Beyond The Headlines
Where did my trillion dollars go?!!
In the last couple of months, the unstoppable, must-own FAANG stocks are down 30% from their highs, and a total of over $1 trillion in market value vanished. What happened? Not long ago, Amazon, Apple and Alphabet (formerly known as Google) each flirted with or surpassed historic trillion-dollar market value thresholds. Where did all that money go?
A trillion made, a trillion lost
“Who here has lost money in a stock or an investment?” — That was my query this summer when I was invited to speak to group of curious minds at a major tech company in Silicon Valley. I often use that question to break the ice because I think it sets the stage for an honest conversation. I usually start by naming the first stock I bought, explaining why I liked it, how I lost money on it, and, most important, what I learned from it!
In the case of the FAANG stocks at all-time highs, we at Sicart saw a brewing storm and potential big losses for gullible buyers. They had heard about sky-high expectations, but didn’t realize they were already late for the party.
The first will be last
In many fields outside of finance, you can often rely on last year’s performance to predict next year’s winner. The best students in a class, for instance, often stay on top predictably. Investing flips that logic on its head, though, because investment success includes not just the grades (profits and growth), but also the other dimension — the price! Sometimes you can pay so much for the results that you won’t make money on your investment and you may actually lose. That’s why it’s crucial to know how much you are paying for profits, and how much extra you are paying for growth.
At times that the equation makes sense and you get an A student for the price of a C or D student. But sometimes A students are priced as if they were ALL bound to be Nobel Prize winners scoring in all categories all at once. That’s when the expectations priced into the stock are so outrageous that it’s only a matter of time until the market wises up, and corrects its mistake.
That’s exactly what started to happen in October among the market’s FAANG darlings.
The history rhymes
Sometimes the stock market resembles a TV channel with never-ending re-runs. The characters change, the setting varies, but if you look a little closer, the story is the same. Until October 2018, many experts tried to convince us all that the FAANG stocks had become one-decision stocks – you buy them and never sell. We were told that their growth would never slow down and their prices would only rise. Of course, there are many parallels to this situation in stock market history: The Internet Bubble of the 1990s, the Nifty Fifty stocks of the late 1960s and early 1970s, or the radio stocks of the late 1920s.
Is the continuity of thought toward higher prices broken?
In his memoir, famed stock investor Bernard Baruch (who not only escaped the 1929 market crash but even profited from it), reminisced about crowd madness at the start of the Depression. He noticed that something trivial or important can break what he referred to as the continuity of thought.
This last October something changed. With FAANG stocks down almost 30% from their highs, skepticism and caution reawakened. Growth is still there, but it’s slower and not as certain.
If you have followed our writings for the last few years, you might have noticed how we took an increasingly cautious stand as the market was hitting new highs. We continued to trim our holdings in stocks that we believed were highly overvalued. Until only recently, it’s been challenging to find good replacements.
How do you make money in stocks?
In investing, you make money not by chasing growth, but by buying businesses for much less than they are worth. They could be fast-growing ventures or more mature, dividend-paying companies. They could be small or large, US or foreign — as long as you are paying less than the business is worth, you are bound to make money in the long run.
To us, the notion of buying anything just because the price has been going up for a while doesn’t qualify as investing. The higher the price goes and the more it disconnects with the fundamentals, the greater the risk of losing money. Buying that stock looks more like a gamble. That’s the ultimate recipe for every bubble we have seen in human history, from tulip mania in the Dutch Republic in the 17th century to the Bitcoin frenzy of late 2017.
If anyone thinks they are smart enough to time their ventures in such a market, we applaud you. But we know we can’t. Even a man as brilliant as Sir Isaac Newton couldn’t. He found himself in the midst of a very alluring market bubble of his time (the South Sea Company). It ruined him financially, and he wrote later, “I can calculate the motion of heavenly bodies, but not the madness of people.”
FAANGs before they had “fangs”
A dear client once mentioned to us that he noticed how often we held similar stocks to his other portfolio held with a different manager. But he pointed out that we tended to buy them when they were cheap, while the other manager liked to pick them when they were expensive. The results of the two approaches couldn’t be more different, as you can imagine.
FAANGs offered some great opportunities long before they were FAANGs. There was a time when these stocks were treated with great caution and skepticism. For example, Amazon lost 30% of its value from late 2013 to mid-2014, and for the next 12 months not only had no “fangs” but was actually considered “dead money.” Its price didn’t move at all until 2015. Apple fell from $100 to $55 between 2012 and 2013, and similarly showed no “fangs” for a while. Finally, Google lost 30% in 2010, and traded sideways for almost 3 long years until early 2013. Every investor knows that 3 years is a long time for any idea to turn around and show signs of life.
Yet these were the times when one could argue that those businesses were worth much more than the market was offering for them, and that may be the case again at some point in the future. As investors we’ve been tracking them for years, in growth and in growing pains. We watched them recover and become fairly valued, and then continue to their “rock star” status. As investors, we enjoyed a large part of that ride up, but we have been cautiously moving to the sidelines for a while now.
In the case of today’s FAANGs (the same as all other investments) given our contrarian approach, we tend to be early to join the party (before others get over their skepticism in times of distress), but we also leave the party earlier than many (before the blind optimism, and euphoria start to dissipate).
Buy the dip?
Today’s 30% drops among FAANGs are different from those of the past. These companies are many times bigger and growth is bound to slow down. In many cases their valuations have gotten so unrealistic that a 30% drop merely leads to a correction from insanely to wildly overvalued. This is a far cry from being actually undervalued and attractive.
To use a sports metaphor, investing is not about discerning where the ball has been, but knowing where it’s headed. We have no doubt that most FAANGs are bound to grow and likely to dominate their respective industries for a while. However, we also believe that their growth rates will moderate, and their valuations (multiple of earnings) will increasingly reflect that.
The question we should be asking today is how much FAANGs should be worth if they were growing at 1-3x the rates of their older mega-cap peers, instead of 10x-20x? It was none other than Bill Gates who suggested that tech companies should be trade at lower multiples than companies in slow-changing industries, given the fast-paced innovation and uncertainty they face.
FAANGs might have been the most exciting stocks to read about in the last few years, but given that they disrupted many industries in what seemed like no time at all, they may be subject to equally dramatic disruptions sooner than one would hope.
Where to next?
We are long-term, patient, contrarian investors. We don’t mind whether we find promising opportunities among growth stocks or slow-growth dividend stocks at any given time. As long as we get a bargain, we are interested!
There was a time when the market had little appreciation for FAANGs while they still had a very long runway ahead. There could be a time when we revisit them again, but today, we lean towards stable, durable businesses that the recent spell of volatility punished harder than they deserve. We see many of them trading at 5-year lows, and cheaper than they’ve been in a decade. We notice that not only do they seem to fare better in the stormy markets, but they may have some underappreciated growth in them, too. They may not be glamorous, but for now they’re more appealing to us than those former market darlings.
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.