Categories
Investing

Why Young Guns should invest in growth stocks

By now it is well acknowledged that most passive investors in a sensible index beat active managers.  

From a medium term financial returns point of view, the rational move is to invest in a diversified index fund and accept your returns will approximate Beta (ie the market return).  Then sit back and let compounding do its work over a period of 20 – 30 years.

Simple.

Well, not quite.

There are a few factors that I think need to be considered and it might make sense for a young gun on the make to include a few growth stocks in their portfolio.  Here are the key points:

1. Growth stocks provide learning experience

I believe a young gun should invest in a basket of growth companies as this provides an additional learning experience and something else to track along your own journey.

Following growth companies helps build experience in an industry. 

If you invest in 5 innovative SAAS business you get a better feel for the industry via your investments.

It also provides an opportunity to see what moves the company makes.

Public growth companies tend to be some of the better businesses.  There is an element of survivorship bias built in – to get to the stage they are at requires them to be decent business. 

Watching how the business executes can provide very valuable lessons and tips for your own business efforts.

Investors can also see how the management team communicates with the market.  How they frame issues in discussions and calls with investors.  It gives the investor a feel for the industry movements.

Now, you could just follow companies, but I think the lessons are magnified when you have a financial interest in them and it keeps you focussed on a small number.

I would suggest that young investors pick a small basket of 5 or so growth companies in an industry that they like and invest in these companies.  

I would not suggest picking businesses like Facebook, Tesla, Google etc.  These are great businesses but they are all over the headlines.  The information published on them is generally very vanilla and often just media driven speculation.

A small basket of interesting fast growth micro-cap businesses will provide you with better perspective and learning.

Investing a small sum in these companies and following them over time (at least 3 years and ideally more) is key to getting value out of the strategy.  This means you should not touch the capital whilst following these companies (ie don’t sell unless it is clear that the business is in a terminal situation).

2. Beating the market is meaningless with low capital

The point of selecting these growth companies is not to beat the market. It is to learn.

Beating the market, or generating Alpha in finance speak, is great.  It is the ultimate goal of every active investor.

But is it worth bothering about for private investors?

Well the maths is pretty simple.

If you have $100k and the market returns 7%, you just made $7k.

But let’s say you spend 500 hours (c. 10 hours a week) over the course of the year selecting companies that you believe will out-perform. 

You do well and manage to return 14% – double the market return.  Congratulations – that is an outstanding result.

A lot of effort has gone into the stock selection and has resulted in a return of $14k.  A whole $7k more than would have made by putting your $100k in the market.

Spending all of that time to make $7k is not a good use of time.  It would equal a return of approximately $14 per hour.  Not worth it.

Graphic for those visual thinkers

What should you be focussed on then?

3. Spend your time growing your income

Now to be clear, whilst the article is focussed on investing in growth stocks, I don’t want to detract from what you should be spending the majority of your time on.

If you do not have a decent capital base (by which I mean $2m+), you need to spend as much time as possible growing your income and keeping your expenses low so you can grow your capital.

4. Once you have built your capital base

As a sneak peak on the future, lets talk about what to do once you have made it.

For old hand investors with a large amount of capital, passively investing in the index is also not always the right answer.  

The index is “safe” to a certain extent in that the yield that should be relatively consistent over time.  

Clearly there will be drops in the capital value (as we have just seen).  But the portfolio is diversified and consists of robust companies so should always do ok over time.

For investors with a decent capital base (lets say $5m or higher), a more preferable option may be to take a control position in an established niche business (probably a private company).  Acquiring a private business that dominates a small mission critical niche for example would potentially be a better option than passive index investing.

For most of the young guns reading this blog however, this will not be their situation so back to reality and what you should be doing now.

5. Portfolio

For Young Guns today, I wouldn’t advocate allocating more than 10 – 20% of your portfolio to these individual stocks.  It should be a set and follow strategy.

The remainder would be split between the index and dividend stocks to provide income.

This is differentiated advice.  I have not seen anyone else suggest that young guns adopt this strategy so clearly it is not something that is for everyone.

Let me know in the comments if you have any thoughts or any companies that you have invested in.

Categories
Investing

Why Crypto is for idiots

I started off writing this post with a view to explaining why all Crypto investors are idiots.  

As I was writing out my reasons, I started to question whether in fact, it was me that is the iodit.  When writing it out, I realised there were some flaws in my line of thinking.  

This is the power of using writing to articulate your thoughts.

I’ll let you read through my thought journey below, but as with everything, there is nuance to be found along the way to developing your own opinion.

——-

If you step into the world of Financial Twitter, it won’t take long before you come across a long list of Crypto “Investors”.

In late 2017 / early 2018, Bitcoin went on a ripping rally and ever since then, every man and his dog claims to be banking healthy profits from trading it.  Some people even claim to have made millions from it.  

Many have made so much in fact that they are now selling courses on how you too can make money from Crypto.  How generous.

These “investors” and the people who buy their courses are idiots.

Here is why.

1. Crypto is not for investment, it is for speculation

Crypto is not a productive asset.  You do not get anything from owning it.

If you own a farm, you get crops which you can sell.  If you own a bond, you get interest.  If you own a stock, you have the right to a share of the cash flow stream or production.  If you own real estate, you get rental income.

Crypto, like all currencies, does not produce anything.  You can own it for 10 years and you will never receive any value from it until the day you sell.

In order for the owner to get a return, the market value of the asset must increase over time.  This is called speculation.  You buy something speculating that the price will increase.

Whilst speculation is not really for me, there is absolutely nothing wrong with it.  Many smart people have made good money speculating.

But to be good at speculating, you must be able to develop and explain why you believe the price of an asset will go up.  Otherwise you are just gambling (like an idiot).

So smart crypto investors should have an opinion on why it is valued the way it is just now, and what will cause the market value of the asset to go up.

This leads to the second point.

2. Crypto can not be reliably valued

Using bitcoin as the most prevalent example of Crypto, 1 bitcoin as I type today is $11,625.

Neither I nor anyone else can tell you whether that price is reasonable or not.

As an asset with an actively traded market, a constantly updated price is available.  Like all markets, the price today is driven by supply and demand. 

The current supply and demand factors have settled on today’s price.

The basic premise that many investors use to justify investing in Crypto is that there is limited supply (unlike with traditional currencies where central banks can and most certainly do create more currency).

The limited supply combined with growing demand over time will drive the price up.

That actually somewhat makes sense to me.  

Crypto currencies are in their infancy and with growing adoption of the Crypto as a payment method, demand will increase over time.

In order for this scenario to play out,  Crypto needs to be adopted as a mainstream currency and therefore it needs to offer some kind of incentive /  benefit to the economy in order to get people to use it.

3. What is the value proposition to the average consumer?

I do not see the use case for the average consumer to switch to Crypto currency as a method of transferring value as it stands today.

My current bank does not charge me any transaction fees.  It does not charge me to hold an account with them.  It offers me many free ancillary services including fraud protection etc.  It does not currently pay any proper interest on my money (but then neither does Bitcoin) although that will change eventually when rates rise.  All of these could of course change.

I wouldn’t say I am delighted with my bank for making payments but I equally wouldn’t say there is a consistent pain point that needs to be addressed.

I can not see the catalyst that will cause me as a consumer to switch to using Crypto-currency as a means of daily payment currency.  I would also venture that the vast majority of consumers have no interest in using Bitcoin to pay for a new TV for example.

Why would they?

For this reason, consumer lead mass adoption of the currency for daily use seems im-probable to me.

4. Merchant-led adoption

One compelling argument that I have seen is that merchants may prefer customers to use Crypto for payment as it reduces their transaction fees. 

Merchant’s currently pay an small fee for the use of traditional payment networks (eg Visa, Mastercard etc)

One of the key benefits is that through the use of Blockchain, Crypto will “disintermediate” these networks. A fancy way of saying it cuts out the middleman (ie the network).

Without this middleman party taking a cut, there are reduced transaction costs for the merchant.

If the merchant was to pass these savings to consumers, giving consumers a reason to pay by Crypto, this could potentially be a game changer.  There is now an economic incentive for consumers to use Crypto as a currency.

At the moment, I have not seen any merchants doing this.  

For the small but admittedly growing number of merchants accepting crypto, the price is still pegged at a traditional currency (eg USD) value and crypto (usually Bitcoin) offered as an alternative payment solution.

Even though some merchants accept bitcoin, most have what I would call a “soft offering.” 

They don’t use it to price goods.  It’s merely as a method for transferring value. The merchant typically immediately sells the Crypto for traditional currency.

As an aside, this does not materially change the supply and demand balance. There is demand for bitcoin immediately prior to the transaction from the consumer to buy the crypto. This is pretty much immediately offset by supply from the merchant just after the transaction as they look to liquidate it into a traditional currency.

The reason the dynamics currently work like this is because Crypto and most famously bitcoin is too volatile, which leads me to the final point.

5. Is Crypto a currency or a commodity purely for speculation?

The volatility of Crypto is notorious.

The wild swings in Crypto make it unsuitable to being a currency. A currency needs to be stable to allow people to transfer an agreed level of value in a transaction.

Some businesses and institutions find even traditional currencies too volatile and will look to hedge exposure over relatively short time periods (days and weeks).  Compared to this, Crypto massively fails as a currency.

We know that the driver of volatility is driven by large swings in supply and demand.  We can’t know for sure, but the probability is that these large swings come from speculators trading the currency.

The flows of capital from speculation currently drive the price up and down in swings of 5+%.  Great for traders.  Bad for businesses that want to use crypto as a currency.

Until the volatility is addressed Crypto can not be used as a currency.  As a result, the sustained increase in demand from new parties using crypto to transact will not arrive.

It is ironic to me that speculators piling in and selling out of crypto are driving the fluctuations in value that prevent crypto from being taken seriously as a real currency.  And because it is not taken seriously as a currency, it undermines the long term value of the asset itself.

The speculators actions are harming the long term interests of those that want to invest in Crypto for the long haul.

So is Crypto for idiots or not?

If I had to bet today, I would bet on Crypto increasing in value over time.  But I don’t have to bet.  And that’s just my hunch. Its not a proper investment thesis.  It would be a gamble.

I can’t say with any degree of certainty that Crypto will generally increase in value.  I can’t say why it would increase.  I can’t predict supply and demand.  And I can’t value it.  For these reason, I can’t invest in it and I don’t understand how anyone can.

The catalyst I can see that would make crypto a good investment is if there becomes an economic reason for consumers to start using Crypto as payment method for daily transactions.  This could be led by merchants offering some form of discount for payment via Crypto vs traditional currency (ie passing on the transaction cost savings to customers).  It could be driven by something else. I have no idea.

Regardless, for the long term value of crypto to go up, it needs to be adopted as a proper currency.

So what is my conclusion?

Well I have come full circle to where I started.  

How many investors today have a well thought out rationale for why Crypto is a good investment?  Not many.  “Crypto is the future bro” is not a reason to invest in something.  

These people are idiots.

They are buying with no sound reason why. The whole game is set up to take advantage of them. They are the greater fools.

Longer term speculators making probabilistic bets on the future use cases of Crypto are another story.   They could be geniuses and have it all mapped out.  Or they could be idiots.  Many are certainly smarter than me but time will tell if crypto is a good investment for them.

What are your thoughts?  Can you provide a reasonable argument for why Crypto makes a good investment?