Big Returns – In Practice!

Big Returns – In Practice!
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No sooner was the ink dry on my article, Big Returns! than the market provided a wonderful example. To set the stage, here is the central point I made in the original article. The idea was that if investors want big returns, they cannot look to stocks of companies whose values are largely driven by current earnings. As we have noted at Cornell Capital Group, the problem for investors seeking big returns is that growing earnings is hard. A company has to build a new plant, buy equipment, hire new employees, attempt to attract new customers, and so on. All that takes time, so stock prices change slowly, there are no big returns. Expectations are different. They can shift dramatically in the short run. All you need is a change in sentiment regarding the future, no actual change in current performance is required. Investors looking for big returns are going to be drawn to stocks whose value is almost entirely attributable to expectations of future growth.

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Big Returns Fom GM, Ford And Tesla

The behavior of the stocks of GM, Ford and Tesla on March 9, 2021 drives home the point. On that day, the market rallied sharply with the S&P 500 up 1.42% and the NASDAQ Index up a whooping 3.79%. As for the three auto makers, there was no new fundamental news about any of them, but that did not hold Tesla back. The stock rocketed up 19.64%, adding approximately $106 billion to the market capitalization of the company. To put that number in perspective, the combined market cap of Ford and GM was only $128 billion – hardly exceeding the one day increase in Tesla’s valuation. As to price changes, Ford was down 0.63% and GM was down 0.60%.

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The small movements in the stock prices of Ford and GM makes sense given that there was no auto related news, although one would have thought they would have moved up with the market. The remarkable thing is the Tesla movement. One of the largest companies in the world by market cap rose nearly 20% on no fundamental information. That means the market revalued the going business of Tesla by almost a fifth in one day - a day on which there was no change in Tesla’s actual or forecast operations. The entire change was due to a one-day shift in the market’s expectations and sentiment.

For those who say the change might be due to interest rates that explanation does not work. Although the yield on the ten-year Treasury security dropped, it fell only 4 basis points from 1.59 to 1.55, hardly enough to justify a 20% stock return that added $106 billion dollars. The only reasonable explanation is a shift in expectations and sentiment. But as I have said in many previous articles sentiment and expectations move with equal ease in both directions.

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Bradford Cornell is an emeritus Professor of Financial Economics at the Anderson School of Management at UCLA. Prof. Cornell has taught courses on Applied Corporate Finance, Investment Banking, and Corporate Valuation. He is currently developing a new course on Climate Change, Energy and Finance. Professor Cornell has published more than 125 articles and four books on a wide variety of topics in applied finance. Professor Cornell is also a managing director at BRG where he heads the practice on Climate Change, Energy and Finance. In addition, he is a senior advisor to the Cornell Capital Group and to Rayliant Global Advisors. In both capacities, he provides advice on fundamental investment valuation.
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