On Ferraris & Investing

April 20, 2017

On Ferraris & Investing

  • Investing in Ferrari is investing in sentiment. As long as there’s a kid dreaming of owning one, you’ll make money.
  • The trouble is that such dreams are usually crushed in recessions.
  • For investment returns, it’s much better for your financial professional to be driving a minivan. If he drives a Ferrari, find somebody else to manage your finances.

Introduction

For the rational human being, it’s difficult to understand the concept of luxury as the utility of such things is questionable. What’s even more difficult to understand is how investing in luxury can be logical or ever profitable, but this is exactly what investors in Ferrari N.V. (NYSE: RACE) have achieved.

Ferrari went public in October 2015 as a spin-off from Fiat-Chrysler (NYSE: FCAU) at $52 per share. The stock reached $60 on the first trading day only to drop to close to $30 in the February 2016 market selloff. A 50% drop makes sense to me as the book value of the stock is only $1.74.


Figure 1: Ferrari’s stock since the IPO. Source: Yahoo Finance.

But as the market likes to invest in hopes of incredible future earnings alongside strong sentiment related to a brand, Ferrari’s stock recovered and is now trading close to all-time highs at $71.20 per share. Apart from the luxurious price to book value of 50, the price earnings ratio is also luxurious at 31.4 which makes the bull run irrational but we must never underestimate investors’ sentiment. Those who have invested in Ferrari at these valuations expect demand from China to continue to grow and hope lower taxes in the U.S. will further increase demand. On top of that, these investors tend to see the biggest value in the brand.

The power of the brand and the vibe around it is perfectly explained by Ferrari’s CEO Sergio Marchionne:

“We have to make sure the demand is there, and we always have to supply less than the demand.”

Ferrari has typically had a production quota of 7,000, but now the target is going up to 9,000 and beyond in order to grow and increase profits. On one hand, investors invest for the power of the brand based on exclusivity, while on the other they expect higher earnings from more sales which will eventually destroy exclusivity.

It’s futile to do a fundamental analysis on Ferrari’s stock, but the vibe around it is a great indicator of market bullishness and how rationality doesn’t really help. The only rationale behind investing in Ferrari is that the global economy and demand for such cars is expected to grow while the company manages to maintain operational efficiency in order to keep earnings high. This is very similar to what every investor investing in this market expects. With Ferrari, it’s just leveraged.

What investors forget is that in 2009, luxury sport car sales dropped by a stunning 35%. Ferrari’s sales dropped only 6% but this isn’t an indication of future recession performance as we are really discussing minuscule numbers here.

Things That We Can Learn From This

The beautiful thing about investing is that you aren’t forced to invest in companies like Ferrari. If Ferrari goes form $71 to $500, it’ll be great for those who invested but as we discussed on Monday, investors should focus on absolute and not relative performance.

Luxurious bull markets are another indication of how markets are detached from fundamentals. This could be a structural trend but then again, nobody is forcing you to follow trends as there are a few bargains around the world still available.

Perhaps the most important thing when discussing Ferraris and investments is the importance of knowing what kind of car your fund manager is driving.

A scientific research paper by academics Yan Lu, Sugata Ray, and Melvyn Teo showed that hedge fund managers who own powerful sports cars take on more investment risk while managers who own practical and unexciting cars take on less investment risk. The incremental risk taking doesn’t lead to higher investment returns and confirms my theory that low risk brings high returns and not the other way around. Additionally, performance car owners are more likely to terminate their funds, engage in fraudulent behavior, load up on non-index and lottery-like stocks, and succumb to overconfidence.

With that in mind, find out what kind of car your financial professional is driving. For full disclosure, yours truly drives a very practical family car. To be specific, a Hyundai as it gets the lowest loss on investment and gets me from point A to point B. In my mind, I expect to continue making more than 25% per year and therefore an expensive car purchase would add high opportunity costs to the fast depreciation cars already enjoy.

By Sven Carlin Ferrari Investiv Daily Luxury Share: