C&B Notes

It’s Always About Price

Jason Zweig’s retrospective look at one of his articles from the height of the Internet bubble serves as a useful reminder on a couple of fronts.  First, buying assets at valuations that require aggressive projections to be met in order to yield a satisfactory long-term return has rarely been a successful investing strategy.  Second, picking winners (and losers) in rapidly evolving industries, even ones with high recent growth rates and transformative potential, is notoriously difficult.

In May 1999, I looked at Internet stocks and counseled readers not to buy them.  Knowing, as you probably do, that Internet stocks lost approximately 90% from their peak in early 2000 to their low point in 2002, you might think this column made points that had to be howlingly obvious at the time, but you’d be wrong.  They weren’t obvious.  Don’t let yourself be blinded by hindsight bias.  The whole reason there was a bubble in the first place is that people really did believe Internet companies would grow faster than any other companies had grown in human history — and never slow down, let alone stop.

Like all bubbles, this one wasn’t completely irrational.  When the potential growth of a transformative innovation is high enough, excitement about the future is what gets the idea funded.  That has been true for almost every “new era” bubble in financial history: the South Sea in 1720 (transoceanic trade), the British railway boom, the craze for electric-utility and radio stocks in the 1920s, and so on.

The Internet was transforming the world, and it is even more pervasive today than many of its most enthusiastic boosters in 1999 expected it to be.  The people buying dot.com stocks turned out to be absolutely right about the industry’s potential.  But they paid too much to participate in it.  History proves that growth rates are finite and that they decay over time.  Just as growth is limited in the natural world — trees can’t grow to the sky, because they would collapse under their own weight long before they got there — it is limited in the financial world.  No company, no industry, no strategy can grow far faster than average for long; if they did, they would run out of new customers and sources of profit.  History also shows that the early leaders in a new industry often don’t turn out to be the long-term winners.