Growth has an almost irresistible allure for investors, whether it’s a rapidly growing economy, a start-up with a hot product, or a new industry that promises to transform our lives, investors are naturally drawn to opportunities that offer growth. Likewise, it is tough to envision looking for new investments in a stagnant economy or dying industry.
Economic and market returns have not correlated
History tells a different story. Looking back more than a century across 19 countries there is a slight negative correlation between real economic growth per capita and real equity returns. So why try to forecast GDP growth, when its difficult to be accurate, and its unlikely to reap superior returns.
Industry trends do not always yield the best returns
Forecasting industry trends have also had unusual outcomes. A case in point is investing in either IT company IBM or tobacco company Philip Morris in 1975. The IT industry has boomed and tobacco use as been supressed. Despite this a $1000 investment in IBM and Philp Morris would have grown to $48000 and $1.2m in 2016 respectively. The main reason for this is the IT industry attracted many new entrance and competition hence reducing profitability with the converse happening in tobacco.
Key is to focus on valuations rather than exciting stories
History shows that one of the worst things an investor can do is to over-pay for stocks based on unrealistic expectations.
The issue is not to ignore new markets or industries, but to rather focus on individual company valuations. Rather than guessing future country or industry growth trends, in-depth research on future cash flows and investment opportunities provides much better investment prospects.
The beauty of this approach is you don’t have to wait for good economic growth or the stock market to be cheap. Instead you can select shares that trade at a discount to their intrinsic value. This allows more time to understand individual businesses and less time trying to divine the future of entire economies.
This article is very pertinent to our time, where economic growth is slow but many investment opportunities exist.
View the full article here: Beware the siren song of growth.