For decades, the mantra of "buy low, sell high" has echoed through trading floors and investment seminars. The idea of seeking out undervalued stocks, waiting patiently for the market to recognize their worth, has been a cornerstone of investment strategy.

But what happens when the market itself undergoes a paradigm shift? When the stocks that soar are not the hidden gems waiting to be discovered, but the shining stars already in plain sight?

Today's market presents us with a fascinating paradox. The "Fab 7" - a group of tech giants that includes names like Nvidia, Microsoft, and Amazon - continue to outperform despite what many would consider sky-high valuations. This phenomenon challenges traditional wisdom and forces us to reconsider our approach to investing.

As someone who has navigated the turbulent waters of the stock market for over three decades, I've learned that adaptability is not just an asset – it's a necessity. 

The ability to recognize changing trends, to learn from both successes and failures, and to adjust one's strategy accordingly, is what separates exceptional investors from the average ones.

In this note, we'll explore the shifting landscape of equity investing, examining how the rise of growth stocks is reshaping our understanding of value. We'll explore the power of adaptability, the concept of growing into valuations, and the importance of identifying key growth trends.

Drawing from my personal experience as a growth investor, we'll see how Fisher's wisdom about learning from mistakes can guide us toward more informed, flexible, and ultimately successful investment strategies.

The Traditional Wisdom -Value Investing

Traditionally, the investment community has been taught that buying undervalued stocks is the surest path to long-term wealth.

Pioneered by Benjamin Graham and David Dodd, and later championed by Warren Buffett, value investing is built on a simple premise: buy stocks that appear undervalued relative to their intrinsic worth.

The principle behind value investing is straightforward: identify stocks that are trading below their intrinsic value, purchase them at a discount, and reap the rewards as the market eventually recognizes their true worth.

The value investor's toolkit includes metrics like price-to-earnings ratios, book value, and dividend yield. The goal is to find solid companies trading at a discount to their true value, often due to temporary market inefficiencies or overlooked potential. This approach is grounded in the belief that, over time, the market will recognize the true value of these companies, leading to substantial gains for patient investors.

Value investing has produced remarkable results over extended periods. Buffett's Berkshire Hathaway, for instance, has outperformed the S&P 500 by a wide margin over several decades. This track record has cemented value investing as a cornerstone of investment education and strategy.

However, the effectiveness of traditional value investing has been challenged in recent years. In a world of rapid technological change and disruption, the metrics that once reliably identified undervalued companies may no longer tell the whole story. 

The Shifting Paradigm - Growth Investing

As we moved into the 21st century, a new paradigm began to emerge.

Growth investing, which focuses on companies with strong earnings growth potential rather than current value metrics, started to gain prominence. This approach prioritizes future potential over present value, often leading to investments in companies with high price-to-earnings ratios that would make traditional value investors balk.

Growth investing isn't new – it was championed by the likes of Philip Fisher (whose quote we opened with) as far back as the 1950s. However, it has taken on new significance in the age of technology and innovation. The rise of the internet, followed by mobile technology, cloud computing, and now artificial intelligence, has created opportunities for companies to scale at unprecedented rates.

This shift is perhaps best exemplified by the "Fab 7" – Apple, Microsoft, Alphabet (Google), Amazon, Nvidia, Meta (Facebook), and Tesla. These companies have not only dominated their respective markets but have also consistently outperformed the broader market, often trading at valuations that would be considered extreme by traditional metrics.

The success of these companies has forced a reevaluation of what constitutes a "good" investment. They've demonstrated that in certain sectors, particularly technology, the potential for future growth can be a more important factor than current profitability or asset value.

The Power of Adaptability in Investing

 In this changing landscape, adaptability has become a crucial trait for successful investors.

The ability to recognize shifts in market dynamics, reassess one's strategies, and adjust accordingly can mean the difference between capitalizing on new opportunities and being left behind.

Adaptability in investing doesn't mean chasing every new trend or abandoning proven principles at the first sign of change. Instead, it involves maintaining an open mind, continuously educating oneself about new developments in the market and various industries, and being willing to challenge one's own assumptions.

Consider the case of David Tepper, founder of Appaloosa Management. Known for his flexible approach, Tepper has successfully navigated various market conditions by adapting his strategy. During the 2008 financial crisis, he made billions by buying financial stocks when others were fleeing the sector, recognizing that government intervention would likely prevent a total collapse. This ability to read the broader economic context and adjust his approach accordingly has been a key factor in his success.

Another example is Stanley Druckenmiller, who has emphasized the importance of capital preservation during downturns and aggressive positioning during bull markets. His adaptive approach has allowed him to generate impressive returns while avoiding significant drawdowns.

However, adaptability also carries risks. It's easy to confuse adaptability with reactivity, leading to frequent strategy changes based on short-term market movements rather than fundamental shifts.

The key is to distinguish between temporary fluctuations and genuine paradigm shifts, adapting to the latter while maintaining a steady course through the former.

Growth Stocks - Growing Into Their Valuations

 One of the most challenging aspects of growth investing is dealing with seemingly excessive valuations. Many successful growth stocks trade at multiples that appear unsustainable at first glance. However, what sets truly exceptional growth companies apart is their ability to grow into – and often beyond – these lofty valuations.

This concept is crucial to understanding the current market dynamic. When we invest in a growth stock, we're not buying its current earnings or assets – we're buying its future potential.

If a company can sustain high growth rates over an extended period, what initially seems like an overvalued stock can turn out to be a bargain in hindsight.

Amazon serves as a prime example of this phenomenon. For much of its history, Amazon traded at valuation multiples that traditional value investors found absurd. Yet, year after year, the company continued to grow its revenue and expand into new markets. Those who focused solely on traditional valuation metrics missed out on one of the greatest investment opportunities of our time.

Similarly, Microsoft's resurgence under Satya Nadella's leadership demonstrates how a large, established company can reignite its growth engine and justify a expanding valuation. By pivoting towards cloud computing and subscription-based services, Microsoft transformed itself from a slow-growing tech giant into a dynamic growth company once again.

However, it's crucial to note that not all high-flying stocks successfully grow into their valuations. The dot-com bubble of the late 1990s serves as a stark reminder of what can happen when optimism about future growth becomes detached from reality.

The key is to distinguish between companies with genuine, sustainable growth potential and those riding on hype and speculation.

 Lessons from 30+ Years as a Growth Investor

Over my three decades as a growth investor, I've witnessed numerous market cycles, technological revolutions, and shifts in investor sentiment. This experience has taught me valuable lessons that have shaped my investment philosophy and approach.

One of the most crucial lessons I've learned is the importance of patience. Growth investing isn't about quick wins; it's about identifying companies with strong potential and staying invested as they realize that potential over time. I've had positions that took years to pay off, but when they did, the returns were well worth the wait.

Another key lesson has been the significance of understanding a company's competitive advantage. In the early days, I often got caught up in exciting narratives or promising technologies without fully considering how a company would maintain its edge in the long term. Over time, I've learned to dig deeper into a company's business model, market position, and ability to fend off competitors.

I've also learned the hard way about the dangers of overconfidence. Early successes can lead to a false sense of infallibility, which can be dangerous in the unpredictable world of investing. I've made my share of mistakes by becoming too attached to my own opinions or failing to reassess my positions in light of new information.

Perhaps most importantly, I've learned that the market is always evolving, and so too must investors. Strategies that worked well in one decade may become less effective in the next. The rise of passive investing, the increasing influence of retail investors, and the acceleration of information flow have all changed the investment landscape dramatically over my career.

The Wisdom in Fisher's Words - Learning from Mistakes

Returning to Philip Fisher's quote, "The chief difference between a fool and a wise man is that the wise man learns from his mistakes, while the fool never does," we can see how this wisdom is particularly relevant in the world of investing.

In my experience, the most successful investors are those who approach their craft with humility and a willingness to learn. Every investment decision, whether it results in a gain or a loss, provides an opportunity for learning and improvement.

When an investment doesn't pan out as expected, it's crucial to conduct a post-mortem analysis.

• Was the initial thesis flawed?

• Did we miss important information?

• Did unpredictable external factors intervene?

By honestly assessing our mistakes, we can refine our investment process and decision-making.

However, learning from mistakes doesn't mean becoming overly cautious or risk-averse. It means making more informed decisions, understanding our own biases and blind spots, and continuously refining our approach.

It's also important to learn from successes, understanding what went right and why. Sometimes, we can be correct in our investment decisions for the wrong reasons, and it's crucial to distinguish between skill and luck.

Fisher's wisdom extends beyond individual investment decisions to our overall approach to investing. As market conditions change, as new technologies emerge, and as global economic dynamics shift, we must be willing to reassess our strategies and adapt.

The Big Picture:

• Investors experienced a good week with the two key asset classes of large-cap stocks and bonds achieving positive returns.

• Commodities came roaring back as energy and metal prices resumed their upward trajectory.

• Unfortunately, US Small Cap continues to disappoint. The valuation gap to US Large Cap Equities continues to widen. In all fairness, Large Cap Equities exhibit better growth and profitability fundamentals but I am surprised at the performance gap.

• International equity investors focused on EAFE experienced a tough week as political uncertainties in Europe have resurfaced after the EU Parliamentary elections.

• Real Estate experienced an up week in a positive development as long-term interest rates trended down for the week. Similar to US Small Cap this asset class has been beaten down more despite a growing under-valuation relative to US Large caps..

• Year to date US Large Cap Equities and Commodities are the best performing asset classes.

• The investment environment remains risk-on. Aggressive asset allocation strategies continue their outperformance.

Economy:

• The US economy continues to be whipsawed by changing growth and inflationary expectations.

• A couple of data reports last week pointed to a slowing rate of inflation but possibly more pressures on the employment front.

• Last week investors seemed to have accepted that at most the Fed will cut rates twice this year.

• The Fed’s fight against inflation took a major step forward this past week. Not only did the data reflect a lower inflation rate but expectations by investors imbedded in Inflation Protected Securities took a nosedive.

Equities:

• Last week was all about Big Tech roaring back. The S&P 500 returned 1.6% for the week with the gains concentrated in the mega-caps.

• The average US stock, however, experienced a down week. The US Small Cap sector dropped 1% for the week.

• Besides Tech, Real Estate and Consumer Discretionary stocks in the S&P 500 had positive returns last week.

• The worst-performing sector was Energy. Surprisingly, the price of oil experienced a gain while the stocks lost over 2% for the week.

• The “size” effect whereby smaller market capitalization companies perform better than their large-cap counterparts worked in reverse last week with mid, small, and micro stocks all experiencing losses.

Bonds:

• The Federal Reserve does not seem to be in a hurry to lower rates, but the board appears willing to only do so based on where the inflation data falls out. Expect two cuts this year at most. More likely we get one cut in September and that’s it.

• Last week was a good week for US bond investors. The yield on the 10-year Treasury dropped 21 basis points.

• Investors should be focused on yield as the primary source of return rather than when the Fed is going to cut rates.

• The short end of the yield curve looks more attractive than buying into long-maturity bonds.

• Credit is also more attractive than Treasuries in light of solid economic growth.

Signal Versus Noise

What’s Coming on Premium Wednesday😀 

• Asset Allocation Performance - Portfolio Implications

Disclaimer: This newsletter is not trading or investment advice but for general informational purposes only. This newsletter represents my personal opinions which I am sharing publicly as my blog. Futures, stocks, and bonds trading of any kind involve a lot of risk. No guarantee of any profit whatsoever is made. You may lose everything you have. We guarantee no profit whatsoever, You assume the entire cost and risk of any trading or investing activities you choose to undertake. You are solely responsible for making your own investment decisions. Owners/authors of this newsletter, its representatives, its principals, its moderators, and its members, are NOT registered as securities broker-dealers or investment advisors either with the U.S. Securities and Exchange Commission, CFTC, or with any other securities/regulatory authority. Consult with a registered investment advisor, broker-dealer, and/or financial advisor. By reading and using this newsletter or any of my publications, you are agreeing to these terms. Any screenshots used here are the courtesy of Global Focus Capital and Retirement With Possibilities. The data, quotes, and information used in this newsletter are from publicly available sources and could be outdated or outright wrong - I do not guarantee the accuracy of this information.