In the context of human evolution, going along with the consensus has generally been the smart move.
For one thing, the majority opinion – in terms of such things as where the food was and when the tigers were likely to return – had a good chance of being right. And, for another, wandering around the caveman world alone probably wouldn’t have left you much time to feel smug even if you were right.
In a market, the herd is also often right, but the crucial difference is that you tend to have to pay a high price for being part of it. As Warren Buffett said succinctly: “You can’t buy what is popular and do well.”
But the herding instinct is ingrained in all of us. It’s precisely why people converge towards a consensus, and it’s precisely why the price you pay to be part of it is generally too high.
You couldn’t find a better example of all this than Flight Centre’s recent performance.
Dark days
In the dark days of the global financial crisis, the stock could hardly find a friend. Economic uncertainty and the weak Aussie dollar were keeping travellers at home, the excess supply of flights was pushing down prices and the company was reporting writedowns and restructuring charges.
But as the bad news flowed, investors’ minds started wandering – as they so often do in these circumstances. After all, you risk looking an idiot if you announce to the herd that such a rubbish stock might be worth buying.
So various background concerns received extra airplay, such as how Flight Centre was going to be put out of business by the internet. On 10 March 2009, you could have bought shares in Flight Centre for $3.43 (down from a peak of around $30 in 2007 when everything looked rosy) – amounting to a multiple of five times the underlying earnings per share made in 2009.
Skip forward almost five years and the company has just reported a profit before tax ahead of its own twice-upgraded guidance … for the second year running.
A ‘business expansion’ has combined with margins at 10-year highs to give underlying profit before tax 18% ahead of last year and more than three times its 2009 level. The full-year dividend was raised 22% to $1.37. In fact, you could have paid for buying the stock in March 2009 just with the dividends received since.
Tenfold rise
As you’d imagine with all this, the share price has taken care of itself, rising more than tenfold to around $47. But the herd may now be running in the opposite direction.
For one thing, the company may have gained a reputation for deliberately undercooking its guidance. We doubt that’s the case – more likely, management has just been offering its best guess, with a natural steer towards the conservative side of things. But investors are likely hoping for more than the 8-12% profit growth management has suggested.
And all the good news stories – such as the boost to travel numbers from budget Asian airlines and retiring baby boomers, and the potential of the company’s new ‘blended travel’ model – have grown legs.
You don’t hear so much about how the weaker Aussie dollar and slow economic conditions might tighten travel budgets. And the worries about how the internet will destroy physical travel agents seem to have disappeared – but if it was going to happen, then we’d be five years closer to it.
At current prices the stock is on a multiple of about 18 times the $2.58-$2.68 management guidance for 2014. Flight Centre is a fine company and holders should be reluctant to let it go, but we’re recommending members trim their holdings to limit their exposure. Much higher and we’re likely to downgrade to Sell.