Buy Cheap Stuff

There is a theory in investing that you should buy cheap stuff because eventually it might become not so cheap. Well, that hasn’t worked in the last 20 years. Cheap stuff has stayed cheap, and expensive stuff has gotten even more expensive. This is the growth/value problem in a nutshell.

If you buy cheap stuff, you have a margin of safety. If you buy something at a 6 price-to-earnings (P/E), it is unlikely to go to a 3 P/E. If you buy something at a 60 P/E, it could go to a 30 P/E and still be overvalued. Buffett and Munger were pretty good at buying stuff with a margin of safety.

If Nvidia (NVDA) dropped 75%, it would still be a $1 trillion market cap. Think about that.

Opportunities That Are Unrecognized

I am a value-ish investor, but I am not dogmatic about it. I will occasionally buy emerging growth opportunities. I will occasionally buy expensive stocks, and I will occasionally buy the upper right-hand corner of the chart. But most of the time, I am looking for opportunities that are unrecognized, thinking that they will someday become recognized.

It doesn’t take much when you buy cheap stocks. If you buy something that is a 6 P/E and it goes to a 10 P/E, you made 67%. Occasionally, a value stock will become a growth stock, which is a happy scenario. Sometimes, you will have a growth stock become a value stock, which is not so happy. I have seen both.

I do think that vibes will shift, and sometime in the not-too-distant future, we’ll go back to buying cheap stocks again. The Goldman Sachs Non-Profitable Tech Index is up over 60% from the April lows. I like to call unprofitable tech “crap.” There is a Ponzi-like element to it—you buy it for the hope of higher prices, not for the cash flows. 

Ultimately, when I buy a stock, I want cash to be returned in the form of dividends or retained earnings. Everything else is hopium. Not that you can’t buy the hopium and make money—lots of people do. Let’s put it this way: Robinhood is not trading at a typical brokerage multiple.

Overpriced Crap

Last spring, I met with a former student for coffee to see how he was doing. He was eager to show me his portfolio. The portfolio was 50% NVDA and 50% Broadcom. I commented that it wasn’t exactly diversified, and he agreed. 

But this is what the typical retail portfolio looks like these days, or something like it: tech stocks, fad stocks, and crap. All of it has no valuation cushion, and if there is a sea change in sentiment, you’re not looking at 20% drawdowns—you’re looking at 90% drawdowns. I’ve seen it before, from 2000–2002. It will happen. It’s not a question of if; it’s a question of when.

But I am wired a little differently than the average investor. When I first started investing in 1997, I got a copy of Money magazine and flipped through pages and pages of mutual funds. I saw that there were “science and technology funds” that were returning 30% and value funds that were returning 6%. Guess which ones I invested in? I picked the value funds, and they didn’t do much for a couple of years, but when the market turned, they outperformed by thousands of basis points. I survived that cycle. I didn’t survive the second cycle because I had a lot of restricted shares of Lehman Brothers that I could not sell.

Investing has something of a Hippocratic Oath: First, don’t lose money. A good way not to lose money is to not buy overpriced crap. 

There was a period during the dot-com bust when I simply shorted stocks with the most ridiculous-sounding names. As a systematic strategy, that turned out to work pretty well. Let me put it this way: I don’t think AppLovin is going to survive the next cycle. Or Super Micro Computer. Never buy a stock that has the word “super” in the name. 

Now, the thing about buying cheap stuff is that you can be made to look very foolish while the overpriced crap keeps going up. You will get FOMO. Other people will pick on you, calling you an idiot or worse. As a contrarian, I thrive on the hate and discontent. I thrive on the negativity, and it only reinforces my belief that what I am doing is right. Other people can’t handle it—they’ll cave under the pressure and buy the overpriced crap. It’s been 21 years since we’ve had a bull market in value stocks—I don’t think it’s going to be another 21 years.

You must have an independent streak. You need to be able to think for yourself. You can’t be a lemming. Nearly all these people buying crap will lose all their gains and more. For sure, some will sell, but most of them won’t. 

Remember, the time to leave the party is when the first beer bottle gets thrown against the wall. You’ll be halfway down the street when you see the cops coming the other way.

Jared Dillian, MFA