Theme Investing, Good Idea?

When you have been in the investment world for a long time, you realize that every era, people get caught up in all sorts of ‘themes’ and ‘stories’.  Back in the early 80s, it was technology.  There was a technology boom that ended in a bust.  This happened in the 60s too, with many companies coming out with names that ended in ‘-tech’ or ‘-tron’ or some such indicative thing.

Of course this happened in the late 90s too with the internet; many companies coming out with names ending in “.com”.  The early 90s saw biotech stocks boom on the promise of biotechnology.  The Japan bubble was partly based on the limited supply of land in the tiny island nation, and those ‘hidden’ assets the Tokyo Stock Exchange-listed companies owned.

Oftentimes, the ‘story’ or ‘theme’ will prove to be correct.  But the accuracy, or correctness of the story does not often lead to good investment results.  In the 1800s, British investors rushed to buy into hundreds of railway companies starting up in the U.S.  The story was that railways across America will change the country.  It did.  But how many of those British investors made money?  Of the hundreds of railway companies that were started, only a few were left by 1900.

The same happened with automobiles early this century.  Autos was the future.  It will change the country.  Every household will own their own car at some point etc…  Sure, it was a big thing.  But there too, many automobile companies were started.  How many survived?  As far as I know, only GM, Ford and Chrysler survived and the rest went under.

This is the same story that we repeated back in the early 1980s.  Computers will change the world!  But out of the hot computer stocks back in the early 1980s, how many are still around today?  Disk drive makers?

The internet bubble.  The story was that the internet will change the world.  Yes, it did change the world.  Those prediction came true, pretty much as people expected.  But how many people made money by buying internet stocks back in 1999/2000?  How many picked the winners, and were smart enough to get out at the top?  Not many.

A similar thing may be happening in natural resource and commodity stocks.  China’s growth is deemed inevitable, and that means more demand for just about everything.  

Another ‘theme’ these days is green energy, solar and things like that.

I think these predictions will come true, about the growth of China and the increase in use of renewable energy sources. 

But as usual, I am highly skeptical of people’s ability to pick the winners.

This doesn’t mean, of course, that people shouldn’t invest in the area.  It’s just that it is a hard game to play, to invest in themes/stories as I showed above with historical examples.

One great example of green energy is Pacific Ethanol.  Pacific Ethanol was a great story. They were a pure play on ethanol, which was a bio-fuel to help reduce our dependence on imported crude oil.  The government supported this industry with incentives.  The stock price soared to $300 or so (actually more like $40 or so since there was a recent 1:7 reverse split).

Corn was cheap and abundant in the U.S., and crude oil was expensive.  What’s not to like about turning cheap, abundant corn into something you can put into your gas tank? And it burns cleaner than gasoline too, and the government is offering incentives.  This is a layup.  How can you lose money?  It kills two birds with one stone (reduce dependence on foreign oil and help the environment at the same time!)

And then on top of that, you had Bill Gates’ investment company owning a large stake.  This is the richest and smartest guy in the world with an investment in Pacific Ethanol. 

What a really great story.  If I was a retail broker pushing stocks, this would have been an easy one to sell for sure.  What’s not to like?  How can you not understand it?

So what happened?  From a high of $300 or so (I’m just eyeballing the chart on Yahoo Finance; ticker symbol is PEIX), it is now trading at $0.38.  That’s not a typo.  It is trading for less than one dollar.  And they didn’t even make subprime loans or buy CDO squareds!    (see chart here)

Another one is Ballard Power Sources.   Check out this chart.  This too is an alternative energy play.  For as long as I have been in the business, Ballard has occasionally been promoted as the answer to the country’s energy problem.  They develop and manufacture batteries, and will presumably be suppying many of the batteries that will go into the future electric cars. 

I have been hearing this story over and over for many years, particularly when oil prices go up and people start talking about electric cars. 

Nobody really knows who will dominate the electric vehicle battery market.  Nissan, Toyota and many other companies are putting a lot of money into R&D to develop a good battery that would work well in an electric car.

Here too, I think the ‘prediction’ will come true.  Some day, most of our cars, buses and maybe trucks will run on electricity.  But who will profit from that?  That’s a very different and very difficult question to answer.

My guess is that the winners will be a complete surprise.

So what matters, then?
At the end of the day, all investments come right back to the two simple questions: 

1. Is it a good business?
2. Is it priced reasonably?

If the answer to the above two is yes, then it’s a good buy and if the answer is no for either one of them, then it’s not a good buy.

If someone can find a good business with a good story, that is great too.  But the above two questions should come before the story or theme.

If people asked these two questions, most of the losses caused by my examples above would not have happened.