Hard to Follow

John Lim

“BUY LOW, SELL HIGH.” This is probably the most famous investment adage. It sounds so simple and commonsensical—a sure path to success. Like so many investing truisms, however, following it is easier said than done.

For one thing, how do we really know when we’re buying low? When it comes to a pair of jeans or a laptop computer, we have a good sense of value. When they go on sale, we snap them up without hesitation.

It isn’t as clear with stocks. The intrinsic value of a stock depends on its earnings and dividend payments extending far into the future. Almost by definition, we can’t know these with any certainty. The price the market assigns to future earnings is in constant flux depending on prevailing interest rates and the vagaries of animal spirits.

Suppose for a moment that stocks did come with price tags indicating their intrinsic value. What would be the result? Trading would grind to a near halt. After all, who would sell a stock for less than its true value or buy one for more?

The lack of clarity around what constitutes a high or low price is what drives markets. As thousands of investors cast their votes daily, with every trade that they make, it’s assumed that stock prices will converge around their intrinsic value. That, at least, is the notion behind the Efficient Market Hypothesis. Prices, it’s believed, reflect the wisdom of the crowd.

But crowds can sometimes behave more like herds, subject to stampedes of collective optimism or pessimism. These are reinforced by our natural attraction to compelling narratives, stories that help us make sense of reality. We’re also creatures of momentum, expecting the future to mirror the recent past.

These forces are powerful and can conspire to drive stock prices far above or below their intrinsic value. Consider Zoom Video Communications (symbol: ZM), a software company. In fall 2020, Zoom’s market capitalization exceeded that of Exxon Mobil (XOM). That’s despite Exxon’s 12 billion barrels of proven oil reserves, as well as its vast array of other tangible and intangible assets.

Fast forward 18 months. Today, the market cap of Zoom is less than one-tenth that of Exxon. With the benefit of hindsight, it’s easy to say that selling Zoom and buying Exxon was a no-brainer. But it’s never that easy.

By fall 2020, Exxon stock had fallen more than 60% in six years, leaving long-term shareholders licking their wounds. With a pandemic raging, the outlook for energy companies was bleak, with crude oil prices at a two-decade low. The last thing most investors wanted to do was buy a stock that had inflicted so much pain.

On the other hand, investors in Zoom were enjoying enormous returns. The stock had risen ninefold in less than two years. Its narrative was equally compelling: Everyone would be working from home in the future. In this brave new world, Zoom would be one of the prime beneficiaries. As with most narratives, there was a good deal of truth to the story. Why in the world would investors sell such a promising stock that had treated them so well?

Problem is, investing that’s based on narratives and past performance—while ignoring price—is the bane of investors. In 2020, Zoom stock was priced for perfection, while Exxon was left for dead. Buying low and selling high sounds so easy. In practice, it never is.

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