This week, two things caught my eye:
The site “LessWrong" and the author’s post titled “Markets are Anti-Inductive.”
JPM’s 2014 report “The Risks and Rewards of a Concentrated Stock Position”
Over the past year, I’ve noticed more and more people (mostly on Twitter) embrace and downright promote the ideas that:
The price you pay for a stock doesn’t matter, as you will get the return over the business over the long-term
Business quality > valuation
Like value investing before it, we now have an entire subsegment of the investing community that thinks this idea of growth investing is the inexorable “truth.” They are making the same mistake as value investors did before, which is taking something that has worked in the recent past and extrapolating those results to the future. The only truth in markets is a hat tip to Robert Bacon’s Principle of Ever-Changing Cycles: “The principle of ever-changing trends works to force quick and drastic changes of results sequences when the public happens to get wise to a winning idea.”
Many “compounders” will be de-compounders in the next decade. Some of them will be the next AMZN. Most of them won’t. Identifying high-quality companies isn’t hard. Yea, I said it. There is no one on Earth that thinks Apple and Microsoft are not good businesses. Not a single one. Identifying mispricings is hard. So how of these compounders will be winners over the long-term?
The JPM report is insightful in that regard. Using a universe of Russell 3000 companies since 1980, ~40% of all stocks suffered a permanent 70%+ decline from their peak value. For Tech (Info Technology), it was 57%. Telecom 51%. Energy (no surprise there) 47%. The extreme winners were ~7% of the universe and include those companies that generated lifetime excess returns > 2 SD over the mean. For tech, it was ~6%, with 70% of them underperforming the Russell 3000. As they note, “The story of the tech sector is a long narrative about disruptive technologies which are themselves disrupted by changes that follow.” Nothing is new under the sun and that will continue to be the story.
I don’t believe in the value and growth distinction the industry uses. It’s simplistic nonsense. That said, I wouldn’t want to be overweight tech for the next decade. I own a software stock trading at a ~2% FCF yield (at least it has an FCF yield?). I also own asset-heavy REITs, cyclical materials, CPG, and healthcare GARP. I think I still make money on the software stock over a very long time period. But I won’t kid myself into thinking that being overweight software is going to make money over the next decade. If you are buying a basket of stuff selling at 30x sales right now, you’re not making a bet on the businesses. You’re making a one-way duration bet. Know which bet you are making.
As Seth Klarman said, “To achieve long-term success over many financial market and economic cycles, observing a few rules is not enough. Too many things change too quickly in the investment world for that approach to succeed. It is necessary instead to understand the rationale behind the rules in order to appreciate why they work when they do and don't when they don't.”
This is a complicated subject. It’s not black and white. Will AMZN, MSFT, V, MA, TDG ,etc. have the same run? Maybe. Will TSLA grow into its valuation? I don’t know and wouldn’t make a bet either way. The one thing I’m sure of is that the next decade will not look like the last. Make your bets accordingly.