Do you want to be a billionaire? If George Soros can do it, maybe you can too.
George Soros's theory of reflexivity points us towards interesting investment ideas. Maybe it could help you become a billionaire, just like Soros!
At the heart of Soros's investment theory is the notion that share prices can affect the underlying business. So the higher the share price, the more profitable a business can be.
He calls this the "theory of reflexivity". It is explained in his book The Alchemy of Finance.
Reflexivity causes booms and busts because trends become self-reinforcing. As a result, businesses and entire industries can spin out of control.
Here are three areas that may benefit from reflexivity:
1) Property
Reflexivity occurs in its most simple form when banks extend credit secured on some kind of asset. As more money is available to buy the asset, the price of the asset class rises. This means there is more collateral than the banks are willing to lend against. So, they lend more.
A bubble caused by reflexivity explains the current state of residential property in the UK and much of the world.
Unsurprisingly, many investors believe there will be a property crash. As a result shares in house builders have been priced down, so today Persimmon
(LSE: PSN)
is on a prospective price-earnings ratio of 9.5, Ben Bailey
(LSE: BBC)
is on one of 7.
But maybe these shares have been mis-priced, because the market hasn't calculated in another player: the government.
2) REITs
The government has enacted new legislation in the UK which allows for REITs or real estate investment trusts to be set up as of January next year. REITs' sole purpose is to invest in property. They are attractive to investors because they pay no corporation tax on their profits as long as they pay out 90% of those profits to their shareholders.
REITs may change the investment landscape and cause the kind of bubble that Soros first spotted in 1970 when REITs were becoming popular in the US.
It works something like this. As interest rates rise, as they are now, REITs become an attractive means of raising money for construction and property. Being new on the market, the number of REITs will expand rapidly, so there will be more and more money available for property. Property prices, therefore, rise. This will, in turn, make REITs very profitable. Therefore, they become even more attractive to investors who will pour even more money into them. A property bubble follows.
Eventually, the bubble becomes unsustainable. Yields fall and nervous banks start to call in their loans. Real estate prices crash and so do the prices of shares in REITs.
Companies that may convert to REIT status and that could benefit from any positive feedback loop include: Workspace Group
(LSE: WKP)
, Liberty International
(LSE: LII)
and BritishLand
(LSE: BLND)
.
3) Technology
Another area which is subject to boom and bust, according to Soros, is technology. A reason for this is that technology companies need to buy a lot of equipment from other technology companies. The more successful a company is, the more equipment it needs. This means that if one technology company does well other technology companies also tend to do well.
As profits rise, so do share prices. This makes it easier to raise money for new ventures. These new companies also need to buy expensive technology kit. And so it goes on, until the bubble becomes unsustainable.
Technology companies that may benefit from this positive feedback loop include telent
(LSE: TLNT)
,Invensys
(LSE: ISYS)
, and Intelek
(LSE: ITK)
.
Of course, making big money the Soros way is not easy, but if you can do it, it should be a nice little earner.
More: The Lowdown On REITS | Behaving Like A Fool
