It is fair to ask of your portfolio manager: if growth has resoundingly beaten value over so many years, why persist against the grain? Why the insistence on a strategy that appears handicapped? Why not adapt to a new normal?
Fact is, it’s not that simple. Publicly traded growth stocks attract primarily speculators. And if there’s one thing I will never endeavor to be, it is that of a speculator. A speculator cares not about the underlying fundamentals of a company, only how/when its stock price will rise. These “investors” are behind every bubble’s dramatic formation and destruction, and over the long run, their odds are no better than a run-of-the-mill casino game.
And yet, there have been spectacular growth stocks that deserved every penny of their erstwhile inflated valuation and more. I am referring to, of course, Google (Alphabet), Apple, Facebook1, Amazon, and Microsoft, et. al. They are truly wealth creators of epic proportions. Over the past 12 months alone, they accounted for over $250 billion in bottom-line profits. They actually earned it and their share prices reflect their profitability, fair and square2.
Their success has caused a ripple effect of investors looking for the next companies that can generate seemingly endless growth. This guessing game of who will be the next trillion dollar market cap behemoth is a rising tide that has buoyed the entire technology sector, which in turn, as it inflates, come to constitute and contribute to an ever bigger portion of the S&P 500.
It is a difficult game to play because it’s not at all obvious. Assuredly, there will be, in the long run, a whole chunk of losers that get outcompeted, just as assuredly there will be a smattering of ridiculous winners, all of whom trade at nosebleed valuations. I have nothing inherently against investing in growth, but right now, there is no margin of safety and I have no edge. Case in point is our saga with BlackBerry. My thesis, pinned on their turnaround growth, has thus far failed to pan out, but we still enjoyed outsized profits thanks to internet message board speculators driving up their stock. We got lucky. But any investment program dependent on luck is by definition irregular and unsustainable.
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1 To be clear, however, I am not a fan of Facebook’s destabilizing societal impact. It’s improbable I will ever invest in them (in their current form), as it would feel icky to root for such a company and share in their profits.
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On the flip side, the more that non-tech names continue to contract, the more their opportunity grows. As capital chases the ephemeral, it ignores the businesses that build and make “real” things. Without affordable capital to build and make, they won’t. Which leads to shortages, which leads to higher prices, which leads to bigger margins and profits… which should eventually lead to, once again, more capital.
The canary in this coal mine are semiconductors. Once a boom-or-bust cyclical, the redheaded stepchild of sexy tech that could never attract consistently affordable capital, persistent shortages are now endemic. Building new semiconductor plants are expensive and years-long, and supply fell far behind the demand curve. As capital gushes back towards the industry, semiconductors and companies that comprise its value chain have been some of the best performing stocks in recent years.
To wit, the Philadelphia Semiconductor Index (SOX) went pretty much nowhere from 2002 to 2016, dramatically underperforming the broader Nasdaq 100 for 14 years:
But from then on, it has more than held its own, especially over the past year and a half:
Until humans can simply upload our consciousness and live solely in The Matrix metaverse, we will need mundane, earthly things. We’ll need to get around in cars and trucks. We’ll need electricity and the power plants that generate them. We’ll need buildings to live and work in, and we’ll need banks to finance them all. These necessities ensure the long-term durability of our portfolio companies, while capital’s cold-shoulder has made their equities cheap. If the story of semiconductors is instructive, this won’t last forever.
