Stocks Without Revenues are Scratch Tickets

Introduction: Index Funds are Eating Speculative Soup
An Easy Win for Active Managers?
But is Biotech so Different This Time?: Maybe Not!
Conclusion: The Frightful Cost of Buying Scratch Tickets in Two Charts
Appendix: Fundamentals
Exhibit

Introduction: Index Funds are Eating Speculative Soup

In the most recent paper Index Rebalancing and the Passive Patsies Kailash Concepts, LLC focused on the mechanical disadvantage inherent during index rebalancing due to its historical bias towards the addition of abnormally expensive and speculative assets. Kailash believes this has never been more relevant than today due to the elevated valuations of recent and potential additions approaching levels last seen at the peak of the dot com bubble. To summarize our prior work since December: passive investors may be ill served as a looming wall of exorbitantly priced unicorns may become eligible for index inclusion in the months and years ahead. As Kailash has shown in prior work,¹ history has brutally punished index inclusions with these characteristics.

Having combed through the listing of recent additions to the R2500 index, not only were these additions trading at record P/S multiples but nearly half could not register a multiple due to an absence of revenues. This has led to an increase in overall index constituents with zero revenues as shown in Fig. 1 below. Since 2017 the percent of firms in the R2500 with zero revenues has more than doubled and is now at an all-time record. As the following research shows, regardless of the recent biotech sector bias, firms with zero revenues have historically offered investors dismal batting averages and terrible returns. It seems the primary appeal to these stocks is akin to buying a lottery ticket rather than an investment.

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As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you. KCR also offers a wide range of easy-to-use but sophisticated tools. Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
Kailash Capital Research, LLC ’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

SOURCES

ADDITIONAL READING

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

Click the following to read more about stock market vs lottery

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital Research, LLC and its affiliates (collectively, “Kailash Capital Research, LLC ”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital Research, LLC . In preparing the information, data, analyses, and opinions presented herein, Kailash Capital Research, LLC has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital Research, LLC , however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital Research, LLC and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital Research, LLC – All rights reserved.

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