Winner take all. Growth at any price. In this kind of environment, there are at least three temptations for value-minded investors. One is to give in and buy those high-priced, go-go momentum stocks that have frustrated you for so long. Another is the opposite -- to fall into value traps. That is, in a high-priced market, you search harder for super-cheap stocks but end up compromising on quality. And then a third is to batten down the hatches and hold too much cash for too long. All these paths are fraught with risk.
I doubt many value investors wake up one day and suddenly decide to switch horses and go all-FAANG. It’s more that there can be a slow creep toward things you don’t normally do. You start justifying higher prices. You decide your valuation of the tech mega-platforms has been too low (which may actually be true). Or on the other side, you find yourself tolerating higher debt and lower returns on capital than you normally would for cheap stocks, and you convince yourself it probably will be okay (and sometimes it is).
But we should remain wary of creep in this strange world we find ourselves in. Wages and transport costs are way up, the consumer is confident, and the Fed is expected to raise interest rates two more times. Yet the yield curve is flattening, which can portend ill for the economy. And while the threat of a trade war is real – just listen to Whirlpool’s latest earnings call -- the U.S. market doesn’t find it too hard to shrug that off.
Meanwhile FAANG powers on. While Facebook is way down this morning after a bad release, it’s still (as of this writing) 13% higher than its March low after the Cambridge Analytica scandal broke. And last Friday, John Authers reported in the Financial Times that FAANMG -- Facebook, Amazon, Apple, Netflix, Microsoft, and Google – make up 17% of the S&P 500 on their own. That’s more than any industry sector in the S&P 500, except Info Tech.
So what are the options here? None seem easy. But one good one might be to raise quality in portfolios. Remember how Warren Buffett said that it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price? Perhaps now is the time to moderate the “cigar butt” investments in favor of high quality companies trading at least at fair prices – ones that will compound in value over time even if they were not bought at a large discount.
Another is being vigilant against “creep” of all kinds – that is, constantly questioning whether you’re settling, or tolerating worse quality for price than you normally would.
And finally, it is well worth recalling some of the big errors of value investing from the past half decade. These might include being too slow to grasp how dominating macro conditions would be, accepting too much leverage, buying companies driven by commodity prices that were beyond their control, and not seeing that GAAP accounting may not do the best job of capturing the value of tech mega-platforms.
But perhaps the biggest error of recent times may have been not being patient enough. After all, in a go-go growth era, it’s very hard to stay patient. I actually think we’re quite patient as investors -- probably far too patient for many. But I can think of a half dozen cases from the last five years where waiting just a little bit longer would have made a huge positive difference in results.
Please Note: The 2-Minute Thought will be on break next week and return August 9th.