The American satirist Ambrose Bierce once described fidelity as 'a virtue peculiar to those who are ...
The American satirist Ambrose Bierce once described fidelity as 'a virtue peculiar to those who are about to be betrayed.' So it must have seemed to growth investors over the past few years.
It wasn't just that valuations were too high and that markets therefore had to come back. It was also that many 'growth' companies literally stopped growing at all. Throughout all of this some investors kept their 'virtue.' To their mind, the loss of revenue and earnings growth was a temporary phenomenon and would soon correct itself.
Not only were these 'growth' firms worth sticking with for that reason, but their valuations looked fine as one should be prepared to pay more for firms that grow more quickly than the rest of the market. Unfortunately, the return to the old ways never came and investors were betrayed by constantly falling share prices.
Fidelity to 'growth investing' won't hit your wallet if you have a correct perception of what it means. Unfortunately, many of us lose the message in the detail and begin to assume that what worked before will do so again in the future without bothering to check why it did in the first place. If investors are capable of these errors of perception, then is it possible that the management teams of the firms they invest in may also at times be misguided?
The answer is that they often are. One such error, which is peculiar to many of us but particularly damaging to management teams, is thinking that we are better at something than we are. We are sometimes helped into this self-delusion by events that work in our favour but are beyond our control. This situation is best described as serendipity.
Perhaps the most lasting example of serendipity at work is the great discovery made by Christopher Columbus. Columbus, by all accounts, was an excellent navigator but perhaps a poor astronomer. As a consequence of the latter he believed the Earth to be somewhat smaller than it actually is.
Armed with this misconception he decided to sail west to get to Asia. Serendipity allowed him to gain from the discovery of America, which lay between him and his ultimate goal. It will not surprise you to know that no small number of management teams have been helped by serendipity at one stage or another.
In fact there is a whole sector of the economy that has benefited from a number of secular trends over the last 10 years or so, which may now be coming to an end. The area I refer to is the consumer sector.
We have witnessed a period of above trend growth here for a number of years for many different reasons. Falling interest rates have helped as has the housing market and the shift towards cheaper goods and working mothers. In the US, the same sort of scenario has evolved and in many cases higher levels of consumption have been the rational consequence of many secular themes. Most of these are now over, however. The very powerful stimulus of falling levels of inflation and the attendant reduction in interest rates now looks to have more or less come to an end.
Real earnings are not rising and in the low growth, low inflation world we now live in it is likely that many will want to save more. Even if we only see a move back to longer-term trend levels of consumer growth the tailwind we have seen for the last decade for many companies will now turn into a headwind.
So, we can all be fooled, both investors and companies. Those that work to look for the reasons why will do best. Unfortunately in some cases there will be a 'marriage' of investor fidelity with management fooled by serendipity at just the wrong time. Such a partnering was also defined by Ambrose Bierce: 'A relation into which fools are providently drawn for their mutual destruction.'
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