It is well known that certain companies, such as the mega-tech FAANG stocks, are trading at valuations that are high relative to historical averages.
If you’re wondering why – there are two main answers.
- Investors and traders believe the valuation can improve further (higher)
- Investors are insensitive to valuation
Factor 2 is what I am focusing on today, as we need to be aware of the investment concept of affinity.
When people have affinity for an idea and they fall in love with it, there are no limits to how far the idea can trend and how hard the stock can rally.
This is happening to Zoom, Facebook, Netflix, Amazon, Beyond Meat, Peloton and many others.
This is what an affinity stock’s returns look like, as the following chart shows Peloton’s price (NASDAQ: PTON) over the last 12 months, +418%.
What is affinity?
Affinity first came to my attention 12-24 months ago when it became apparent that Tesla’s (NASDAQ: TLSA) market capitalisation was going to eclipse the likes of General Motors and Toyota, despite not being profitable at the time and producing far less vehicles, with far less market share.
If you’re a user of Reddit, a global social news and discussion website, you may have experienced the extreme vitriolic reaction of Tesla followers when anyone would express any form of negative opinion about the company of its valuation relative to others.
This is epitomised where financial analysts have been harassed in their workplaces by Tesla fanatics, who would come to their places of work seeking to argue their more positive opinion. There’s been quite a lot of restraining orders around the world as a result.
I’m telling you this story because while we label such people fanatics, they are expressing opinions that are insensitive to valuation.
People are fanatical about Tesla, as well as the likes of Beyond Meat (NASDAQ: BYND) – but are not about oil giant ExxonMobil (NYSE: XOM) or domestic banking juggernaut National Australia Bank (ASX: NAB). You’d be hard-pressed to find somebody passionately dedicated to the world’s largest uranium producer like Cameco Corp (NYSE: CCJ) or Australia’s largest oil and gas producer Woodside Petroleum (ASX: WPL). There are companies that lack affinity.
What makes a stock affinity-esque?
Affinity, as a stock indicator, is a thematic view – a macro view – that does not evaluate fundamentals or a bottom-up approach.
It makes more sense for retail investors with less investment expertise and less time, or for those buying into global trends (“trend following”) driven by shifting human behaviours.
An example I’ve had brought to my attention recently was IDEXX Laboratories (NASDAQ: IDXX), an American multinational that develops, manufactures and distributes products to vets and farms – the most popular are their testing and diagnostic equipment – but are known because for their products that (generally) improve the quality of life of animals.
The company is based in Maine, USA, has 9200 employees and was founded in 1983.
It has a P/E ratio of ~79, market cap of 36bln USD and its stock price is up +200% since March 2020, or +78% since November 2019.
Fundamentally, this may be seen as expensive, and it’s not a new entrant to its market.
Investing in IDXX is an affinity play because there is a long-term trend that we are humanising our relationship with animals.
A growing part of society is aware of inhumane animal treatment, and the number of vegetarians is growing faster than population growth due to non-medical reasons. Our behaviour is shifting and therefore, so will our spending and investing habits.
Examples of affinity stocks
There are many obvious examples of affinity stocks as they have large followings and are generally integrated into our daily lives, where we can’t imagine the world without them.
Examples: Apple (NASDAQ: AAPL), Beyond Meat, Amazon (NASDAQ: AMZN), Netflix (NASDAQ: NFLX) Tesla, Afterpay (ASX: APT), Peloton and Zoom (NASDAQ: ZM).
All of these are broadly known as “pandemic stocks”, that have benefitted from the global environment affected by COVID-19 this year, but in nearly all cases (bar Zoom), their affinity was established pre-COVID – the pandemic has just accelerated the trend.
Insensitivity to valuation
In seeking affinity stocks, we are finding equities where investors are not discouraged by higher than historical average valuations. Their own perception of value is based more on sentiment and belief in product, than it is in top-line growth or ROE figures.
From a quantitative point of view, this is hard to screen for as there’s no true measure of affinity, and proxies such as momentum, P/E value or Elliot Wave (trend) may not fully capture the investment thematic.
Therefore, this becomes a more qualitative thematic, where we screen based on perceived sentiment, news articles and where bad economic data is met with continued bullish buying of the equity.
We saw the latter when Tesla’s Elon Musk tweeted “funding secured” and was later investigated by the US Securities and Exchange Commission (SEC) for this misleading comment before funding was indeed secured, yet Tesla’s stock kept going up.
Telsa’s stock price is up 552% since November 2019.
This example sums up the behaviour around affinity stocks nicely; Musk is just the window into Tesla, people believe in his word because they believe in the vision of the company – the forecast value is any number higher than what it is today, so long as they have affinity for the product.
That may be what makes affinity stocks so compelling – if your view is that the product is the way of the future, and the present fundamentals of the company are irrelevant, then the value of the company will always be at least more than what it is worth today. Affinity creates the closest thing we have to a perpetual motion engine for a stock.
The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.