Trading the Trend - the madness of crowds

It is scary how quickly this year has gone. It only feels like yesterday the entire equity market was collapsing and supermarkets were (bizarrely) being emptied of toilet roll. 

There is a fantastic book called The Extraordinary Popular Delusions and the Madness of Crowds. It was first published in 1841 so archaic in language but offers insights into how people react and think. 

The truth is that people are not rational and are often incapable of making decisions in their own best interests. 

For example, let’s say I am offered £200 by a third party and told that if I share it with someone and they accept then we can both keep the full £200 between us. If the other person doesn’t accept, then nobody keeps the money. 

You might expect that because I am fair I would offer you £100 and keep £100 for myself. If you say yes, then we both keep the £100. 

But I have studied economics. The economic argument would be to keep £199.99 for myself and offer you £0.01. This is because you would be one penny better off than if you did not have the penny. Therefore, under this argument you would accept my offer because this is clearly in your own best interests. 

However, it turns out I am generous and have decided to offer you £5. I will keep £195 which I will book a nice spa hotel for my wife and I. You can buy a flat white and keep the change. 

Do you accept?

Possibly not! Despite you being a whole £5 better off – the unfairness of it stinks and it’s possible that you want me to miss out of the money as a result out of spite. 

This goes against all economic theory. But that’s the problem with economics. It assumes that there are no emotions. No greed or jealousy, no fear of missing out, no comfort in doing what everyone else is doing and no being scared of acting outside of the herd.

What does this mean for stocks?

The market is slow to change its opinion. It lags change, and presents opportunities. 

I remember something Paul Scott once said at a Mello presentation: “The ability to change your mind when the facts materially change is a key factor of outperformance” – or something similar! He is right and especially so in small cap stocks.

Fireangel (FA.) (I hold a long position in Fireangel)

Fireangel is a company that produces and sells smoke alarms and carbon monoxide detectors. 

It’s been a dog for as long as I can remember and puts out profit warning after profit warning.

The company has been transitioning to a technology company with recurring revenue. Here is a snippet from the recent RNS detailing an IoT partnership with the London borough of Ealing: “Utilisation of FireAngel's unique connected technology will eliminate much of the costly requirement to gain physical access to properties as data is transmitted wirelessly in real time through a secure cloud network.” 

The company is hoping to make the change to a Software-as-as-Service business. This commands higher margins and can be scaled up

Here is the price chart for the last five years.

These are monthly candles (so I could fit it the timeframe on) and we can see that aside from a brief spell of positivity on listing the stock has begun a downward trajectory. 

If there was a stock to win the “perennial turnaround” award now that Hornby has turned a profit then this would be stock to win it.

I pulled the trigger yesterday on the RNS. October was the highest revenue in year to date, with an earlier update saying that October 2020 had been the highest revenue in any month for almost three years. 

Yesterday, we were told that November had been significantly higher (I read that to be 10%+ although we are given no numbers). 

There has also been a recovery in gross margins. The company raised £6.1 million gross proceeds at the end of March so I assume placing risk (for the moment) is low. 

I think there is an opportunity for a trade on a beaten-down stock to trade higher as some positivity starts to creep in. 

Do I believe Fireangel to be a quality company? No, I don’t. It could be in the future, but then so could every stock.

Do I care? Again – no. It’s a trade on negativity and sentiment changing. Small cap stocks provide these opportunities because they are often ignored. I still believe The Works has upside although buying now is a lot less attractive than buying on the RNS. 

The chart looks as if it’s in a stage 1 base. I’ve drawn a resistance line at 17.5p as I think this is a key level which could indicate a change in trend. 

I could be wrong about Fireangel, but at the 15p-16p level I feel the risk/reward is in my favour with the current cards that have been played. I get plenty wrong though, so time will tell! 

Finally, this will be my penultimate column on Stockopedia. It’s been hugely fun writing here for over a year now, and I’m grateful to Ed and the rest of the team for offering me the opportunity. Stockopedia is a fantastic community that I’ve been a part of since nearly the beginning of my trading career. 

The market has been hugely volatile this year and taken up far more of my time. I’m expecting (and hoping!) this will continue next year. 

Gervais Williams thinks so too: 

“The risk-reward ratio is really the best I’ve come across in my career. It’s sensational. We’re buying companies at what I consider are not just inexpensive relative to other companies, but in absolute stock valuations stunningly cheap."

With that in mind, I’d like to wish you and your family a happy Christmas and a healthy and prosperous 2021!

You can download your copies of Michael’s books at www.shiftingshares.com

Twitter: @shiftingshares