Dislocated Stock Prices - Are They Worth the Trouble?

One of the best opportunities either to make (or lose) money while investing comes about via a stock dislocation. Whilst it has been often stated that the market is in fact efficient, I personally hold the view that the people who hold this view probably couldn't spot an elephant on an ice rink.

Whilst the stock market is generally fairly efficient, there are times when either paranoia or exuberance take over - turning a well priced stock into a source of ridicule for all those able to see that the emperor does in fact have no clothes on. 

What makes investing really interesting though, is that that there will also be times when those of us 'in the know' will point out that the emperor has no clothes, only to find that he is in fact dressed in his full royal regalia.

The great thing about investing is that most of the time you are wrong.

Stock Manias - e.g. Tesla?

But manias do exist, and the more discussed examples come about through irrational exuberance - where the positive story about a stock becomes so attractive to investors that investors believe the story to the point where they leave all sense of reality (and risk) behind (cough, Tesla, cough, cough).

In these situations you can be looking at a stock's earnings, and then cast your eye over the share price - and start to wonder if you are still in the real world. 

But the history of manias is a long one (probably dating back to a time when speculation in stone age tools led to a stone knife being worth as much as an entire herd of goats) - and indeed there are whole books dedicated to the more recent history of stock manias, of which one of the best is the excellent Devil Take the Hindmost.

But whilst potential manias are often discussed in real-time, the rebuttals are often quick to arrive - and it feels like investors often find it hard to separate the critique of a stock price with a critique of a company.

Companies often seems to be viewed through the lens of a singular thread, where the company succeeds (or fails) in line with a given investment thesis. The reality, however, is a lot messier, with millions of potential futures existing for any particular company at any given point in time.

For any given company there is a scenario - maybe if only one in a trillion - where you end up with a complete failure of your investment, but also a scenario where the company outperforms beyond your wildest dreams. Between these two extremes you then have an infinite supply of potential alternate outcomes.

Where a stock gets caught up in a mania, you end up with a concentration of focus on the most positive future scenarios, with an all too easily found willingness to discount the more negative scenarios.

But, why do I say that I believe Tesla to be a Mania in terms of it's stock price?

Well, at the time of writing, the Tesla stock price sat at around $400/share, this translates into an earnings multiplier of 273 times earnings - which in itself is a bit of a red flag.

Here you have to be slightly careful though, as earnings are at the end of the day principally an accounting measure, and not always a fair metric for valuation. Earnings can also change over time as the company continues to operate.

But having accounted for any one off items that are not representative of underlying performance, the earnings multiple of Tesla remains at astronomical levels that imply a substantial improvement in future profitability.

Against this, Tesla is facing market headwinds, both due to global factors impacting all car manufacturers, and due to other issues more specific to Tesla. 

Offsetting these risks, there is a big fan following of Tesla, and it always has very ambitious plans that it's very hard-working workforce are very committed to delivering.

And so whilst the $1tn valuation can be accounted for by some future scenarios, a proper risk and time adjusted weighting of all possible scenarios feels more likely to result in a much lower market valuation.

And that is my basis for calling it a mania - the market is in my opinion too heavily focused on the potential upside for Telsa if all goes to plan (and afraid to not participate in this upside), and not sufficiently worried about what might happen if it does not go to plan.

And this judgement is okay for me to make - because at the end of the day investments are as much about opinions as they are about facts and realities. You yourself might disagree, but in many ways that is what makes investing fun.

Stock Madness - e.g. PayPal?

At the other end of the extreme you have the more miserable investor's dream scenario - a company which has dislocated and is trading well below fair value.

But what is interesting about this other type of dislocation is just how tricky these companies are to invest in.

With these companies, the focus will swap to the worst case future scenarios - and for any company the worst case scenarios are usually pretty terrifying. 

A real-world example that looks to be going through an interesting phase is PayPal and the stock price seems to be dislocating downwards as investors start to give up hope of a recovery:

At the moment, the valuation looks pretty attractive - and investors have been taking sizeable positions in PayPal in recognition of the fact that you have a top brand name at a discount valuation.

The challenge you have here - as before - is that some of the doubts about PayPal are not without merit. Indeed if you ask AI for a list of reasons not to invest, the list is fairly long and pretty convincing - but there has to be a point at which PayPal can be bought for a good price, isn't there?

Well yes, of course - if it were trading at one times earnings I think we can all agree that to be a very strong valuation - but the challenge with a company like this as an investment, is that the legitimate doubts create a level of uncertainty around the stock price.

Unless there is a clear trigger for short-term improvements in earnings, the reality is that the stock is probably more likely to continue to drift down rather than up in the short-to-medium term horizon. And so the challenge you have got here is when to invest. 

Our thesis for any investment would be that the market is focusing too heavily on the worst case scenarios, and not correctly weighting for all future scenarios (some of which might be good, and some of which might be bad). But by definition this thesis implies that the market is assuming bad things are about to happen to PayPal.

PayPal is a fairly clean example of a stock that has become out of favor, and so in this scenario I would tend to take the view that you should pull the trigger at around 10 times historic (if stable) earnings - as that offers a price at which you should still be able to extract value, even with declining earnings.

The revenues of the company have grown in recent years and the growth percentages are healthy - but the worry I would have at pulling the trigger at $60/share is that it may well go even lower. And if the market is indeed focusing on the very worst case scenarios then the $30-40/share range doesn't become too incredible a prospect to imagine.

Personally I have added it to my watchlist - but to only invest if it falls below $52/share, which feels low enough to cover off any risks, whilst continuing to have very healthy levels of exposure to any upside.

Here there again might be those that are in favor of PayPal, who might get a bit upset by this judgement - but in setting these levels my intention is not to buy at a fair price, it is to buy at a valuation that seems like daylight robbery, maximising the range of scenarios where I get a profitable investment.

I do still remember when Netflix was dying out, when AI was going to kill Google, Amazon was starting to peak etc etc. And in many of these cases there was a genuine risk to the companies that had validity, but the quality of the operation ensured that it kept going in the right direction and managed to overcome those problems.

Maybe in an alternate universe Netflix and Google failed, but in this one, the companies bounced back and investors made good money. Maybe they still will fail, but maybe they won't, it's all possibilities and probabilities at the end of the day.

But where it gets really interesting is when you see an extended period of poor share price performance, and this is because in these scenarios investors start to get twitchy.

Stock Misery - e.g. Mobico Group?

One of my larger holdings - and probably the one I'm most academically curious about - has been Mobico Group. And I think the only way of describing it's share price activity is that it has been an absolute bloodbath.

I won't divulge the size of my holding or the buy in price as I don't see that as overly important for this article, but it is hard to be up when something is at all time lows.

Indeed, this stock chart is the stock equivalent of sending off your troops to land in Normandy on D-Day, and then watching them be relentlessly mown down by machine guns on the hills of the beaches. You can applaud the bravery, but you certainty wouldn't choose to be part of it if there were any alternative.

So what causes a share to lose 91% of it's market value?

Well, whilst Tesla and PayPal should be known to all, Mobico Group is probably less well known and so will need more explanation.

The company runs transport services across the world, with operations in Europe (particularly UK and Spain) and America, with much smaller operations in Africa and the Middle East.

Formerly trading its stock under the name National Express, it has pivoted away from using that name as it's UK coach operations (operating under that brand) have gone from operating profits of £85m pre-covid (2019), to a cumulative loss of about £150m since 2020.

And since 2020 it's German rail operations operating under the same brand have lost £275m - including provisions for future losses.

Otherwise very little has gone right as the company continues to battle headwinds, partly due to market forces, but also due to weaknesses in their risk assessments when bidding for contracts.

Back in February 2020 the company published the 2019 annual report in a buoyant mood, with earnings of 27.6p per share translating to a share price of £4.40/share - trading at 16 times earnings.

But what followed would have made a fitting sequel to the Chainsaw Massacre, as Covid, a disastrous German rail contract, tough market conditions and a dodgy decisions led to writedown after writedown - and a never ending series of losses.

The cash outflows from the business in 2020, 2021 and 2022 were enormous. Then as hope started to reappear in 2023, the business was slow to recover post-Covid, and the German operations got worse - with total provisions exceeding £200m created in 2023 and 2024 to account for current and future expected cash outflows within the German rail contracts alone.

To make things worse, the original flagship UK coach business continued to lose money, and still looks set to continue to lose money in 2025, as the business struggles to operate profitably against an aggressive competitor in FlixBus.

So I hear? Why on earth would anyone invest in this garbage?

Well, taking off the Hat of Misery, and putting on the Hat of Hope - once the discontinued US School Bus operations are removed (a recent disposal), the company had 2019 adjusted operating profits of £198m (based upon my maths), versus an expectation (as it stands) of £180-195m of adjusted operating profit in 2025.

Much of this is due to very strong performance in the company's Spanish subsidiary ALSA, which has managed to crack the code of bidding for new contracts in a profitable and sustainable way. And there is further upside if the German rail contracts can be renegotiated to restore profitability (this is apparently close to reaching a conclusion).

This offers a glint of light and a potential basis for some level of cheer going forwards - but is that glint of light real?

Well, yes and no.

With such a troubled history, the accounts of the business really have to be rebuilt to be properly understood - and the figure that I'm interested in is the pre-tax profit excluding any discontinued operations, removing non-cash amortization, removing writedowns and impairments and then adding back in cash costs related to any written down items (phew!).

There is no handy acronym for this metric as normally the books aren't messy enough to need it, but this 'Corrected' Pre-Tax Profit was £126m in 2019. 

If this figure could be replicated in future years, that would be quite the win for shareholders as the business is trading at a market capitalisation of just £129m - but as ever it is never quite so simple as to just pluck a number from the past. Instead we need to account for the key changes.

Most notably the net debt position has changed, and should shift from £1.3bn in 2019 (rounded down on the first decimal) to £1.6bn by the end of 2025 (rounded up on the first decimal).

In terms of a delta to earnings, this probably means a £30m increase in net finance costs from 2019 assuming flat net debt going forwards (accounting for increased debt costs on an unusual 'hybrid' debt instrument the company uses).

Additionally we also have that troublesome German rail contract to deal with, as that continues to be causing problems, and is not accounted for in that £180-195m adjusted operating profit expectation for 2025.

This adds a further negative delta of about £55m, reducing our new 'Potential 2025 Pre-Tax Corrected Profit' metric to about £45m per annum.

And then from here there is always the usual risk of underperformance versus expectations - so maybe a prospect of dropping £20-30m below this level.

And so is that good?

Well - potentially yes, because if pre-tax earnings were £45m on a real basis, the company probably has a real value of about £450m or about 75p/share. That is sufficiently larger than 21p to feel pretty good about.

So the End of the Tunnel Has Been Reached?

Well, to be honest, probably not.

You see, throughout the history of this company there have been all these ups and downs, and the harsh reality is that these ups and downs go hand in hand with the underlying business of the company.

The company evaluates contracts, bids for them and then over the life of the contract they can make more or they can lose money depending both on their assessment of the risks - and also based upon pure luck really.

Having more contracts diversify those risks, but on larger contracts, or on the larger blocks of similar activity - the risks can be problematic.

And so here is a company where bumps and scrapes are going to be part of doing normal operations, albeit with superior operational activity potentially reducing those risks. 

These risks increase when market conditions are bad, which does mean that there is still elevated risk during this post covid world - and at some point the company needs some clean years if it is to start making progress financially.

So why on earth did I invest?

Well at the end of the day it is all about that range of potential outcomes. 

With such a disastrous history the company is being valued on the worst case scenarios, but the financial performance behind all the writedowns does not appear to be disastrous and there are plenty of far more positive future scenarios that could provide significant uplift.

For example, those German rail contracts are being discussed with the German transport authorities and there is hope from the company that some sort of settlement could be agree to restore some of value to the contracts.

Whilst the potential outcome of those discussions are very unclear, the company believes it has contractual protections against some of the losses - and so we have an upside case, although not one the market seems to factor into it's considerations.

And so you have a company with on-going issues that may indeed have serious issues, but from a probability standpoint is likely to have fewer issues than those represented by the share price valuation.

These sorts of companies are tricky and awkward investments where it is easy to make mistakes and get things wrong (and to be clear none of this article is investment advice), but they do fascinate me as an intellectual challenge.

Would I ever recommend this company to anyone as an investment? No. But in many ways that is exactly why I like having it on my own books.

Is the Market Smarter Than Me?

And this is where investing gets interesting as far as I'm concerned.

Returning to PayPal, we have a situation where there is the potential to buy in at a valuation that assumes a reasonably poor level of performance going forwards. 

In our dead duck more extreme case, we have Mobico Group - where the management turning up to work without underpants on their heads is probably an upside case.

But despite all this, if we had invested in all three companies discussed here, it is only Tesla that would allow us to feel good about our investment right now - in PayPal we would probably feel moderately depressed, and the feeling about investing Mobico Group is probably a bit too close to home to talk about right now.

It definitely feels good to buy things that have gone up - it is a bit like being declared the most popular guy in school - and it definitely it feels bad to buy things that have gone down - you might as well have won the 'Ugliest Face in School' award.

But stocks do dislocate - the problem is that we don't know for sure if it is really a dislocation or just an error of judgement on our part at the time. 

Tesla might be a really smart investment, but people buying it now might also lose a fortune. Equally Mobico Group was almost certainly a stupid investment at it's peak - it's business is exposed to ups and downs after all - but back in 2019 it probably felt like a cracking little horse to have backed.

And this is where PayPal gets interesting, as one of these stocks going through a period where people are starting to call it mean names (PainPal is one I hear a lot).

You could pull the trigger at sub $60/share and probably feel pretty happy about your assessment of the situation. If it falls further that would definitely feel sub-optimal, but maybe that doesn't really matter in the scheme of things.

But that is what makes these scenarios so interesting - as soon as you feel another bottom has been found, there is often another one waiting to clip you round the face - and nothing at all is very clear, except in hindsight.

Disclaimer - this article discusses specific investments but is NOT investment advice. References to specific investments are only provided to support the discussion and the accuracy of any of the details is not guaranteed. Do your own research and take your own investment risks.