Do stocks ever get a second chance?
This week we'll start with a maths question (sort of).
Suppose we have two stocks A and B. During the pandemic bubble, A was a 10-bagger while B was a 15-bagger. However, after the bubble popped, both stocks declined by more than 90%. Which one of these two former multibaggers has more bag holders?
The answer of course is the one that isn't mostly owned by Softbank.
Last week we looked at the flow of money between macro markets on the theory that for a new trend to be born, an old one has to die. This week we are interested in a related question for equity markets.
Suppose we have a stock which at one point in time attracted a significant amount of capital, but has since fallen significantly. This may be because it was some hot new technology that subsequently fell out of fashion, such as the Metaverse. At present we have many examples of companies such as Carvana, which invested heavily in the pandemic, only to be saddled with debt when growth didn't materialize quickly enough.
The question is whether these stocks ever mount a comeback to make a new high, and how might we predict stocks with a chance?
To investigate, we looked at a universe of the largest 3500 US stocks by current market cap. We also filtered these stocks to include only those which were traded prior to 2000, in order to make the statistics comparable. This left us with around 1300 stocks. This universe of course has survivorship bias. There were about 500 stocks that went bankrupt in the dot com collapse for example. These stocks should be included in the denominator when estimating percentages.
Let us start with the easy question: it doesn't matter how much a stock sells off, there is always a chance that it comes back.
In every group of 50 stocks (ordered by size) we can find stocks which came back from a drawdown in excess of 95% to make a new high.
For the top 300 or so the median recovery was from a drawdown of 70%, while for smaller stocks it was about 80%. These two numbers correspond approximately to the drawdown of the S&P in 2008 and the Nasdaq in the dot com collapse respectively.
In other words, if a company survives, then the market largely determines whether it will make a new high.
We are more interested in companies that remain stuck in a drawdown while the market has recovered.
If we restrict ourselves to drawdowns that still hadn't bottomed when the market (represented by SPY) had fully recovered we still find cases above 95%. However, these were mostly tech stocks such as AMD and WDC which lost out in the desktop era, but came back in the mobile era. If we wait until the Nasdaq recovered then we have many fewer cases, although this is in large part because it took around 15 years for the Nasdaq to get back to its dot com highs. The notable instances above 95% here are biotech stocks such as NBIX and NVAX. The success of drug trials is evidently independent of what the tech sector as a whole is doing. These long term drawdowns are not particularly interesting however. Who wants to wait 15 years to get their money back from a stock?
What we really want to look at are stocks which hit the bottom of a drawdown at a time when the Nasdaq is already in a bull market, though not necessarily back at a high. This is the situation we are currently in, with many once-great stocks getting left behind.
Stocks which hit a bottom more than 60% below their peak at a time when the Nasdaq had rallied more than 20% in the prior year rarely recovered to a new high within 3 years.
What this tells us is that based on historical precedent, it is unlikely that any of the pandemic bubble stocks that are down 90% from their highs will recover to a new high any time soon.
The only cases are NVAX, which was helped by an unprecedented pandemic, and ARLP, which tracks the price of oil.
If you are a bag holder in LCID, DISH, or CHPT, which all made new lows recently, be prepared for a long wait.
The other side of this is the opportunity. A stock which drew down more than 80%, but survived and rallied with the market rather than making a new low has a chance to be a multibagger.
Let's look at an example next.
1. On the screen: CIBR
After an IPO in 2019, Cloudfare (NET) was a 12-bagger at its peak in 2021, but subsequently declined by over 80%. Over the past year it has outperformed the Nasdaq, but would still need to go up over 200% to make a new high.
It has a chance, in part because it is in the growing Cyber Security industry. Indeed a current focus of NET is on poaching customers from competitors.
In beat the market we discussed how this kind of competition might result in equal weighted ETFs such as ROBO starting to outperform their market cap weighted peers such as BOTZ. The relative increase in riskiness of BOTZ is an indication that we may wish to switch soon.
The cyber security ETF CIBR is also market cap weighted, but is much less concentrated than BOTZ. As a result it similarly has lower implied volatility than BOTZ at present ,which would allow us to hold more of the position.
For now, as we will detail next, we are going to trim our position in BOTZ with the intent to add back if and when we see a deeper correction. In the event that it is CIBR that has a deeper correction, we may choose to switch.
2. Portfolio positions
At present, our position in BOTZ is about 20% above average for the portfolio.
We will therefore trim our position by 20% to bring it back in line.
The only other position that is an outlier is in UVXY. This is in part due to the decline in value, and in part because the volatility of the (future) VIX has collapsed.
In increase in the vol of vol is generally seen as a precursor to an increase in vol, so we don't think it makes sense to add to our position. We still like to have a tail hedge at present though.
With the reduction in the BOTZ position, the new portfolio weights are as follows.
In our equity portfolio, we will sell 8.1% in XLP and buy 7% XLV. Health insurers dropped as seniors started using services again after the official end of the pandemic. In the medium-long term this ought to be good for the sector though. XLV looks ready to break higher. Staples is the most effective way to fund this position, and looks due for another leg lower.
In the unbound balanced portfolio, this week David is neutral.
Talking stocks is now taking place at our daily discussion category on the forum. https://www.davidwoounbound.com/forum/daily-discussion
We have irreverent but insightful commentary on stocks in the news, updates on trades we have on, and new trades throughout the week.
Make sure to follow the category if you want email notifications when there are new posts.
I think that there should be some sort of relationship that says the bigger the n in an n-bagger, the more bag holders are created when it crashes. Interestingly, the origins of the term bag in these two expressions are not related.
I looked at reverse stock splits to see if they work. I found 100 stocks which made a new high after a split out of 550 that survived. Of these, not many were just trying to maintain listing requirements, but rather were trying to meet mutual fund requirements, or simplify the payment of dividends. Then you have cases like AIG and C which only survived due to being bailed out. I guess the possibility of bailouts is another variable to consider.
Percentage drawdowns for TSLA have actually being getting bigger through time, which is weird. AAPL survived 3 drawdowns of around 80% but have since seen their drawdowns getting smaller, possibly as a result of buybacks. AMZN was down over 93% at one point.