We are three quarters through 2022 and the household name growth stocks have taken a beating: Meta -61%, Netflix -52%, Tesla -39%, Alphabet -30%, and Amazon -28% [as of September 30th].
This is the bad part about growth stocks. They feel so wonderful when they are going up and then one day they face the reality of being valued relative to other assets. Even before their earnings decline, the stocks hit an air pocket called “multiple compression” and come crashing down.
We anticipated this bleak season for growth stocks (albeit, the speed and magnitude has surprised us), and we reduced our holdings significantly over the past few years, but it never seems like enough. During growth stock bull markets these companies become more difficult to avoid as they crowd out the value and core stocks in market cap-weighted indices.
Investing strategies or styles run in cycles. Growth stocks do well for several years and then value stocks do well for a new period. Growth stocks dominated this last economic expansion from 2010 to 2020, followed by a bonus round of dominance during the 2020-2021 pandemic boom. This chart shows how growth stocks pulled away from core and value stocks beginning in 2015.
Stocks entered a bear market in 2022 as the Fed began raising interest rates to cool inflation and stock investors lost their appetite for highly priced stocks, especially growth stocks. As this bear market runs its course, it looks like a good time to reacquaint you with a place called “Graham and Doddsville”. This is a mythical place described in a 1984 speech by Warren Buffett.Every serious investor should read this speech and I will include a link at the bottom of this article. It came to mind a few weeks ago as I was reviewing the horrid growth stock returns and compared them to the best value managers we own and follow. I found myself saying, if people were just more patient and willing to lag the hot stocks, they wouldn’t be subjected to the way growth stocks can come crashing down.
In a 1984 speech at Columbia Business School, Buffett made the case that luck is not the source of the market beating performance of a small group of investment managers that all trace their roots back to the teachings of Benjamin Graham & David Dodd. The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of the business in the market.
Buffett enumerates his evidence in great detail and concludes that there are “much inefficiencies in the market” and “market prices are frequently nonsensical”. And he notes that the secret has been out for 50 years (as of the time of the article in 1984) and yet he was not worried about the method ceasing to work. He attributes this to a perverse human characteristic: we humans likes to make things difficult.This isn’t to say that value investing is easy. One of the most difficult things to do is resist FOMO and the thought that “times have changed, so should I.” And growth stock investing feels so good – who wouldn’t want to own the stocks that everyone is talking about?
Now, this also isn’t to say that we should throw the baby out with the bath water. There is a permanent place for growth stocks in a portfolio – even Buffett has come around to the idea that some of the best companies to own rarely become cheap enough to be called a value. But the way to build a portfolio is to take a step back and recognize that these long cycles do exist and the day of reckoning always comes, and the exact time of its arrival is never very clear. So, we diversify and tilt; we want to lean into growth after value has led for a while (2010-2022) and then lean into value when growth has been the leader (2022 – ?).
Now is the time for us to return to Graham-and-Doddsville.This chart shows the lost decade in the US stock market when the S&P 500 lost money on a cumulative basis from 2000 – 2010. Value stocks were positive during this time and handily beat growth stocks. The popularity of investing styles can run in long cycles.