In all biological systems, organisms compete for resources. Whether that’s food, sunlight, space, reproduction, or even social position, organisms compete in some form or another.
Humans are no different. We compete for food, jobs, beer, living space, tacos, energy, and even our investments… just like any biological system in nature. Where things get a little different is how humans compete for these resources — we use money. The price of scarce resources can be bid up so high, that only the most successful humans can afford it.
While there’s plenty of criticism of “money” in this world, it’s a far better system than beating each other with sticks and rocks to see who’s the baddest mofo around.
This competition for resources generally works wonders for doling out the world’s goods and services — except when it comes to investing.
Competing for Growth
As investors, we compete with one another to buy the “best” investments. What metric is used to define best? Investors favor “growth rates” above all others. Higher growth rates mean higher share prices as a result.
Index investors aren’t immune from engaging in this behavior either — typically fast growth companies command premium spots in indexes. For example, the top 5 holdings of every S&P 500 index fund are high-tech growth companies that command premium prices — Apple, Microsoft, Alphabet (Google), Amazon, and Facebook.
There’s more to investing than just growth of course — investors must remember that investing works a lot like a parimutuel system. The higher the price you pay, the lower your return. As the share price continues to climb, you’ll pay a higher price for future earnings and realize lower dividend yields. This hurts investors by making them rely on future growth to justify extremely high share prices. What if those growth expectations never materialize?
Take for example — Netflix. It’s growing fast, and is part of the S&P 500 . The company currently trades at a PE of 222 and has a market cap of 120.8 Billion dollars. (Yes, really!) That’s a tiny earnings yield of 0.45%. Currently Netflix has 57 million subscribers.
How many times would the number of subscribers have to double for a current investor to realize a 7% earnings yield?
It would need to double 4 times . This would mean 912 million (nearly 1 billion!) subscribers at current levels of profitability.
Is this realistic? 912 million subscribers is A LOT. Netflix is currently the biggest online video streaming company, but the Amazon’s and Disney’s of the world aren’t just going to just roll over and die. There’s plenty of competition on the way.
Netflix is a perfect example of an investment being bid-up well BEYOND what seems rational.
Who’s The Greatest Fool?
Wait a minute — What if an investor doesn’t plan to hold Netflix shares “long term”? What if you don’t care about things like profitability and earnings yield? You simply want to sell at a higher price than you purchased.
In essence, this is The Greater Fool Theory. Investors that follow this strategy are share-flippers, not shareholders. This kind of investor only looks to capture growth momentum and then sell to the next “Greater Fool”. In theory at least.
The problem is — What happens if you’re the greatest fool?
Eventually the law of large numbers kicks in, and growth slows. Will you get caught holding the bag when everyone runs for the exit?
Everyone tells themselves “I know when to sell”, but in reality humans are notoriously bad at predicting the future.
Ask yourself — are you a shareholder or really just a share flipper?
The Best Investments Aren’t Always Growth Companies
What the investing press doesn’t tell you, is that you don’t have too chase growth to be a successful investor. Grow is only one part of shareholder return.
If you read my last post on February’s investing ideas, you probably noticed that NONE of my investing ideas were growth investments. A few of them might end-up seeing considerable growth over the long term, but none of my picks were the fast growers that attract the attention.
Why? I’m not willing to overpay for growth prospects. Growth is a guess.
Let’s also not forget how the world’s greatest investor earned his fortune — Warren Buffett, (easily one of the richest men in the world) got his start by buying garbage companies at very cheap prices. Now days, he’s well passed those days of cigar-butt companies, but he still buys companies where growth is slow.
Need more examples?
How about one of the most successful stock investments in the world? It’s Altria (aka Phillip Morris). Yes, the cigarette company! Despite being in a declining industry, Altria has managed to produce returns averaging 20.6% for the last 50 years!
Declining industries, slow growers, and unloved companies can make some of the best investments because they attract so little attention. In my opinion slow growth with a very long runway can be a truly a wonderful thing. These investments (mostly) get ignored by the investing public and will earn a much bigger “bang” for your investing dollar.
Culturally, humans get excited about shiny new things and big changes. Fast growing investments gets so much more attention because they’re exiting — “Netflix grew subscribers by 20% last year!!” is a far more exciting headline than “Large bank earns slightly more than last year!!”
This “excitement sells” attitude is a cultural bias. We want to read interesting content, and good headlines sell newspapers (or get pageviews). The most exciting growth companies are always going to be on the front page (or whatever top spot on your favorite website).
This bias blinds us to the fact that popularity (at least in investing) is our enemy.
There’s been dozens of studies that prove this point over the years, but one of my favorites can be found in “The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New “ by Professor Jeremy Siegel. It’s a great book, and on my list of recommended books for a reason. Check it out!
Rather than fighting over growth, I posit there is a better way to invest. Instead of fighting over growth, investors should focus on what’s timeless about our lives and cultures.
No matter how much new technology can change life, some things are never going to change:
- We’ll always have a need to borrow money, invest it, and store it in a safe place.
- Safe and affordable shelter will be required to protect us from the harsh environment.
- Energy (in some form or another) will always be needed to power society.
- People will always have an need for quick and efficient transportation both in the air (long distances) and on the ground (short distances).
- Humans will need to eat food produced at scale, due to large productivity advantages over individualized farming.
- And so on…
This idea is exactly why I own investments like banks, energy companies, apartment REITs, and airlines. Simply put, investor are better served by trying to capture the timeless qualities of human life rather than trying to capture what’s changing fastest about it.
The world is always changing, but change is often the enemy of investors. Few companies are able to successfully adapt to change over long periods of time. (“The Innovator’s Dilemma” covers this concept idea in incredible detail.)
Find and invest in what’s timeless instead!
All this isn’t to say that growth is a bad thing. I love growth! Growth can be a very good thing when it comes at a reasonable price. It’s just that reasonable prices are exceedingly rare unicorns in this lovely little world.
It’s better to not compete for scarce resources. Find overlooked investment areas, ignored by popular media. That’s where great long term investments are going to be found. If these are slow growth industries, that’s completely OK.
Sometimes it’s better to be more like the tortoise than the hare.