China’s tech bonanza gets a fail on this fund manager checklist

Applying the six-point checklist of noted fund manager Peter Lynch offers up an alternative narrative to the recent IPO boom in Hong Kong

PUBLISHED : Monday, 27 November, 2017, 5:14pm
UPDATED : Monday, 27 November, 2017, 11:24pm

Hong Kong’s stock market has seen a flurry of fundraising this year by technology and internet companies ...

Business, November 25

One of my all time favourite stock pickers is Peter Lynch, the fund manager who achieved an average annual 29 per cent return on Fidelity’s Magellan Fund when he ran it between 1977 and 1990.

Among his great gems of investment advice was that he liked the kind of company any fool could run on the grounds that sooner or later some fool would.

His checklist for stock picks included such tips as (1) its name sounds dull or even ridiculous, (2) it does something disagreeable, (3) institutions don’t own it and analysts don’t follow it, (4) there are rumours of involvement with the mafia, (5) it’s in a boring no growth industry and (6) it has a niche.

He once tried to imagine his ideal stock. It would be called Cajun Cleansers, it would make a patented gel that cleans mildew stains and it would be headquartered in the Louisiana bayous, far from any airport.

No publications except those that believe Elvis Presley is still alive ever mention it and no analysts follow it. But directors have all been buying back the shares, earnings have shown steady, moderate growth and the market is down because the guru economist of the day predicts higher interest rates.

“Don’t pinch me. I’m dreaming,” wrote Lynch.

Having thus established this checklist, let’s run it across our flurry of technology and internet stocks.

They all offer bright attractive names, although, given the favoured genre in books sales these days, China Literature might wish to consider compounding its name into one word with the “hina” taken out of “China”.

There is no slime disposal here and so none do anything disagreeable. Institutions and analysts all follow them closely, none have links with the mafia (or even grand bauhinia medal winners) and they are all in exciting, high growth industries. Most of all, there are no niches except in the columbarium stocks.

So that’s a straight no-go on every count of the Peter Lynch test.

Take particular account of that absence of a niche. None of these internet stocks really have one. The internet has already been invented and none hold any exclusive rights to it. All they can do is use it to offer goods and services to the public through a more price efficient channel than the shopping mall.

This works wonderfully for a while, as it did for the first shopping malls that supplanted high street shopping. But anyone can enter this game and do so much more easily than building a mall. Soon they will all have to compete just as fiercely as the malls did, with the same frighteningly thin margins.

Of course in some countries (guess which one) government is likely to suppress competition by refusing entry to foreigners while elsewhere specialist websites offering expert services, or particularly trusted ones will thrive.

But the bulk will not. Their returns, already slight (hello, Amazon) or in loss (hello, Zhong An), will be severely constricted and then investors will find themselves asking one crucial question:

Why am I doing this in the first place?

Back will come the obvious answer:

To make money.

But if that money can no longer be made by riding a speculative boom, for the simple reason that there is no escape velocity in speculative booms and all of them must come back to earth, then the money can only come through the company’s earnings.

If the earnings are then slim, as inevitably they must become in the highly competitive environment that will overtake these internet stocks, then there will be no reason to justify a high share price multiple and share prices will collapse.

I excuse anyone under the age of 30 from remembering just how this happened 17 years ago to the brave new world of the B2B internet outsourcing solutions platform. I do not expect anyone under 40 to remember such great Hong Kong tech names as Conic Industrial, Atlas Industries and Lafe Holdings.

I don’t even expect many investors these days to recognise Peter Lynch’s name.

But I do expect them to lose a lot of money.