“The first principle is that you must not fool yourself, and you are the easiest person to fool.”
Nobel laureate Richard Feynman offered this famous warning in a 1974 commencement address at Caltech. He was speaking to a batch of very bright young scientists, but he might as well have been talking to we investors.
Every market cycle produces its own objects of fascination. The catalyst is often a new technology or a hot sector. Sometimes it is a single company with a captivating narrative, a soaring stock price, and a loud chorus of believers explaining why the old rules no longer apply. Occasionally, the thundering herds of bulls are proven correct. But much more often, it turns out that they were simply conflating excitement with evidence.
I make this observation without any pretense of superiority. Over my 30+ years as an investment professional, I have made plenty of mistakes, including a few from the late 1990s whose principal contribution to my net worth was educational. Those experiences shaped a conviction that sits at the center of how we invest at JAG. A popular story and a good investment are not the same thing. The difference usually comes down to fundamentals, price, and valuation.
The Anatomy of Hype
Hype cycles are easy to identify with 20/20 hindsight, but remarkably difficult to see in real time. Hype typically arrives in a persuasive package made up of a vast market opportunity, a charismatic founder, a genuinely disruptive product, and a price chart that appears to climb northward without interruption. None of these attributes is disqualifying. Indeed, many durable growth companies begin with precisely this profile. The analytical problem is that the same framework also describes most of investment history’s biggest calamities.
Evaluating investments requires one to correctly and unemotionally interpret the underlying evidence. Among many other factors, growth companies should be judged on the size and growth rate of their addressable markets, their competitive positioning, the durability of revenue growth, the trajectory of their margins, and management’s record of execution. And of course, investors’ entry price is a huge component of long-term returns. Establishing an investment too late or too early can be indistinguishable from being wrong.
As Benjamin Graham famously observed, the stock market behaves like a voting machine in the short run. Powerful stories drive investor excitement, and people “vote” with their brokerage accounts. This buying panic can drive stock prices higher (sometimes much higher) over relatively short periods of time. But over the long run, Graham’s adage reminds us that the market functions as a weighing machine. Price eventually follows earnings and cash flows, and valuation matters.
When a company’s share price embeds an assumption of near perfection many years into the future, even modest disappointments can produce outsized declines. Slower growth, softer margins, or a shift in investor sentiment can turn a market favorite into a cautionary tale with remarkable speed.
Artificial Intelligence: Opportunities and Risks
No discussion of growth, hype, and valuation would be complete right now without addressing artificial intelligence and the likelihood that several trillion-dollar companies will be coming public over the next several months. Readers of our Insights pieces and quarterly commentary know where we stand. We believe AI is very real. In fact, it might well be the biggest, most consequential wave of innovation and investment since the Industrial Revolution.
At the same time, we also think the investment cycle surrounding it has entered what we have described as the accountability phase. After years of euphoria, markets have begun differentiating between companies that can monetize their substantial AI investments and those that are merely spending. We regard this as a healthy development that helps investors separate the likely winners from the eventual losers. The relevant question is no longer whether AI will matter (it clearly will), but which companies will earn adequate returns on this historic deployment of capital, and over what timeframe. We work hard to make sure our portfolios reflect this distinction. We have concentrated exposure in businesses we view as genuine beneficiaries of the AI buildout, while reducing or avoiding exposure to those we suspect are most vulnerable to disruption. We expect the gap between AI’s winners and losers to widen considerably from here. In that environment, selectivity and sell discipline could matter more than ever.
Growth investing is not the same as chasing hype. At JAG Capital Management, we look past market narratives to discern business quality, earnings power, valuation, and the potential for long-term value creation. New favorites will arrive with every market cycle, as they always do. Our educated guess is that discipline, rather than excitement, is what compounds.
As always, thank you for your trust and confidence.
Norm