're looking for a financial return. But what drives that? Well, it could be earnings guidance. That's the obvious one. If management comes out and says, well, we thought we were going to make R1 a share or $1 a share, now we think it's going to be double that, well, guess what, the share price is definitely going to do better.
But it could also be more vague stuff. It could be them coming out with a different narrative, maybe a different product or different service, or giving good news about a customer. For example, I think Broadcom, that happened with last week where they talked about a big order that was coming in from a customer. So management teams will do this. IR teams will do this. They'll give these little breadcrumbs and try and get a message out into the market.
And of course that's part of our job, right, is to look through the narrative and try and distil it into actually what's happening. Because management is very incentivised to give a narrative that will support the share price. Management is not short their own stock, so you can be sure that if they can give you great news or good news, they'll probably choose great news every time. Unless it's a management team that actually has a reputation for conservatism. Someone like Johann Rupert is quite famous for being Rupert the Bear. When he gives the Remgro discussions, etc. or Richemont, the market knows that he's going to almost downplay what's going on out there.
So this is part of what drives surprises, right Moe, is just a change in expectations?
Mohammed Nalla: Indeed. And I'm so glad you actually raised another point there because you mentioned guidance. And that's an important point because given the current structure of markets, companies, if they expect an outsized move on the earnings to come through, they usually are compelled to put out guidance there. And so sometimes the moves you're looking for are not just centred around the formal release of the company's results. Sometimes you actually see that move on the earnings guidance announcements that come through. Pay attention because those events are event driven catalysts, which I quite like.
Another one Ghost that I want to touch on because it's quite topical right now is when you actually see news, whether those are rumours or confirmations around mergers and acquisitions. And the reason I want to put this on the table is just this morning we actually saw news of Anglo American potentially considering a merger with Teck Resources. Now this is relevant to me because Teck is a Canadian firm. Anglo looking at merging with them, they will be headquartered in Canada and they will have their primary listing in London. So again that's fresh news, we don't know if that will actually be approved by competition authorities. But that kind of move so saw both TecK Resources and Anglo American stock ratchet up very, very strongly on the news.
Now again, maybe it's buy the rumour, sell the fact, pay attention. But we're talking about catalysts and again, if you follow Anglo closely, you will have seen that they've had a lot of restructuring. They recently unbundled what was Amplats now into Valterra. They sold down that shareholding and so it was really quite probable that there was going to be some news here.
Anglo itself was the subject of a potential takeover by BHP a little while ago and then again that didn't succeed. So pay attention because where there's smoke, there’s fire - a lot of consolidation is probably required in that resources space. And sometimes those are the macro themes that you're looking for in an industry. And then if you look below the radar, if you look at actual company results, what they've been doing, that might actually give you some sort of indication in terms of which stocks in a particular sector you want to focus on as the potential recipient of a catalyst around M&A.
I'm going to segue from that into another look at maybe something different. We look at technicals in our Magic Markets Premium report that we cover. It's both fundamentals, bottoms up analysis as well as some high-level technicals. It's not very complicated, but there are some key indicators that I generally just try and look at to say, is the stock trending? Is it range bound? You can look at a number of indicators but if I were to distil this down into one of the key ones that I look at, it's usually moving averages because here you can look at it on either daily or weekly timeframe depending on what your investment style is. But usually, if you actually see those moving averages cross over bullishly, so you actually see the 20 above the 50 above the 200, that actually gives you an indication that a stock is starting to develop a new trend and that can be a catalyst for an upside move. I also look at a sustained test of the 200-week moving average. We've seen that on a number of stocks that had sold off quite aggressively recently, they then break above the 200-week. That may be an early catalyst that you want to look at, but what you're really looking for is a test and a confirmation. That is your second catalyst to inform a bullish view on a stock. And obviously vice versa, if you are an investor or a trader that looks at going short.
That's just one of the indicators that you can look at. You can look at things like volume, do you actually see unusual trading volumes that signal an accumulation or distribution phase? Is the move being backed up by large numbers of participants and investors following through on that move? And these are all really just some of the technical indicators that you could look at as catalysts if you want to enhance what you're doing in the fundamental space.
The Finance Ghost: Yeah, and we strongly think that you should use both technicals and fundamentals, or at least get a working knowledge of both. The extent to which you use them will ultimately be up to you. But it just doesn't make sense to only use one and not the other. It's like going to go and fix something and then only taking half the tools in your toolbox. I mean, what is the point?
At the end of the day, we know that both of these things are used by people in the market. We know that both of these things are important. So why decide to just look at one?
So I'll give you a good example on the fundamental side, something like dividends. Dividend signalling is a really big catalyst for a stock. And this is something that again, if you studied finance at university, you would have probably done some dividend theory. There are the very academic arguments, but basically what happens in practice is that management teams will just about rather sell their firstborn child than cut their dividend because they know that it is a very poor signal to the market. It basically sends a screaming message to the market to say, hey, earnings are inevitably lower - you don't often see a dividend cut when earnings went higher, that is just not going to happen - so earnings went lower and by the way, they're probably going to stay lower. And by the way, we're also actually kind of scared and we're going to hang on to all our capital and so really sorry, the dividend is lower as well.
Now sometimes a company has thought this through and has got a dividend policy that allows for this. So they might say, for example, in any given year, they pay 40% of headline earnings per share as a dividend. Now, if HEPS goes down, you can therefore expect your dividend to go down and it's kind of just par for the course.
If a company has a vague dividend policy. So it's not as formulaic, it's not just, okay, 40% of HEPS, that's what we pay. Now, the signalling effect becomes much higher because now the market will interpret whatever the dividend decision is as a management decision, not an outcome of the maths. And that is where the signalling effect is so important.
Now, you do see this a lot in the US market, where we do our Magic Markets Premium research, where you will see these dividend aristocrats, as they are known, and they get that status by basically having this track record of increasing their dividend every year since forever. So what do they do? They have an artificially low payout ratio, and then they just allow the dividend to go up and up and up every year. And if you actually look at the payout ratio, it flaps all over the place because they're not targeting a payout ratio, they're targeting a particular dollar dividend. This year it's $1 a share, next year it's $1.20, then it's a $1.40, and earnings will flap around, but basically what they'll do is they'll set the dividend so low relative to earnings that the chances of it dropping are almost zero. And what they do then is in a year where they have excess earnings, they then put it into share buybacks.
Now, unfortunately, that creates a really difficult situation where in a very good year when the share price has probably gone up, they have more capital available for share buybacks, and so they do more share buybacks at a time when the share price is very high. So that's not really the way you want to use share buybacks. The truth of it, and management teams don't do this, but what you'd actually love to see as an investor is if earnings go down and the business comes under lots of pressure, rather pay a lower cash dividend. And if you believe that the share price has overreacted to the negative news, go and do more share buybacks, buy them while they're cheap, and bring the dividend back later on when the share price has actually gone up a lot and it looks expensive, etc.
You very rarely see that, unfortunately, in practice - you only really get execs like Jamie Dimon at JP Morgan who will have blunt conversations about capital allocation. Outside of that, I'm afraid, it's generally quite a minefield.
Mohammed Nalla: Yeah, Ghost as someone who really likes a juicy dividend, I think dividends are really important to look at. You've raised a couple of very important points. But again, those of you that look at markets in a lot of detail quite closely, pay attention as well in terms of when the dividend is announced versus when the stock actually goes ex-dividend and then when the dividend is actually paid. Because around those dates, around those times, you do see some action that could actually be a catalyst either to the upside, to the downside, there are some strategies out there like dividend harvesting, so just pay attention to those dates because it does change the structure of how the share price moves through time related to those specific dates.
I'm going to then lastly Ghost touch on a key point because we mentioned meme stocks and this now comes into some of the other indicators that I mentioned all the way up front, like for example, what is the short interest in a stock and so forth. Let's jump into some of that because first and foremost, when you're starting out with let's call it meme stocks, and maybe that's an impolite term, some of these stocks actually do have an investment thesis behind them, but let's call it meme stocks for lack of a better word. The first thing I try and look at there is what's actually happening on social media, because that's where the memes originate. So if that's the origination, you want to look at social media trends, whether that's on X, whether that's on Reddit, which is actually quite popular, you've got Wall Street Bets there that became quite iconic around GameStop.
And when you look at that, you look at what's happening with social media momentum, are people mentioning this a lot more? Is that increasing, is that decreasing? Are the mentions positive or negative? And that could give you a very nice indicator to actually pick up whether something is going to be trending and whether that has some momentum behind it. I would use that as an initial screen, certainly not a definitive “yes, this is the investment thesis” - and then I would go and have a look at the stocks they're mentioning and underlying that. Not your traditional technical indicators. Yes, you can look at those as well.
But you want to look at something like the short interest ratio. Now, what is this? It shows you how short the market in on a particular name. Hedge funds very prevalent in some of these names. And usually those pop up on the meme stock radar because it's retail versus the old school, if you want to call it that. They want to punish the shorts. Traditionally that's what's happened in the meme stock space. And so a stock that has a very high short interest means that a lot of people are sitting short. And if you actually see a strong rally in the stock, potentially some of those investors would be forced to liquidate their short positions.
Now how do you do that? You go and you actually buy the stock and that gives you some rocket fuel to actually propel the stock even higher. And that gets into this loop which then forces other people who are short to actually cover those shorts as well. So short interest, a very important metric, you want to look at stocks, if you're bullish, you want to look at stocks that have a high short interest ratio that are then starting to trend positive because that suggests that a rally could have some legs.
Another metric to look at is a ratio called days to cover. How many days would it take those shorts to actually exit based on average trading volumes? This now starts to blend it back into some of the technical indicators that we're looking at. You're looking at volume. If the stock actually has fairly low volume, it's going to take those shorts a lot of days to cover that, which means they would arguably be a lot more desperate to execute on that. And again, just gives you some rocket fuel in terms of a rally to should the shorts be forced to cover. Now there are a number of other indicators here. I don't want to get too complex. You can actually go and have a look at what's happening in the options market. Are there more buyers for call options out there? And again, that starts to have some dynamic in terms of movement versus where the spot price is at any point in time.
I know it's quite a lot to digest there Ghost, but again, this is not meant to be exhaustive. It's meant to just give you a couple of key thought starters out there to say if I want to go and look in the space, what are some of the potential catalysts I could look at? Whether I'm a long-term investor, some of those are fundamentals. If I'm a short-term investor, if I'm a meme stock investor, and again, I hope that this has shone some light in terms of some useful metrics and data that you can actually go out there and have a look at.
The Finance Ghost: Yeah. The last thing I just want to say on this, which is as applicable to meme stocks as downtrodden, horrible stocks that no one wants to own, is just remember there's an old saying in the market, and I think it is incredibly true, which is that the narrative follows the price.
So basically, if something's doing really well, then suddenly you will have lots of people who have a positive opinion on the stock. If something's doing badly, you will find loads of naysayers. And this is where contrarian investors really get their kicks. They actually deliberately look to go against the herd and kind of really dig deep and say, well, you know, what's really going on here?
Now, if you're contrarian on every single thing, then I guess almost by definition you're going to lose money over time because you're always doing the other thing to the rest of the market. So you have to be very careful with that strategy, but you also have to be very careful with a situation where suddenly a share price is doing well and now everyone is bullish. That's also like - why are they bullish? Is there a good reason? You've got to go and dig deeper. So just be very careful, particularly if you follow a wide range of financial media sources, which all of us should do. Just be aware - I mean, Sasol is a brilliant example. I swear, Sasol goes up 2% and suddenly there's someone else out there with a podcast or a bullish view or something on Sasol, for example. It's just one of those things.
So I guess whenever you're seeing something in the media, whenever you're reading a report, just apply your mind to it and just ask yourself, is this a sensible view being put out on the stock regardless of the price?
Mohammed Nalla: Yeah, Ghost, maybe. I'll challenge that a little bit. The narrative following the price, that does seem to hold, but in this new era we find ourselves in, sometimes the meme stock narrative actually comes through before the price and then just builds momentum as the price rallies. It's been so remarkable observing markets, certainly in a post pandemic era where a lot of the old rules just don't seem to hold.
Why are we even talking about meme stocks? A couple of years ago I'd have been like, this is complete fluff and nonsense. I'm not going to look at this. But the fact of the matter is that there are some people out there that have made remarkable amounts of money. So call it fomo…
The Finance Ghost: …you’ve just got fomo. You're putting the Moe in fomo. That's what's happening here, actually.
Mohammed Nalla: Yeah, I'm definitely putting the Moe into fomo. It's definitely fomo. I looked at this and I said, is there some merit behind this? At the end of the day, if something's going up, should I divorce this from my contrarian bearishness on it, or should you ride the wave? And I haven't resolved whether that's a good strategy or not. Again, a strong voice of caution out there.
The Finance Ghost: I feel like this is because you're not allowed to gamble Moe. This is a response to not being allowed to gamble. I'm convinced of it. You're trying to get your kick on meme stocks.
Mohammed Nalla: It's a response of trying to understand the world. We live in such a different world right now. Social media is ubiquitous. I generally try and shy away from it, but again, there's something there. There are some people that have been remarkably successful at getting this right. So for me, it's trying to understand those dynamics.
What I will say to our listeners is be very cautious out there. Do not chase meme stocks just blindly. That is a recipe for disaster. For every meme stock that goes up, there are nine that probably fall down to zero. So be very careful out there. I'm certainly not going out there betting the farm on meme stocks. It's not a complete change to my strategy and my psychology. It's just trying to say, there is something here, I want to understand it. There are different strategies that work for different people. I'm still sticking to my knitting in my traditional portfolio, my trading portfolio. This is just something on the side that is intellectual curiosity to say, does this have some merit? Are there some names out there that might legitimately pop onto my radar? Because it emerges as a meme stock that might have some sort of solid underlying fundamental, technical basis, whatever that might be.
Again, Moe being curious, fo-Moe for sure. But we hope you've enjoyed this. I mean, this was a show that was somewhat different. We've covered a lot of material here, lots to digest. Let us know what you thought of the show. Hit us up on social media.
It's @MagicMarketsPod, @FinanceGhost, @MohammedNalla, or go and find us on LinkedIn. Pop us a note on there. We hope you've enjoyed this. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
