Foreword
This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.
The major cap growth stocks just took a long walk off a short cliff, and even with the rally today, most of them are still underperforming the SPY, something that has been a fairly rare sight in the past decade and a half.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
Value value stocks
If there is a theme to outperformance so far this year, it is to take a long hard look at value stocks. And then buy the good ones.
Mind you, not just any value stocks, only the good ones — There are two main definitions of value stocks, one popularized by Benjamin Graham in his genre defining book “The Intelligent Investor”, and one popularized by Fama and French in their, also genre defining, quantitative three-factor model.
The former talks about understanding the fundamentals of a company, and trying to figure out whether it is underpriced for its earnings potential, while the latter talks about metrics which hint at the potential underpricing of select stocks. The differentiation seems minor but is important — Graham’s model suggests that investors should thoroughly understand their investments and with that understanding, gain confidence to concentrate their portfolios. Fama and French’s model is the direct opposite, and relies on diversifying across many stocks with certain characteristics (such as low P/B ratios), and trying to profit off the aggregate average outperformance.
Here, I’m talking about Graham’s model.
Negative growth
Over the past 15 years or so, large cap growth stocks like Google, Microsoft, Apple and Facebook have collectively (and independently) outperform the SPY by dramatic amounts. At their peaks, these companies were commanding P/E ratios of more than 30, with many investors treating them as safe havens. Cathie Woods even famously talked about moving excess cash in her funds into these stocks temporarily while she looks for better opportunities.
Today, after a series of mistake starting late last year, most of these stocks have been beaten down severely, as investors rediscover their goals of actually making money; John Authers says it best:
This is all a tad reminiscent of the period of a few weeks in early 2000 when dot-com investors suddenly moved from metrics like “clicks per eyeball” to “burn rate” — an old metric with a new name, referring to how quickly startup companies were burning through their cash flow. Meta has become a vastly more substantial and tangible concern than the entities that evaporated 22 years ago, but the sudden and swift realization that it had been valued far too generously still rings those bells.
John Authers, Bloomberg 10/28/2022 – https://www.bloomberg.com/opinion/articles/2022-10-28/tech-s-fangs-plummet-in-wile-e-coyote-moment-on-earnings
Investing vs Speculating
As folks grapple with their buyers’ remorse, it is important to remember the fundamental difference between an investor and a speculator: If you are investing, you are looking to profit from the productivity of the asset, while if you are speculating, you are looking to sell that assert at a higher price to someone who values it more.
If you are comfortable with a 3% (assuming no growth) rate of return from your investments, then buying at 30P/E make sense — 30P/E implies a return of 3.33% (assuming no growth).
If you need your investments to return quite a bit more than 3.33%, then either you have to consider potential, realistic growth — nothing grows to the sky, so projecting 30years of 30% growth is almost definitely wishful thinking, or you’ll need to find stocks that are trading for less than 30P/E. Simple as.
Janky Thoughts 