Watch Out For One-Liner Investment Advice

Source: Thinkstock

Source: Thinkstock

As an investor I come across a lot of sayings, “proverbs,” and terse pieces of sage-like advice that is very tempting to follow, but which is also very dangerous as well. Investors want things to be made simple for them. They want to be told to look for a certain event — a chart pattern, an economic indicator, or something to this effect — and use this in order to make significant investment decisions.

Now some investment advice of this sort is worth following. A lot of Warren Buffett’s one-liner advice is very useful. For instance I often consider his advice that it is better to buy a wonderful company at a fair price than to buy a fair company at a wonderful price. Of course such advice is more complex than it first appears because you still need to differentiate the “wonderful” companies from the “fair” ones, and the “fair” prices from the “wonderful” ones.

But a lot of this advice that makes for great headlines is not just bad, but it can be downright dangerous.

On Thursday I read an article that referred to a piece of advice given by infamous short seller Jim Chanos. Mr. Chanos suggested that investors take a look at Sotheby’s (BID) share price. Sotheby’s owns the famous Sotheby’s auction house that auctions off extremely rare collectibles, expensive real estate, fine art, and virtually anything else that the rich are going to be selling to one another. Chanos pointed out that, in the past, when the company’s share price peaked and started to downtrend, it was a sign that a bubble has popped. He points out  that this took place before the leveraged buyout bubble burst in 1987, before the Dot-com bubble burst, and before the real-estate bubble burst. He also points out that this happened recently — Sotheby’s stock peaked towards the beginning of the year, and the stock is already down 17 percent year to date.

From this logic it follows that we are going to see another bubble burst. But is this the case? Maybe, but we really can’t be sure. First, I should point out that we saw a similar peak in Sotheby’s stock in 2011. The shares fell from about $50 per share to $30 per share. While the stock market did fall in the summer of 2011 by about 20 percent the fall was short-lived and it was followed by a strong uptrend.

Second, if you look at the performance of Sotheby’s in the long term you will find that it has been underperforming the market. Since bottoming out in 1988 the shares are up just 388 percent versus 623 percent for the S&P 500 during the same time frame. This could be due to poor management or poor market positioning. For instance the world of auctions changed dramatically with the rise of the internet and with the rise of eBay (EBAY). eBay share’s haven’t peaked. True, a lot of the items sold on eBay aren’t multi-million dollar paintings, but eBay still does a lot of high end business.

Third, Sotheby’s is a fairly small company. It has a market capitalization of just $3 billion. It is possible that a hedge fund held a $50 million position and decided to liquidate with prices at a peak. While more than $50 million in market capitalization has been lost, other traders could have seen this selling and followed this hedge fund out of Sotheby’s stock. In other words something else besides a bubble in rich people spending could have resulted in the fall in Sotheby’s shares.

Finally, Chanos could be right about the trend, but he could be wrong about Sotheby’s peaking out. The stock is only down 17 percent for the year. If you look at the downtrends in Sotheby’s that Chanos is referring to we find that they are much larger.  For instance prior to the bursting of the Nasdaq bubble Sotheby’s fell by more than 50 percent, and it fell another 60 percent plus during the bear market. If this is the pattern, then we could see Sotheby’s trend downward for some time without a bubble bursting.

Ultimately I do think that stocks in the aggregate are overvalued. The S&P 500 trades with an historically high P/E ratio and with an historically low dividend yield. I think that in the aggregate that the S&P 500 will trade lower. But this may not happen this year, or even next year. I really don’t know when this will happen. Furthermore there are many stocks in the S&P 500 that are undervalued, or that have growth rates that justify higher price to earnings multiples.

Therefore I wouldn’t take this “Sotheby’s Indicator” too seriously. So long as you emphasize value investing and focus on investing in secular bull markets you will do fine.

Disclosure: Ben Kramer-Miller has no positions in the stocks mentioned in this article.

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