The Business of Value Investing.pdf

190 The Business of Value Investing

terms, there is an asymmetry in the risk/reward ratio between being

short or long in the stock market. The asymmetry reveals itself in

this way: Losing on a long position reduces an investor ’ s risk expo-

sure while losing on the short position increases the risk exposure

because it means that the stock price is going up. However, at times,

short selling certain stocks can be a very value - oriented investment.

In the early 1970s, a group of large investor favorites known as

the Nifty 50 were widely regarded as “ one - decision ” buy - and - hold

stocks. Regardless of how high the stock prices rose, investors came

to believe that the predictable rapid earnings growth of the Nifty

50 was suffi cient to justify their purchase at any price and produce

market - beating results. During this time of unyielding optimism,

the average P/E of the Nifty 50 stocks was 37 versus a market mul-

tiple of 18. It was clear that the valuations afforded to this select

group of stocks were dependent on continuous growth at a rapid

rate, which becomes more and more impossible as the numbers

become larger. Indeed, it would appear that the margin of safety

existed in going short a basket of Nifty 50 stocks as there wasn ’ t any

margin of safety at a P/E of 37. The severe market downturn of

1972 to 1974 brought devastation to Nifty 50 stock valuations and

taught investors that price does matter and that people can pay too

much for even the soundest of companies.

This lesson didn ’ t last long; the technology mania ushered in

a reincarnation of the Nifty 50 episode. This time, the Nifty 50 was

replaced by the NASDAQ 100 Index. Whereas the Nifty 50 epi-

sode consisted of the best - of - best businesses with long records of

operating history — including Polaroid, McDonald ’ s, and Johnson &

Johnson — the NASDAQ 100 included new start - ups with little or no

operating history to speak of. Clearly, investors had forgotten the

lessons learned in the early 1970s because the valuations afforded to

this new group were extraordinary. At the height of the tech bubble

in 2000, many fl y - by - night businesses were trading at astronomical

valuations without any fundamentals to back them up. In February

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