Avoid the Hype

“Warren and I don’t focus on the froth of the market. We seek out good long-term investments and stubbornly hold them for a long time.” — Charlie Munger

2023 saw many of the pandemic-era’s most hyped sectors come crashing down to Earth. Take EVs, for instance.

Barron’s recently wrote: 

There’s no question the EV bubble has burst. The combined peak market capitalization, reached in 2020 and 2021, of Nikola, Fisker, Rivian Automotive, Lucid, NIO, XPeng, Polestar Automotive, Canoo, and Lordstown Motors was as high as $470 billion. Today, the nine companies’ market caps add up to just $68 billion—a drop of 86%.

That’s $402 billion of market capitalization destroyed. That’s like zeroing out ExxonMobile, MasterCard, or LVMH. Each is worth about $400 billion today. 

The carnage wasn’t limited to unprofitable start-ups either. Barron’s continues:

So far, only three EV makers are consistently profitable: Tesla, BYD, and Li Auto. But even those stocks have taken it on the chin. Their peak market capitalizations totaled some $1.4 trillion. Today, that sum is down to about $910 billion. Tesla’s market value has gone from about $1.2 trillion to about $790 billion.

Risk is always a function of price paid. Every asset is a good deal at one price and a bad deal at another. Investors could be entirely correct that EVs will dominate the auto market and still fail to make money if they over pay. Correct predictions don’t automatically produce profitable investments.

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Do you have a “stranded” 401k from a past job that is neglected and unmanaged? Eagle Point manages separately manage accounts for retail investors and these accounts are often an excellent fit for our long-term investment approach. If you would like to invest with Eagle Point Capital or connect with us, please email info@eaglepointcap.com.

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In fact, that’s exactly what happened the last couple of times transportation technology changed. Trains, ICE cars, and airplanes each initially attracted significantly more capital and production than demand.

The result was painful for investors. Most companies went bankrupt and the survivors consolidated. The US started with hundreds each of rail, auto, and airplane manufacturers. Today we’re left with 3 ICE auto OEMs, 4 railroads, and one civilian airplane manufacturer. 

Investors were correct that these new forms of transportation would revolutionize the world. They were wrong about the timeframe, and incorrect to think that a world changing product would automatically produce life changing investment returns. 

A similar pattern recently played out in the pharmaceutical industry. Pfizer’s COVID-19 vaccine  literally saved the world in 2020. The company shattered previous vaccine development timelines, bringing its vaccine to market in less than a year and saving countless lives.

Pfizer’s stock doubled from its March 2020 COVID low to its December 2021 high. Several competing vaccines from producers from around the world hit the market. Since then it is down over 50% and languishing at ten-year lows. Pfizer’s stock is 20% lower than it was in March 2020.

It is entirely possible for a company to save the world and for its investors to lose money by overpaying. As Warren Buffett says, “You pay a high price for a cheery consensus on Wall Street.”

The common thread between these examples are large addressable markets that excited investors. The hype drove valuations to nosebleed levels and encouraged capital and competition to flood into the industry.

This created a two-fold problem:

1. Valuations were priced for perfection.

2. Supply exceeded demand.

One way to avoid these scenarios is to invest in industries with barriers to entry. We spend a lot of time analyzing an industry’s structure. We want to invest in a consolidated or consolidating industry with clear barriers to entry and rational competition.

Another way to avoid these scenarios is to avoid investing in hyped sectors. Where’s the hype today? AI and GLP-1s, for starters. 

Avoiding the hype doesn’t mean writing off EVs, AI, or GLP-1s as worthless. It means being patient, gathering data, and letting the valuations come to you. Chasing an investment is a recipe for disaster. Letting price come to you stacks the odds of success in your favor.

Avoiding the hype is easier said than done.

We learned this the hard way with our investment in Alibaba. We fell for the hype and convinced ourselves to pay a higher multiple than we should have. Since then Alibaba’s earnings and free cash flow per share are up, but the stock’s multiple compression has erased all of that growth and then some. It was an unforced error we won’t soon forget.

Avoiding the hype is difficult because it make your appear out of step. Here individual investors have the edge over the professionals. Professional investors are under constant scrutiny. Individual investors answer to no one but themselves.

In December 1999 Barron’s wrote an article titled “What’s Wrong Warren?” to call out Berkshire Hathaway’s stock’s annual decline in the face of a raging bull market. Buffett had the last laugh, but it could have turned out differently had he been supervised by a committee like most institutional investors.

Professionals may feel the career risk of avoiding the hype isn’t worth it. If a hyped sector fails to deliver, a professional will say that they were duped like everyone else. This is why most active managers are closet indexers.

While you're waiting for valuations to calm down, focus on sectors mired in fear and pessimism. Sometimes fear and pessimism takes root in sectors deemed the losers of the hyped technology. 

Bill Ackman bought Google after it sold off on fears it was falling behind AI. He’s up about 50% on that trade. 

The GLP-1 hype produced even more stark losers. Restaurant Brands International (RBI) – incidentally another of Ackman’s positions – fell 20% between July and October as the GLP-1 hype convinced investors fast food would be a relic of the past. Since then the stock has round tripped back to where it started.

It was even more dramatic at Davita. The stock dropped from 109 in August to 73 in October, a 33% decline in a matter of weeks. Since then it has also round tripped back to where it started.

To be fair, these are cherry-picked examples. Pessimism is often warranted, so you still have to do your research. But you have a better chance at finding a deal when other people are fearful instead of greedy.

Where are investors most fearful about now? Commercial real estate, oil, China, and asset management come to mind.

We prefer to invest in what investor Allan Mecham called “cockroach-like” businesses – businesses that are very hardy and almost impossible to kill. We often find them lurking in the shadows, well out of the limelight. They might be ugly, but they can sure be profitable.

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Do you have a “stranded” 401k from a past job that is neglected and unmanaged? Eagle Point manages separately manage accounts for retail investors and these accounts are often an excellent fit for our long-term investment approach. If you would like to invest with Eagle Point Capital or connect with us, please email info@eaglepointcap.com.

Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.