Sentiment and Fundamentals

It's often said that investors are too short term thinking and that even professional analysts are only focused on the latest quarterly earnings reports of a company.

While I definitely think this is true, I think in order to truly understand this behaviour we need to understand the nuance of what is going on.

Is it really true that investors are too short term thinking?

After all, many investors who trade a lot in the short term still talk about being long term investors.

Are they just saying that? Or is there something else going on here?

I think the disconnect is that many investors might not care so much about a particular quarters earnings, but they very much care about what those recent earnings might indicate about the long term trend of where the company is going. Investors tend to extrapolate out whatever is going on currently into the future. So if a company delivers disappointing earnings, then investors will project disappointing results in the future. And that means that a small change in sentiment when extrapolated out into the future can lead to a large change in valuation, and market price.

In order to see a demonstration of this, one needs to look no further than Amazon one of the largest and most widely covered companies in the world.

Amazon's stock price is up just under 60% this year from the lows near the end of 2022. During that time, the sentiment around Amazon's business couldn't have been much worse.

"Retail makes no money"

"AWS growth is slowing and losing share to it's competitors"

"Amazon wastes too much money on experiments that have no discernible value yet"

These were the comments investors were making at the time. And those sentiments were being projected into the stock price.

Now, less than 10 months later the sentiment has changed dramatically. Amazon is one of the most widely recommended stocks in the world, with 44 analysts rating Amazon as a "buy", six analysts rating Amazon as an "overweight", and 3 analysts rating it as a "hold". There are currently no analysts recommending that you sell your Amazon stock. (Sourced from the Wall Street Journal)

Have the fundamentals of Amazon changed that much in 10 months?

Retail was always a profitable business and although it optically looks better because of some cost cuts, I would argue the strength that retail is showing today was caused by investments and decisions made years ago.

AWS still faces tough competition in cloud and while the development of AI probably improved their long term fundamentals, I think AWS was going to be a great business with lots of potential growth for Amazon with or without AI.

Amazon has always spent money on moonshots. Without experiments like this Amazon would never have created AWS, or Kindle, or Amazon logistics. I have always found the argument that they spend too much to be a little shortsighted, and more to the point, Amazon is pretty upfront that they are going to do this. So shareholders in December of 2022 shouldn't have been surprised by this.

To be fair there have been incremental improvements in Amazon's business. They've grown into their cost structure a bit and they've also been able to introduce some very interesting new services like Buy with Prime and Amazon Supply Chain. But the reality is that the 60% increase in the stock price probably has more to do with the improvement in the sentiment from “extremely negative” to a more rational opinion of Amazon’s business now. Right now quarterly earnings are improving, and investors are projecting those improvements into the future.

So what's the lesson that we can draw?

As I already said, I think investors are actually thinking long term, but what they're failing to account for is how their long term view is influenced by their short term sentiment around the stock price.

There are several investments that we own where I think that the sentiment is about as negative as it has been over the past 3 years, even going back to the COVID lows. This has been reflected in their lower stock prices. If we can accurately identify those situations where the current negative sentiment is clouding a brighter future, then these can be tremendous opportunities as Amazon's stock price has demonstrated over the past 10 months. We think we have several in the portfolio currently and are always on the lookout for more. This is how we think we can provide value by being "long term investors".

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