Darktrace (LON: DARK) has long had a rather fragile share price. In part this is simply because it’s something of a hot, go-go, stock and therefore any contrary news hits the price hard. When prices are based on dreams and assumptions about the future then anything that deflates the balloon hits hard. As we’ve noted about Darktrace it’s also true that there are certain beliefs out there. There’s the Quintessential short selling report, alleging that some of the – highly disputed – accounting practices at Autonomy moved over to the new company. After all, Mike Lynch was a founder of both, Mike Lynch is now extradited to the US to face charges etc.
Do the Darktrace stories actually matter?
In one sense it matters greatly as to whether these stories are true or not. If they are then a short seems sensible. But more importantly the fact that those beliefs are out there makes it an easy thing to short. If someone rocked up and insisted IBM was doing the same things, then the shares wouldn’t move an inch. No one even dreams that IBM might be doing such things. That some suspect Darktrace might be is what allows a short report to be profitable – it’s pushing on an open door, not a piece of string. That either explanation can be used to explain the existence of a short sellers report does mean we have to think, hard, about whether to be short or not.
However, as we’ve also noted about DARK, we should also consider the prospects for the business itself. Assume away all talk of accounting and think about the sector. The base idea seems entirely sound. Cybersecurity is an ever-growing problem. No one ever has really bothered to make routers, printers and so on really secure yet they’re there, connected to all the networks and offer great backdoors. If someone enters a network, then we’d expect to see changes in data movements across the network. Artificial Intelligence is really very good indeed at pattern recognition. Set the AI to watch network traffic and you’ve a warning system. Stripped of complexity that’s what Darktrace does – it’s a great idea. Implementation matters of course but the base observation works.
Perhaps there’s a sectoral problem for DARK to deal with?
But what if all that’s true and yet others in the same sector just can’t get the cash out of people. Management say it’s a great thing but won’t, when it comes down to it, actually sign off on the purchase order? This did happen to both NCC and Shearwater, their share prices dropped 40% in a day as a result. We speculated that might be true of Darktrace too. Even could be true – if the sector is facing a problem, then that’s a problem that’s likely to hit all those in the sector. That’s what a sectoral influence means, that it hits all in the sector.
Near two months after we pointed this out BofA’s analyst, Victor Cheng, started coverage of Darktrace with this: “In a weak macro environment, customers are often likely to buy additional solutions from existing providers than from new ones “ Add this to competition in the sector and it’s going to be harder to get management to commit to the purchase order – it’s the same analysis. Darktrace shares promptly dropped 11%.
The difference in the share price reaction being that of course NCC and Shearwater both admitted it, with Darktrace it’s still someone saying it might happen.
Perhaps we told you so about Darktrace?
One possible conclusion here is that we’re just terribly perceptive and you should start applauding right now. This is true, of course. But that’s also the wrong takeaway lesson even if it’s a right answer. The correct takeaway is that anyone can do this. It is possible to grasp the market better than many of the people in it – to gain an edge.
That information from Shearwater and NCC was free and published on the stock exchange site. It’s not that difficult to sort through the number of listed companies and work out which of them are in the same line of business. It would have been very difficult to spot the NCC and Shearwater problems before they announced – that would have been inside information, in fat illegal to try to trade on it. But the inference that if the sector’s in trouble then the sector’s in trouble is a conclusion we can all come to for free. And would have made money trading upon too.
As we like to say, details matter in investing
This might sound a little trite but we’ve all seen that bookcase made by the guy who didn’t really bother to find out how to make bookcases first. So, it is with investing. A certain amount of thought and effort and it is possible to work out what’s likely to happen next. Foreknowledge is the precondition of getting the trading position correct. The thing to really grasp here is that in the very short-term markets are entirely random – but in the medium term and longer they are rational. Things happen for a reason – crack the reason and happy trading.
Will Darktrace have problems with accounting? Who knows? Is cybersecurity having problems getting customers to open their wallets? Seems so – that’s enough to work on.
