Lessons From Decades Past

Jan 2020

How do we recognize low and high in real time? Also, where are we today as we begin a new decade? Here are our thoughts: First, although there will always be exceptions to any general rule, it’s typically the norm, not exceptions, that powers decade returns. Indeed, too great a focus on exceptions will likely lead to disappointment. Second, “low” and “high” are most effectively determined by stock prices relative to business fundamentals such as revenues, earnings and cash flow per share. For example, prices for high-tech stocks in the late 1990s vastly outpaced their companies’ earnings growth, causing these stocks to become very expensive relative to business funda­mentals. Interestingly, while growth stocks were enjoying their time in the sun 20 years ago, value stocks were in the doghouse. Indeed, many investors sold their attractively-priced value stocks (“they never do anything”) to raise funds to chase the stocks that had performed much better in the recent past. Summing up the experience of the last five decades (and longer), strong relative stock returns often lead to high prices, and high prices usually lead to disap­pointing returns going forward. Correspondingly, relatively weak returns often lead to bargain prices, and bargains typically lead to stronger returns going forward. These conclusions provide the foundation for value and contrarian investing. Investors who can’t understand the relationship between past and future stock returns seem destined to chase their tails. They may even give up on investing in stocks—swearing off something they simply don’t understand.