Avoiding Value Traps in Beaten Down SPACs

March 22. 2022. 7 mins read

You don’t need a high school education to understand how supply and demand works. It’s intuitive. If many people desire a product with a limited supply, then the price typically goes up. At some point, demand will fall because the product becomes too expensive and people turn to substitutes. But supply and demand theory falls flat on its face when Veblen goods enter the picture.

For a Veblen good, demand goes up as price increases. The higher something is priced, the more people demand it. Screaming Eagle wine from the Napa Valley would be a good example of such a good. In the stock market, we can recognize a similar psychology at work. As a stock price plummets, retail investors start to become suspicious and question whether it’s worth holding. As prices fall, the asset becomes less desirable. Then, when prices go up, investors have a serious case of FOMO and it becomes more desirable. No wonder most investors can’t beat a broad market benchmark.

For more astute investors, price drops represent opportunity, but the challenge always remains the same – how can we tell when a stock price represents “good value for money?” Since most tech stocks don’t have positive earnings, traditional valuation methods like price-to-earnings ratios don’t work. That’s why our own tech investing methodology has adopted the simple valuation ratio which focuses on revenue growth, not earnings. Still, ratios don’t provide us with the sort of intrinsic value measurement that sophisticated institutional investors might use. For that, we can look at past valuations.

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