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One article that has captured tremendous attention from the investment industry lately is billionaire investor Ray Dalio’s recent piece on his opinion that a paradigm shift will soon occur in financial markets. Dalio defines a paradigm as a relatively long time period “(about 10 years) in which the markets and market relationships operate in a certain way.” When Dalio speaks, people listen: His investment firm, Bridgewater, manages about US$160 billion in assets today.
According to Dalio, the current paradigm that we’re in started in late 2008/early 2009, when economies and stock markets around the world bottomed out during the Great Financial Crisis. Driving this paradigm have been central banks’ actions to lower interest rates and conduct quantitative easing, creating a debt glut.
We’re now nearing the end of the current paradigm and we’re in a state in which “asset prices are relatively high” and the market expects growth to “remain moderately strong” and inflation to “remain low.”
Driving the new paradigm will be central banks’ desire to deal with the debt glut by increasingly (1) monetising debt, which is the act of printing money to purchase debt, and (2) depreciating currencies. These actions create inflation, and will lower the value of money and inflation-adjusted returns for creditors. In such a paradigm, Dalio thinks the best way for investors to navigate the investment landscape will be to add gold to their portfolios.
The more things change, the more they remain the same
We don’t invest based on paradigm shifts, and here at The Motley Fool we are certainly not advocating that investors abandon stocks. In fact, we much prefer stocks to gold. Through stocks, we are able to invest in pieces of companies that are producing real cash flows – in other words, productive assets.
Gold, on the other hand, just sits there – it’s an unproductive asset. Check out Warren Buffett’s thoughts on the matter in his 2011 Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) shareholders’ letter (link opens a PDF – read pages 18 and 19).
But Dalio’s article on the paradigm shift got me thinking. What are the things that don’t change in the financial markets? This inverted thinking can be really powerful in the world of business and investing. Jeff Bezos, founder and CEO of Amazon.com (NYSE: AMZN), once said (emphases are mine):
“I very frequently get the question: “What’s going to change in the next 10 years?” And that is a very interesting question; it’s a very common one. I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time. … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, “Jeff, I love Amazon; I just wish the prices were a little higher.” “I love Amazon; I just wish you’d deliver a little more slowly.” Impossible.
And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.”
I focused my inverted thinking on the stock market and came away with one thing that I’m certain will never change in that area: A company’s value will increase if it grows its revenues, profits, and cash flows over time at a rate higher than inflation.
And finding great companies – companies that are able to grow much faster than inflation – is something at the core of The Motley Fool. It is something The Motley Fool has been doing since our founding in 1993. But herein lies the hard thing about investing: A great company becomes a lousy investment if its price is too high.
The hard part of investing
Former Fool Morgan Housel wrote an article in March 2017 titled The Hard Part of Investing for a Motley Fool service in the US. Morgan shared (emphasis his):
“Warren Buffett was on CNBC years ago, talking his usual brilliant-but-down-to-Earth approach to investing. This was around the 2009 financial crisis, when millions of investors needed encouragement to be optimistic about the market’s future. Buffett said he liked the opportunities he saw. The host asked him how he found his opportunities.
“I look for companies that sell for less than their intrinsic value,” he said.
“How do you calculate intrinsic value?” the host asked.
“Well, that’s the hard part,” Buffett laughed.
The quote always stuck with me. That’s the hard part.
This applies to so much of what we do in investing, where what seems like a simple question can lead to a staggeringly complex and nuanced answer…
…Great companies can make great investments. But great companies can be extremely expensive, which can make poor investments. How do you reconcile that conflict? Well, that’s the hard part.
I experienced this last week at a conference in Atlanta. An audience member asked a panelist a half-dozen questions about venture capital. How do you know if a company will succeed? How do you measure the power of a brand? How do you value a company that has no revenue?
The panelist’s answer for each question was effectively: That’s the hard part. He became frustrated and said, “If I had easy answers for your questions, I couldn’t justify my salary, could I?” The audience laughed, but it was a serious point.”
Investors often struggle with the hard part of investing in determining what’s an appropriate price to pay for great companies. Unfortunately there’s no easy answer, no magic spreadsheet that can tell us, “A P/E ratio of X is too high. A P/E ratio below Y is right.” Morgan explained in The Hard Part of Investing:
“It’s not that these questions don’t have answers. It’s that the answers could fill several books while barely scratching the surface. Or the answers can’t really be described; they fall into the fuzzy world of intuition that comes after decades of experience. Or, more often, the answers to these seemingly simple questions are so unique to one situation that they can’t be summarized in a broad formula.”
Fortunately, we’re not helpless when faced with this conundrum.
David Gardner, co-founder of The Motley Fool, is one of the best investors I know. He recommended and bought Amazon shares in September 1997 at a price of US$3.21 and has held them since. Amazon’s share price is around US$1,800 today (go figure the return!).
In the Motley Fool US’s Stock Advisor newsletter, David has made seven recommendations since the service’s inception in 2002 that have gains of more than 5,000% each. Back then, did David imagine that these winning recommendations would deliver returns of such incredible magnitude? No. In David’s own words:
“I assure you, in 1997, when we bought Amazon.com at US$3.21, we did not imagine any of that could happen. And yet, all of that has happened and more, and the stock has so far exceeded any expectations any of us could have had that all I can say is, no one was a genius to call it, but you and I could be geniuses just to buy it and to add to it and to hold it, and out-hold Wall Street trading in and out of these kinds of companies. You and I can hold them over the course of our lives and do wonderfully. So, positive surprises, too. Surprise.”
My US colleague Bill Mann, who has been with The Motley Fool since 1999, once said he has “never, ever heard David Gardner talk about an expected rate of return because his basic investing philosophy could probably be boiled down to the words “Surprise me.””
Great companies can be extremely expensive, which makes them poor investments – this happens in some cases. In many cases, in fact. But great companies can also surprise us on the upside massively, because great companies are often run by innovative and capable leaders. If we invest in greatness with patience and perseverance (the stock market is after all, volatile!), and diversify, we can set up our portfolios to be positively surprised.
Whether we’re in an old or new investing paradigm, I know one thing that’s not going to change in investing: Great companies will become more valuable over time. So, I’m going to continue finding and investing in great companies, and telling them: “Surprise me!”
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Chong Ser Jing owns shares in Berkshire Hathaway and Amazon.com.