The ‘Silly Stage’ of Day Trading

by | Apr 16, 2021 | Podcasts

In this week’s podcast, the guys discuss a few stories that confirm we have reached the ‘silly stage’ of day trading stocks. From a deli in New Jersey with a market cap of $100 million, to tax problems for Robinhood users, the day trading boom is reaching new heights.

The guys focus in on some lessons for people to pull away from the chaos.

Show Notes

‘There’s a Single NJ Deli Doing $35k in Sales Valued at $100 million’ – CNBC

‘New Investors Discover the Tax Pitfalls of Robinhood and Other Trading Apps’ – The Wall Street Journal

‘How Can You Owe $800k on $45k in Profits?’ – Mullooly Asset Show

The ‘Silly Stage’ of Day Trading – Transcript

DISCLAIMER: Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions in securities discussed in this podcast.

Tom Mullooly: Welcome back to the podcast. This is episode number 351, Brendan and Tim are joining me today on the podcast. Guys, how you doing?

Brendan: Very good. Happy Friday.

Tim: Yep. Doing well.

Tom Mullooly: Interesting story that actually surfaced with David Einhorn who was, years ago, interested in buying the New York Mets as a venture capital deal. In his quarterly letter to investors, he talked about a local business here in New Jersey, Hometown Deli, it’s located in Paulsboro, New Jersey. And if you don’t know where Paulsboro is, it’s in Gloucester County. And actually if you’re in Gloucester County or looking at the map, it’s directly across the Delaware River from PHL.

Brendan: So this isn’t the deli that Tony Soprano and his crew hung out at?

Tim: It’s not Satriale’s.

Tom Mullooly: No, it’s very far from there. I don’t know how close it is to the river, but on a map it’s directly across from the Philadelphia Airport, which is just south of the city.

Tim: But it has a market cap of $100 million.

Tom Mullooly: A deli.

Brendan: It’s got folding chairs inside.

Tom Mullooly: A deli. So this deli did $35,000 in sales over the last two years, not even one year. And it was closed from March 23rd until right after Labor Day last year for COVID, so they had six months where they weren’t even open.

Tim: During that time while they were closed, the price of the company, of the stock went from $3.25 a share to $9.25 a share, which on a percentage basis is insane.

Brendan: I’m not sure why this company even has a publicly traded stock, but you can make that happen if you want, regardless of the company or the sales that you do or whatever, and that’s obvious in this case.

Tim: That was one of my first questions. How was this deli even a traded company, or why?

Tom Mullooly: That is a good question. I don’t really know the answer to that. There were…

Brendan: People did this though, which maybe you could speak to, with shell companies in the dotcom bubble. So I want to just speculate that it’s something similar to that.

Tom Mullooly: Well, in Godfather Part III… I’m kind of going off on a tangent here, but they came up with this script. The Corleone family sold all their interests in the casinos and they were going to bail out the Vatican by buying their 25% ownership in some big corporation, Immobiliare, and it became a way for them to launder their money and make the business legit.

There were a lot of shell companies that came out 20 years ago in the dotcom era. Even before that in the mid 1980s, there were a lot of stocks listed on the pink sheets and we’ll get to that in a moment, but there were a lot of stocks that were listed on the pink sheets, and the only information you could find out was that they were a shell corporation. Today, they’re not called shell corporations, they’re called SPACs, which are, correct me if I’m wrong, Special…

Brendan: Purpose Acquisition.

Tom Mullooly: Special Purpose Acquisition. So it’s a shell corporation that they’re raising money for…

Brendan: It’s a black box with a public figure slapped on it to say, “Give me your money and I’ll buy something good with it.” Mystery box.

Tom Mullooly: The mystery box. As if the returns from the market weren’t satisfactory, now we have to come up with this, basically the third generation of venture capital. “Just give us your money. We’ll figure out a way to make this work.”

Brendan: You talk about this a lot with investments that are not just regular old publicly traded companies of reputable quality. Maybe you’ve heard of them, or market caps larger than this. But the idea that if something needs to go public via a SPAC or a shell corporation, why do they need your money? Obviously there are going to be examples to the contrary, but in most cases, if this thing were any good, they wouldn’t need to ask just randos to fund their company. They would have backing from somebody better.

Tom Mullooly: There’s absolutely no way that you can value Hometown Deli on a per-share basis. The reason why the company’s balance sheet has $2.2 million is because they sold shares last year. Wouldn’t you? This stock came out in 2019 at a dollar. It traded between a dollar, and a dollar and a quarter. It had no business as you guys just said going public, but as the stock went up last year, they sold more shares. I would do the same thing and put the money in my pocket. There’s only 60 shareholders in the whole company.

But again, why is a deli in Southern New Jersey going public? That’s really hard to explain, but in this world where we talk about GameStop at three and four hundred dollars a share, makes no sense of a stock trading at that kind of level for the business that they do, why would a deli be any different? It’s now got a $100 million market cap.

Brendan: I think people are just getting sucked into this whole narrative of it doesn’t… It’s obvious that nobody’s looking at the balance sheet or the earnings of this company or anything like that. They’re just watching the stock price go up and saying, “Why am I not in on this?” And then they get in, and a lot of these “meme stocks”, or whatever we’re calling this group of nonsense these days, is just fear of missing out. So people are piling in and I don’t think they’re going to have a good time.

Tom Mullooly: I think this is… Unfortunately I’ve used this phrase a couple of times now, especially in the first quarter of this year, these things are going to end in tears. It’s going to be bad. Unfortunately, I’ve seen this script a few times over my career, where this is going to end very badly for people. It’s almost… A lot of times they’ll refer to it as the Greater Fool Theory. Like, “I’m just going to buy this stock and hopefully sell it to somebody else at a higher price.”

It almost becomes a game of musical chairs. So sooner or later you’re going to be in a stock, one of these penny stocks or over-the -counter stocks, very thinly traded, and the music’s going to stop, and you’ve got no one to sell this to. And you bought Hometown Deli at $13, and now it’s back to a dollar, sorry.

Brendan: Not to come off as Galaxy Brain Brendan or anything, but I think there may be a fundamental misunderstanding of the idea of stocks like this, having a low dollar cost per share, and then being “cheap”, as in “cheap” as in air-quote, a good undervalued investment because the price of a stock has no bearing whatsoever, it’s what the business underlying it does that adds into that equation to make it undervalued, overvalued.

You can have a stock that’s trading at $2 a share that’s blatantly overvalued because they do nothing. They gross $35,000 a year in sales. So it’s not cheap.

The lottery ticket mentality kicks in there where it’s like, “Well, if I can just buy thousands of shares of this $2 stock, and if this happens to be the one that continues going up to a hundred, the needle in the haystack, let’s call it. If it’s one of those, then I could get rich based off of nothing.” And it’s just that whole idea that Buffett it speaks about, about how nobody wants to get rich slowly. We all want it now, we want it to be fast. Listen, I get it. It would be great to wake up with a hundred times profit in a week.

Tom Mullooly: You know, in a certain way, this is venture capital on steroids. I think you’ll hear a pitch from a venture capital fund where they’ll say, “Hey, over the span of a period of time, we’re going to invest in 100 companies, really a hundred projects. 96 of these 100 projects are going to wind up going bust. They’re not going to work. Two of them are going to be okay. The other one or two that’s left are going to skyrocket.

The returns might outweigh everything else that’s out there on the table.” But venture capital really was reserved for people who could afford to lose that kind of money, not be the primary part of your portfolio or your net worth. I just see a lot of gambling and a ton of speculation going on. It’s a little scary.

Tim: It’s also venture capital without the research.

Tom Mullooly: Well that’s what’s going on now.

Tim: I feel like venture capital firms don’t just pile into something that they don’t understand. They’re buying, they’re buying like a 10%, 20% stake in a company, not just a hundred shares of some $2 penny stock. The concept of, of like the success rate is the same. I feel like it’s just VC without any sort of research or understanding of what they’re buying.

Tom Mullooly: Unfortunately, the idea that you mentioned a moment ago, Brendan, about, “Why shouldn’t I buy this low price stock?”… I’ve been fighting that now for 35 years, just in calls with folks.

Brendan: It literally will not go away, and I understand it’s never going to. There is no connection whatsoever between a stock’s true value and, and its dollar per share, that is meaningless.

Tim: That’s why stock splits exist. Cause people are like, “Oh, this…”

Brendan: It’s marketing.

Tim: “It went from $1000, now it’s $500, I can buy more of it.”

Brendan: “It must be cheap.”

Tom Mullooly: After the podcast is over, I’m going to go back and look at what Citibank is trading at on the pre-reverse split that they did in 2009. I can’t remember if it was a five for one reverse split or a 10 for one reverse split, but that was Citibank. $3 stock.

If you go back to where it was, that stock hasn’t really done very well in the 10 years since, or 12 years now, since then. So you’re still down a lot. Look at AIG, same thing. They did a gigantic reverse split. These are two stocks that were in the Dow.

Brendan: Stocks, stocks splits and reverse split… None of that is bullish or a reflection of the underlying business or anything, it’s marketing. And they do it because it’s marketing and the people who decide to make the stock split know that it’s marketing and they do it anyway, even though it has no bearing whatsoever on the underlying business.

Tom Mullooly: Maybe I’ve missed a few, but it’s just been my experience that reverse splits are really bad, that they rarely work. They rarely work out for the existing shareholder, someone who’s being now reversed into a smaller position.

Let’s segue from talking about Hometown Deli, where you should definitely try the pastrami…

Brendan: I’m sure their food is great.

Tom Mullooly: Yeah… And now talk about the pitfalls of day trading. We did a video on this about two weeks ago. I guess someone at the Wall Street Journal subscribes to our YouTube channel because we did a video on this two weeks ago, today it’s on the front page of the Wall Street Journal, where people are getting their taxes completed and they’re discovering that they owe a lot of money in capital gains.

Tim: I mean, it goes hand in, in hand with what we were just talking about. It’s these people that are, I think Brendan said it before we turned the mics on, that if you play stupid games, you win stupid prizes. So if you day trade into oblivion last year in 2020, now you’re left with a mile-long tax form and potentially a lot of capital gains that you have to pay.

Brendan: Also, don’t forget to take the tax bill that you have and subtract that from whatever your returns were beforehand to get to your after tax return, which is what you actually eat…

Tim: The one that matters.

Brendan: A lot of mutual fund managers and professional money managers will tell you that the after tax, after fee returns are what kills them. On a gross basis, they might look a little better versus their benchmarks, but we know that after you account for all of that other stuff, the majority of them can’t beat their benchmark either, and I think that a lot of individual investors that believe they do outperform on a regular basis are mistaken because they just don’t know how to calculate the returns properly.

Tom Mullooly: So what Brendan is saying is if you’re investing in a fund, you also have to take into account what taxes you’re going to pay when that investment gets sold and any fees that have been assessed along the way.

Brendan: So you should do the when you’re day trading your Robinhood account or whatever it is in individual stocks. I think a lot of people read these stats about mutual fund managers and think they’re the problem, but I just think that actively trading your stocks is not a good strategy overall, whether you’re managing other people’s money or just doing it with your own account. You’re not, you’re not going to outperform.

Tom Mullooly: I think that’s actually a very important topic we could spend more time on. I think people just don’t really understand. The example that we used in the video was someone started with $30,000 and they made a profit of $45,000, good for them. So their account grew from $30,000 to $70,000 or $75,000. That’s great. But the guy also owed $800,000 in taxes because he didn’t understand how to match his cost basis when he goes to sell.

I know that when I was studying years and years ago for the Series 7 exam, we had to know what “versus purchase” means. It’s an old phrase, nobody uses it anymore, but basically what it means is you’re identifying which lots you’re selling. So if you bought 100 shares three different times at three different prices, you could go in and depending if you want the gain or loss or a bigger gain, you could say “I’m selling today the 100 shares that I bought first,” or “I’m selling the 100 shares that I bought, at its low rice or its high price.”

You can go in and identify those lots. They’ve tried to simplify things a lot in the last 10 years, by saying “You’re permitted to use the average cost basis.” Doesn’t really help you if you’re an active trader.

Tim: Yeah, and they said in the article, in the Wall Street Journal, how a lot of these apps like Robinhood, there were a couple other platforms, that they don’t allow you to identify which lot. Not that I think that there are… I think the majority of the users on the platform don’t even know what we’re talking about to begin with anyway.

Brendan: There’s no guarantees that would actually improve their results either.

Tom Mullooly: Also true.

Tim: Even if it was available.

Brendan: It may not. You could do all the specific lot trading you want, but it might not make your after tax returns any better. It might improve them a little bit if you heated wash sales and things like that. For the person who owed $800,000 in taxes, that’s a negative return, no matter what, even though they thought they more than doubled their money, from the start. So they didn’t do a very good job.

Tom Mullooly: Want to talk about someone who has recently passed away in prison?

Tim: This week, Bernie Madoff died in jail. I think he was serving a 150-year prison sentence. I think he had 130…

Tom Mullooly: Nine.

Tim: 139 years left. Obviously he had the Ponzi scheme over a decade ago. We did a video on this as well this week, but we just wanted to expand the conversation a little more. Looking back, how do you think Bernie Madoff actually ended up helping investors and advisors?

Tom Mullooly: I think the way that it helps investment advisors, like our firm, it made crystal clear that there is a distinction between brokers who have custody of the assets and advisors who do not. He had two firms running side by side, one was BLM Securities. And the other one was Madoff Investment Advisors. I may be messing up the names.

But he owned an investment advisory firm and a brokerage firm, and he never clearly disseminated, when a client’s money would come in, where the money was going. And so it became pretty easy for him to just start cooking the books in terms of making up these statements. And he went to great lengths to keep this a big secret until it finally unraveled.

What really ended the gig for him was 2008, when the market started falling apart, everyone started calling up saying, “I want my money back,” or “I want some money back.” And unfortunately the way a Ponzi scheme works is, I take in your money, and I return it to Brendan, who gave me money a couple of years ago, and then I find the next person and I bring their money in and Tim, I pay you back or give you money. And that’s kind of how the Ponzi scheme works.

The way the story unfolded, it appeared as if he… First, the story was that he hadn’t done trades in five or six years, and then it was well, maybe 10 or 12 years. I know that I’ve said on a couple of different podcasts that I don’t think he ever made a trade. I mean, going back 30 years or more. Impossible to prove now, especially that he’s now deceased. We’ll never get the full story. But one of the very positive points that came out of this, in addition to everybody learning about custody, is that most of the investors got a lot of money back.

So they were able to pinpoint… I think Irving Picard was the trustee who was basically given the task of going out and trying to claw back a lot of money. He was able to identify that there were $17 billion missing, and they’ve been able to claw back or recover almost $14 billion. I know that these people have not had use of the money and the market’s done fantastic since 2008, but on the other hand, these people are getting most of their original capital back at a time where they were told 10, 11 years ago, they were not going to see another dime.

None of that money was coming back. So I would expect that there’ll be a couple of people who don’t appreciate that comment, but it really is spectacular that they’ve been able to recover as much as they recovered because normally in these Ponzi schemes, when the whole scam gets uncovered, the money can’t be clawed back it and it is gone. So it really is pretty remarkable, what’s what’s happened here.

Brendan: I think overarching theme of… Easy to point out in hindsight, but a red flag for me is somebody promising market returns without market volatility: scam. I don’t know exactly how it will be a scam or how it will disappoint you in the future. It doesn’t have to necessarily be a Ponzi. It could just be somebody being dishonest.

I’m just using this as, as a reminder for folks that market returns, volatility is the cost of admission. If somebody is promising you to somehow miss those or not have them and still reap the upside you should be a very, very skeptical, at least.

Tim Mullooly: Well, that’s going to wrap up episode 351 of the Mullooly Asset Podcast. Thanks for listening, and we’ll see you on the next episode.

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