Thoughts on Growth Investing
On Tuesday, my earnings review on Visa will be sent to paid subscribers. On Saturday, Mercado Libre’s. Lastly, my research on the salmon farming industry will be published on the first week of January, and perhaps my dive into Winmark a week after that. Discount will expire soon.
The Sunday deadline is, I think, dramatically limiting the value I can add in these write-ups. Lately, I find myself in a position where I feel some topics deserve 5-10-15 pages of writing. Seeking length for its own sake is ultimately undesired. However, I suspect the value per word will remain as high as in these pieces. At the same time, I think further depth should incrementally improve output at faster paces than input.
I understand the convenience of the current newsletter’s structure, being 700-1000 words per Sunday, but this length and deadline are not allowing me to dive into some topics:
I’m at 5 pages on an article about how part of the livestock segment from Zoetis might be getting disrupted. Estimated length will be 10-15 pages.
I read The Outsiders this past week and Mark Leonard’s letters prior to that. Curiously, I haven’t found actual dives into his philosophy. Therefore, my intention is to write a 15-20 pages on Mark’s management, in a similar line as those featured in The Outsiders.
I started writing today about Richard Zeckhauser, but I also estimate 5-10 pages of output. The reason for the latter is the intellectual depth of his work.
And many more. It’s rather interesting to see how many ideas I had to let go due to this. Ideally, I would anyway write these articles and post them every Sunday. Nonetheless, I’m already running at the bare edge of my time management skills, not to mention my mental incapacity to produce that amount of work without compromising quality. I do not know what I will do. For now, I’ll keep the usual modality, with some occasional long write-ups. Anyhow, some short thoughts I wanted to share with you today on growth investing.
This is perhaps the strategy that attracts the largest number of investors, or at least initially. There is something in growing at a rapid pace that we find intrinsically intriguing and appealing. Nonetheless, ever since I read The Intelligent Investor, my skepticism towards such a practice has increased. Graham first lays down how sensible of an analysis is required to pursue this endeavor. Among the issues:
Companies’ growth is not hidden from our peers. Hence, these businesses are generally priced according to high expectations. Statistically, maintaining high growth for a long time is unusual. Therefore, it becomes very easy to overpay for a growth that never materializes.
On a similar line, we are paying for a certain stream of future cash flows that the financial community expects from this business. And alpha arises if the company exceeds expectations. Being the latter already high makes this, again, statistically unusual.
When we buy authentic growth companies, we are placing a big emphasis on, most likely, cash flows the business will produce on a 10-15yr+ horizon. However, time magnifies mistakes. Essentially, our bets would be on unlikely events that will occur far in time, but our analysis includes inputs all throughout. That makes the likelihood of a misanalysis extremely high.
Our estimates of the understanding of ourselves is highly subject to the overconfidence bias. Not only do we barely know how our mind operates, but even if we somewhat thought we did because of long reflection and thinking, our estimate would very likely be above the actual number.
Investing in growth stocks is psychologically difficult due to volatility, which can destroy one’s temperament and lead to irrational action. Further, fluctuations test all hypotheses and, the weaker they are, the easier they will get overridden.
Investors are prone to thinking the likelihood of misanalysis can be patched by diversifying one’s portfolio. The thesis for these portfolios is something like “I will allocate 1% to 100 companies. Only one has to be a 100 bagger for the strategy to pay off. The rest will only increase overall performance”. I don’t know the numbers, but I would suspect the statistical chances of hitting a 100 bagger are around 0.001%. By only investing in 100 companies, it is unlikely that a person hits a 100x.
Note: Skill can for sure increase chances, but I’m not sure how to estimate the impact of increasing skill. In any case, high levels of skill are only attainable after truly unusual dedication. The latter, by definition, is unusual.
Regarding the diversification argument, Benjamin then proceeds to display some studies on people that have tried to exercise this strategy. The results are fairly conclusive:
“No outstanding rewards came from a diversified investment in growth companies as compared with that in common stocks generally”
Takes From Reading Mauboussin
The competitive advantage period reflects the life expectancy of a company’s moat, which reveals how long is a business expected to generate excess returns on capital. Prior to the 1990s, traditional companies tended to generate somewhat “low” excess returns, but they lasted 15-20 years, or even more. New economy companies, to the contrary, tend to generate very high excess returns, but might have a CAP of 5-10 years, or even shorter.
This is due to the rates of industry change embedded in both worlds. Traditional companies are immersed in industries that rarely change, or at least on a significant scale, while new economy companies live in industries in continuous change. What this means for an investor is that, to generate excess returns with a strategy that involves new economy companies, such as SaaS, one would need to recurrently and opportunistically switch boats. Else, the investor falls victim to an expired CAP.
To do so, not only great skill is required, as in the traditional investing sense, but also deep expertise on current and new verticals. If any of both ingredients are missing, I suspect the investor will only switch rooms in the Titanic. If one’s intention is to build a long-lasting and sustainable investment strategy, I’m not seeing very clearly how such a framework could be manufactured (except for the 0.01%) so that it fulfills this objective.
These are some of the thoughts I’ve been having over growth investing. I will need to revisit this topic in the future, most likely. For next Sunday, I’ll try to have either Zeckhauser’s or Zoetis’ long article. Hope you enjoyed today’s!
Finally, in case you missed it, Jared invited me to write a one-pager for his newsletter, alongside other writers. You might find the compilation of one-pagers interesting. Here’s the link.
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