With Tesla having recently joined the S&P index as the largest ever new entrant, an important point to note is that Tesla’s meteoric rise has been delivered into a healthy amount of scepticism[1] from the financial community over the last few years, as reflected by the large short interest (including a number of high profile hedge funds). To this end, there are similarities with several of the investments that we make through our PVT philosophy and process, which can often start from a position of feeling unloved within the financial community, particularly within our Recovery and Asset-backed categories.

However, this is pretty much where the similarities end … and in fact this note is about why business fundamentals play such an important role throughout our investment process. Ultimately, we believe the cash flow that a business generates and the investment it requires to deliver this are the arbiters of what a business is worth, but clearly sentiment can cause share prices to diverge materially from this intrinsic value in both directions, sometimes for a short period and sometimes for years at a time.

The most important thing, from our perspective, is to avoid being sucked into the temptation – driven by human emotion – of being a slave to fashion, which often entails selling low and buying high. This is particularly hard to do when whole groups of stocks move into either the adored or detested camp. Fundamentals bring us back to evidence-based investing and crucially allow us to have a repeatable process. So while it may seem twee to investors who think the past is of little merit as they are only focused on how fast sales might grow in the future, we continue to place a lot of emphasis on the historic profile of profitability and cash generation, because these provide evidence upon which we can repeatably build conviction in our view of sustainable earning power going forward.Source: Hedgeye

Keeping a cool head and an unemotional focus on fundamentals, courtesy of a clear investment process, feels more important than ever within the context of the wild moves in the share price of GameStop et al over the past fortnight. Put another way, we think this focus on business fundamentals is worth its weight in gold if it allows us to avoid following the crowds into disasters…

[1] Including, I must admit, from the author.