Beware of ‘long stocks’: Instead of focusing on companies’ future growth, consider current profitability These are the stocks of companies believed to have many years of rapid growth ahead. For these companies, more of the projected cash flows are in the distant future. Yet, investors may become more attracted to these stocks when the rates are low
Dhirendra Kumar
CEO, Value Research
At this time of the year, people usually write about what the previous year was like or what the year ahead will hold. Last January, I looked back at 2022 and said it was a ‘Good Bad Year’. What I meant was that on paper, it looked like it should have been a bad year, what with the war in Europe, oil price spike, and Covid issues. Despite these events, it was a relatively good year for investors. By the same standard, 2023 was a good year. So, by the principle of mean reversion, are we now due for a bad year or, perhaps, a bad good year? It doesn’t matter.
Most predictions are worthless over a period as short as a year, even though these might make sense over a longer period. Here’s a good example. Over the past three years, the consensus Wall Street forecast for the US equity market’s performance has been 7%, 9% and 7%. The actual performance was 27%, -19% and 24%. The forecast may have been completely wrong, but here’s an interesting fact. Aggregated over three years, the forecast was +25%, and the actual performance was +28%. So, while the forecast managed to look utterly delusional for each of the three years, the mistake actually lies in the very idea of having an annual forecast because a three-year forecast would have been accurate.
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Still, macro-economic factors have clear trends that can affect investors, the biggest being the cost of money, or interest rates. Generally, almost anyone with a say in economic matters wants lower interest rates, but there are exceptions. A few days ago, investor-writer Howard Marks wrote a note on ‘Easy Money’. As you would expect from the title, Marks is no fan of low interest rates and free flow of liquidity to whoever wants it. He argues that while these policies can stimulate economic growth in the short term, they often lead to inflation and asset bubbles that can have devastating effects in the long term. Marks points out that the excessive liquidity in recent years has led to unprecedented levels of corporate debt and an overvaluation of assets, which could spell trouble for the market if interest rates start to rise.
In this note, Marks uses the term ‘long stocks’. The word ‘long’ here does not mean what it normally does in equity investing, but is used as an analogue to ‘long bonds’. Here’s what he says: ‘Under easy money conditions, long-dated bonds may appear particularly desirable…’
However, long bonds are more rate-sensitive than short ones, meaning their prices change more in response to a given change in interest rates. Later, it seems to me that there’s often a similar movement of capital towards ‘long stocks’ when interest rates are low. By this, I mean, the stocks of companies believed to have many years of rapid growth ahead. For these companies, more of the projected cash flows are, by definition, in the distant future. Yet, investors may become more attracted to these stocks when rates are low because they want the higher returns that such rapid growth is likely to bring. There’s less opportunity cost associated with the long wait for the relevant cash flows. Just as the prices of longer bonds fluctuate more in response to a given change in interest rates, the so-called ‘growth stocks’ usually rise more than others in times of easy money, and fall more when the money dries up.
It’s not a precise analogy, but equity investors should pay attention to whether they are too enamoured with future growth when that growth depends on the continuous flow of cheap money. As in the case of consumer products and services, the time for free stuff is gone. Money, especially money over time, is worth more now, and everything being funded for the future will have to be examined closely for real value. The present is more important now, especially the profitability of the companies that you invest in.
(The author is CEO, VALUE RESEARCH)
Connect with Experts - Wealth creation made easy(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
This story originally appeared on: India Times - Author:Faqs of Insurances
