Who Wants to Own a Ferrari?

It’s impossible to describe what it’s like to drive a Ferrari.

The supermodel lines, the smell of fresh leather, the crisp wail of the V12 engine — words can’t do it justice.

Your heart beats faster the first time you sit behind the wheel. The style is as intoxicating as the performance.

That feeling goes far beyond the tech specs and the driving pleasure. People buy Ferraris to inspire envy in their peers.

If you could invest in that feeling — the power and glamour — would it make you richer and happier?

Soon, you’ll be able to make that investment — but it doesn’t mean you should…

Car nuts around the world are agog at the prospect of buying shares in Ferrari.

The sports-car maker’s parent, Fiat Chrysler Automobiles NV [BIT:F], has mooted plans to spin off the Ferrari brand as a separate, independent company.

Fiat Chrysler may offer Ferrari stock through an initial public offering (IPO). Although Ferrari shares would likely trade in the US or Europe, very little would stop Aussie investors from buying the stock.

For generations of devout fans — from young boys who’ve plaster their bedrooms with red posters, to ultra-wealthy serial buyers — this could be a dream come true.

Who wouldn’t like to brag at a dinner party about their Ferrari (stock) ownership?

But if you’re thinking about buying any ‘luxury’ stock — whether it’s Ferrari, Hermes International [EPA:RMS], Burberry Group plc [LON:BRBY] or LVMH Moet Hennessy Louis Vuitton SA [EPA:MC] — clear your head of those ‘warm and fuzzy’ feelings.

When it comes to luxury shares, don’t let that swelling pride of prestige ownership coax you into paying more than you should.

Don’t fall for this lark

It’s too early to tell how expensive a Ferrari IPO might be. But we think it’s safe to assume its vendors will pitch the stock at a high valuation.

They’ll point to the company’s industry-high profit margins of more than 13%. They may quote plaudits from cheerleaders like Brand Finance, a consulting firm that values the Ferrari marque at $4.5 billion. And they’ll definitely offer gallant projections for revenue and profit growth.

But think about who benefits from an IPO. Either the vendor or the new investors win — and the other loses. And judging by the fact that Fiat Chrysler shares rose by more than 12% after the announcement, the market seems to be tipping that the vendor will win this one.

Fiat Chrysler knows they can charm a high IPO price out of emotionally driven investors. If you fall for that lark, here or in any other ‘glamour’ stock, you’ll only limit your potential gains.

Value outperforms glamour

This simple chart shows how investing in glamour stocks can cost you money in the long run.

Renowned economists Eugene Fama and Ken French studied this phenomenon recently and came to a simple conclusion.

Using data from 1951 to 2013, Fama and French tested the annual and compound returns for more than 2,000 US stocks. They were interested in the performance of the cheapest 10% (in terms of price-earnings ratio) and the most expensive 10%.

As you can see, ‘value’ (the green line) clearly outperforms ‘glamour’ (the red line) over 60 years.

Source: Greenbackd

This is not to say stocks with high price-earnings ratios can’t go up in good times. But if emotion drives a big chunk of that P/E, you’re setting yourself up for a fall.

Dirty performance

Would you rather tell people you’ve invested in a Ferrari or a Rent-A-Bomb?

Nobody wants to be the person at the dinner party with a jalopy. But guess what? The Rent-A-Bomb could be a far superior investment.

Dirty, low-status businesses are often the best performers, because they don’t attract capital. There’s no glamour. In our work, we find lots of shockingly high-quality junk yards, pawn shops, storage units, waste managers and funeral homes. They’re recession-proof cash cows.

In short, if you’d be embarrassed to tell people you own it, it’s probably a great business.

Keep that in mind the next time you consider buying stock in a trendy company.

Tim Dohrmann
For The Markets and Money Australia

This article originally appeared in Money Morning.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, Markets and Money is published in 7 countries with a worldwide readership of almost 1 million people.

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