Finance blog


Willy Wonka and the Chocolate Factory

January 13, 2021

One of the coolest movies I remember as a kid was Willy Wonka and the Chocolate Factory. It came out in 1971 and tells the story of a poor boy, Charlie Bucket, who lives with his four grandparents (who strangely share a gigantic bed) and four other children from around the world. All five children acquired a special golden ticket—by hook or by crook—that entitles them to a tour of the Wonka Factory. The film is so hectic that it can actually make the last couple of weeks seem boring.

We all know that Charlie is one of the lucky kids that found a golden ticket and gets to go on the tour, and has a one in five chance of winning a lifetime supply of chocolate. In case you never saw the movie (or are over 50 years old but can't remember) the other four lucky winners were: (1) the infamous Augustus Gloop who is characterized as a gluttonous and selfish young boy; (2) the spoiled and mean-spirited Veruca Salt; (3) the crazy, gum chewing Violet Beauregarde; and finally, (4) the television-obsessed Mike Teavee. These characters, along with Charlie, form the group that tour and perhaps win the lifetime supply of chocolate. The type casting is not only obvious, but also awesome in a way. It should be noted that of the five "winners," Charlie was the only one who only bought one candy bar. Grandpa Joe is so excited by the find that he hops out of bed for the first time in many years. As far-out as it sounds, it makes me think of today's environment. The contest that Willie Wonka devises is really made to tempt and ultimately catch each of the children falling to their base natures. This seems like a perfect metaphor for the current financial markets, which, to me, seem poised to be trapped in their "base natures."

Bear with me: it may be a stretch, but I think you will enjoy my theme.

The first to fall is Augustus Gloop.

As you may recall, the children enter the wonderous and mysterious chocolate factory through a door that leads them into a magical garden of edible candy and chocolate treats. Augustus is the glutton and immediately starts drinking out of the chocolate river. Soon, he falls in and is eventually sucked out through the drainpipe and ejected. Willy Wonka doesn't seem all that surprised, but is disappointed that Augustus has contaminated the chocolate.

What is today's Augustus Gloop? I think it's the stock market. Valuations are high, and everyone is drinking from the river of chocolate. Let's first examine the major indices. The Dow Jones Industrial Average is at roughly 26x, the S&P is around 30x, and the NASDAQ is at 68x earnings. Maybe those don't seem so outlandish to you, but consider just a couple of the big names in the news lately, for instance Door Dash (DASH), which recently had an IPO. It has negative earnings. In fact, its current price is around $162 per share while it is actually "earning" (losing) -$1.74 per share. You cannot even calculate a P/E ratio for this stock because with negative earnings, that is undefined. Another company with what might be a gluttonous valuation is TSLA. While it actually does have earnings, it is trading at a multiple of 1,326 times them! If you are like me, you are probably tired of Zoom calls, but the stock market must think they are going to multiply many times over from here. Why do I say that? Because the stock (ZM) is trading at 235x earnings. You get the picture; it just doesn't make rational sense. I could give many other examples. As they say, there are bulls, bears, and pigs and the pigs usually get slaughtered. Poor Augustus; at least, got the easy route—through the plumbing and into the fudge room!

The second to fall is Violet Beauregarde.

Violet loves chewing gum. Mr. Wonka shows the remaining children a workshop where the amazing Everlasting Gobstopper is being developed. The Everlasting Gobstopper promises a full meal of flavors and is meant to last forever. He warns the children that the product has not been perfected yet, but as most of you know, Violet cannot resist and pops a stick of the amazing Gobstopper into her mouth. Unfortunately, the dessert course of blueberry pie causes her to blow up like a blueberry, and she is rolled out to get squeezed.

Today's Violets are the SPACs. In a "normal" environment, if someone came up to you and offered you an investment in a shell company that has no guidelines or purpose except to invest in an as-yet unknown company, you would laugh at them. The name alone should give us an indication of what these "companies" are supposedly going to do: Special Purpose Acquisition Company. As defined by taxing authorities, they are "blank check" shell corporations designed to take companies public without going through traditional IPO protocols. Does this mean they will all turn out to be terrible investments?No, as Violet discovered with the Gobstopper, the first few courses were delicious…it was just the Blueberry Pie that got her in the end. I suspect the current inventory of SPACs will feature more than a few dessert glitches.

Charlie and Grandpa Joe nearly lose it in the Fizzy Lifting Room (more on that in a moment).

In the Golden Goose Room, Veruca Salt is the next to go down the tube.

Veruca is a mean-spirited little girl. I'm actually a little surprised that she doesn't get bumped first. Her main fault is greed, something driving a lot of decisions today.

Veruca, for me, could live in several of my recent posts discussing those selling really cheap options without measuring their cost over time. Investors that have chased those few, measly extra basis points by selling cheap options are just like Veruca. They want more income, now! But they haven't really looked at the risks, and unfortunately, just like Veruca, they will likely get sent down the trash chute. It won't be pretty.

The last to fall is the television-obsessed Mike Teavee.

BTW—for the first time, I just noticed that his last name Teavee is a tie-in to T.VI—learn something new every day.

Mike makes the unfortunate choice to have himself teleported from his full size down to a couple inches high, so he can get into a TV program. In my memory, Willie Wonka kind of stands to the side, slowly shaking his head while this is occurring.

To me, this is a direct example of short-term decision making. I have been beating this drum for years, but once again it bears repeating: short-term decisions are almost always bad. We cannot invest as professionals without including time into our equation. In this situation, his impatience and lack of understanding the implications of making decisions in a zero-time manner cost Mike dearly. Will he always be three inches tall? Similarly, when we use metrics that do not employ time like yield and duration, we are setting ourselves up to be teleported into bad experiences.

Back to the Fizzy Lifting Room.

Charlie and Grandpa Joe screwed up. They should not have sampled the fizzy lifting soda without permission or an understanding of the product, but alas, they did.

Throughout the tour they had remained disciplined and followed all the rules…until now. This just reinforces the reality that even the most disciplined and hardworking investors can screw up. No one is perfect and I bet if you, like me, look back over your investing past you will find identifiable mistakes (I sure can!). Luckily for Charlie and Grandpa Joe, they quickly recognized their error and figured out how to correct it. In the movie, that extricated themselves by burping. In investing, it may not be quite that simple.

Riding out errors seems noble. Live with the consequences and sometimes you might get lucky and events will save you through no skill of your own, but far more often, the sooner we acknowledge mistakes and let others know what has happened, the sooner we can move forward. Believe it or not, your co-workers, committee members, board, etc. will actually appreciate your forthrightness. Just don't make the same mistake a second time!

You can only make timely corrections of your mistakes if you practice a disciplined process of looking both forward and backward on all of your investments.

Well, in the end, you know what happened. Charlie actually gets far more than a lifetime supply of chocolate: he gets the whole factory.

Final, final thought: I didn't mention the Oompa Loompas yet. I'm not sure if they represent lawyers or brokers—I'll let you decide!

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