In his most recent memo, investor Howard Marks (Trades, Portfolio) touches on a number of reasons why the commonly heard refrain of "It’s really different this time" is likely to not hold. The whole piece is excellently written, and covers topics ranging from the inverting yield curve to modern monetary theory, and I would encourage you to read the whole thing. However, I would like to draw particular attention to two sections that are most directly-relevant to stock picking -- the (re)emergence of profitless glamour stocks and the relative underperformance of value to growth.
Profitless success
Ask any regular person what kind of business they would like to own and they are likely to say one with a steady flow of cash. However, when it comes to publicly-traded businesses, many seem to forget that the shares they own represent fractional ownership in real companies, rather than tradeable pieces of paper. Accordingly, the stop caring about profits and cash, and care more about what the next fellow will pay for their shares. Marks writes that we are now seeing the return of the kind of profitless companies that dominated the stock market in the late '90s:
“Tech and venture investors have made a lot of money over the last ten years. Thus, there’s great interest in tech companies (including ones like Uber and Lyft that are applying technology to enable new business models) and willingness to pay high prices today for the possibility of profits far down the road. There’s nothing wrong with this, as long as the possibility is real, not overrated and not overpriced. The issue for me is that in a period when profitless-ness isn’t an impediment to investor affection -- when projected tech company profitability commencing years from now is valued as highly as, or higher than, the profits of more mundane firms - investing in these companies can be a mistake.”
So paying now for future cash flows is not necessarily a bad idea, but doing so when there are comparable and tangible alternatives in the here and now is. Because the profits of these companies exist in the future (an imaginary place), we are wont to overestimate size of said profits. The grass always seems greener on the other side.
Growth investing preeminence forever?
A common argument in the growth vs value debate is that growth (read: "tech") companies are just better businesses than old-school value ones. Accordingly, it does not matter whether they are highly priced, because in the long-term they will win out. Marks demonstrates the problem with this line of thinking:
“Companies that do have better technology, better earnings prospects and the ability to be disruptors rather than the disrupted still aren’t worth infinity. Thus it’s possible for them to become overpriced and dangerous as investments, even as they succeed as businesses...And I continue to believe that eventually, after the modern winners have been lauded (and bid up) to excess, there will come a time when companies lacking the same advantages will be so relatively cheap that they can represent better investments (see value versus growth in 2000-02).”
In other words, shares can be risky, even if the underlying businesses do well. No one argues that Facebook (FB, Financial) and Amazon (AMZN, Financial) have been extremely successful, but that does not mean that rushing to buy these businesses now would be a prudent decision.
Disclosure: The author owns no stocks mentioned.
