Incredulous, incredible, not credible, not to be credited or believed, describes the facial expressions I have seen many times in response to my optimism. Pessimism is accepted and expected. People wag their heads and either express sympathy or pass along advice. Then the conversation continues. Optimism frequently is followed by eyes askance, a head tilting away, and silence or a question of doubt. Conversations can halt or frantically jump to another other topic. Change the polarity on a piece of news from bad to good and it changes from believable to incredible. It is a natural tendency that is not tied to logic but can driven by math that makes no judgment.
One of my stocks dropped from $40 to $10. (DNDN – read Triple Whammy for some of the details) People hear that and believe it. It is easy to believe that the story was too good to be true. Cancer vaccines are new. No one knows what to expect. Maybe expectations were too high. A dropped stock price hurts but it’s almost as if folks are more comfortable with the loss after the stock has dropped than the risk of the loss when the stock was high. The surprising part is when I mention that I think the stock was cheap at $40, continue to think the stock would be cheap when it recovers to $40, and continue to think that a proper valuation is more like $120. I rarely mention $120 in public because it is so outside the bounds of expectation. Even the possibility that it can recover its loss, that it can rise from $10 to $40 creates incredulous glances. For me, $40 is one-third of my expectation, and I know others that think $120 is too low; though I suspect that they are even less likely to speak up when the stock is below $10 as it is now.
My basis for reacting to an investment’s swings is based more on the company’s value, not as much on the stock’s price. Company valuations are based on assets, liabilities, income and expenses. Those financial measurements move much more slowly. Dendreon missed earnings by about 20%. The stock dropped70%-80%. In my view, the company’s value was based on 80% of the expected revenue instead of 100% of the expected revenue. They made money – not as much as they expected, but they made money. In effect, the timing of the expected twelve month revenue total was delayed, not cancelled. The timing of the revenue shifts the timing of the value, and ultimately the timing of the stock price. By that logic, the stock should’ve held constant or dropped 20% at most.
A common reaction is to think that a 20% recovery from a 20% drop is a harder task that is less likely and will take more time. But there’s a trick in the numbers that is counter to common perception. A 20% drop is corrected by a 25% rise. A company that cuts 20% of its workforce has to hire 25% back to recover the same total. From 10 to 8 is -20%. From 8 to 10 is +25%. The beauty of math is that it can be made that simple.
Incredulity sets in though with something on the order of an 80% drop. An 80% drop can be countered with a 400% rise. But we are told to never expect more than a few percent return on any investment. Anything above 20% is considered too risky, too good to be true. Math doesn’t make such judgments.
Stocks do not move in synchronicity with their company’s value. They are more like the leaves on a tree in a stiff breeze, blowing back and forth even if the trunk is going nowhere.
Dendreon’s value diminished when only 80% of the revenues were realized. Estimates of new products are never precise, except by chance. Estimates of anything medical is even less certain. Estimates of new products in new technologies using the body to treat itself are going to be difficult. Being off by only 20% is not a surprise to me.
Dendreon’s value estimates tend to ignore expansion into earlier treatments, booster shots, other regions like Europe and Asia, and other treatments for bladder and other cancers. Ignoring each of those expansions is effectively a conservatism instituted into the valuation and subsequently the stock price.
I wouldn’t be concerned if I could hold the stock. I’d be interested in buying more. Personally though I have bills to pay and my other revenue streams are in their early growth phases. and therefore unable to fund my lifestyle – yet. I’ve been selling DNDN to pay my bills and may have to do so soon again. The near term drop directly affects my lifestyle, but it all may recover nicely.
Within the last two years DNDN has been over $50. Within the last week it has been below $8. When DNDN was at $50 there was much more uncertainty about the treatment’s safety and efficacy. They have both improved. The company’s cash position (2Q11) is over $600,000,000. Physician awareness, treatment infrastructure, process flow are all much better now than then. The value of the company now should be closer to what it was then. From what I’ve seen, that value should increase as the treatment spreads and expands, and has the potential to rise to three or four times the value it had at a $50 share price. The company valuation may sound reasonable, but if I say that I think the stock can rise 400%, 500% or 1,000% the same story can sound incredible even though the math is equivalent.
I use DNDN as an example. Other companies have had their stocks dramatically disconnected from the company value. It is always happening somewhere in the market. Mistakes are made. Some investors take advantage of the mistakes and make money. Of course, sometimes the drop in valuation is appropriate and subsequent purchases show up as silly in retrospect.
There are many such mathematical holes we’ve fallen into. Unemployment, GDP growth, bankruptcies, underwater mortgages, all sound like dismal numbers from which we can’t recover. Maybe that’s right because there are no guarantees, but fundamental values persist. People are working. Bills are being paid. Houses are being built and lived in. Businesses are being started. The prices of somethings, the metrics used for other things, can make it sound as if we can never recover. But I’m an optimist and my view is that the good news will come – even if it seems incredible.