Han Dieperink: When the market disregards quality
Han Dieperink: When the market disregards quality
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
The investment world is in turmoil. Shares in companies that have been generating reliable profits and solid growth for years are being sold en masse. At the same time, money is flowing to companies that have never made a profit.
This remarkable situation has been going on for over a year now and raises important questions about the rationality of financial markets. Large technology companies that have been investors' favourites for years are now underperforming the general market. This is despite the fact that their operating results are still excellent. They are making profits, growing steadily and have strong market positions. But investors are no longer paying attention to them. Instead, their attention is focused on a colourful collection of speculative investments: quantum computing start-ups that are still in their infancy, drone manufacturers without a clear revenue model, heavily shorted shares, meme stocks that go viral on social media, and companies burdened by sky-high debts.
This development seems to fly in the face of sound investment sense. Why would you sell shares in companies that have proven to be successful in order to invest that money in companies that may or may not ever become profitable? The answer lies in the psychology of the market and the changing composition of the investor community.
After years of rising share prices, many investors are sitting on significant paper gains in traditional growth stocks. It is psychologically easier to take profits on shares that have performed well than to take losses on failed investments. This freed-up capital is looking for a new destination, and in the current market climate, that is not the next solid growth share, but rather the speculative alternative with the promise of quick riches.
The growth in the number of private investors plays a crucial role in this. A new generation of investors has entered the market via user-friendly apps and online platforms. This group, often younger and less experienced, uses different criteria than professional investors. They are less interested in fundamental analysis and look more at momentum and stories. An exciting narrative about the future weighs more heavily for them than proven past performance.
The hype surrounding artificial intelligence reinforces this trend. Any company that is even remotely involved with AI can count on increased interest. It does not matter whether the company actually has meaningful AI technology or is profitable.
The association with this popular theme is often enough to drive up the share price. This phenomenon illustrates how narratives are becoming increasingly important for share price movements, at the expense of fundamental company analysis. Historically, these kinds of periods of speculative excess are not unusual. Financial markets experience cycles in which quality and speculation alternately dominate.
The tulip mania in the 17th century, the dotcom bubble around 2000, and the housing bubble of 2008 are well-known examples of moments when speculation prevailed. Each time, these periods ended with a painful correction in which speculative investments were hit the hardest.
The current situation bears similarities to previous speculative bubbles, but also has unique characteristics. The unprecedented monetary easing by central banks in recent years has created an abundance of capital in search of returns. At the same time, the democratisation of the investment market through technology has led to an influx of new, often inexperienced investors. This combination creates fertile ground for speculative excesses.
For the sensible long-term investor, the current market situation offers interesting opportunities. High-quality growth stocks have become relatively cheap, not because their prospects have deteriorated, but simply because they are temporarily out of fashion. This contrasts sharply with the high valuations of loss-making speculative stocks. The classic investment advice to buy when others are selling seems to apply here.
The challenge is to resist the temptation to go along with the speculative flow. Seeing others making quick money from risky investments can put pressure on your own investment strategy. But it is precisely discipline and adherence to proven principles that distinguish successful investors from the crowd.
It is important to realise that market sentiment can change. When the economy shows signs of weakness, interest rates rise or geopolitical tensions increase, investors typically seek the safety of quality shares. Companies with solid balance sheets, proven business models and strong market positions then become the favourites again. The speculative stocks that are so popular now could be severely punished in such a scenario.
The lesson to be learned from this market situation is not that fundamental analysis has lost its value. On the contrary, it is precisely in times of speculative excess that the importance of thorough research is underlined. Companies that actually create value will ultimately be rewarded. The challenge is to be patient until market sentiment turns around again.
For investors who do not like to take big risks, the focus on quality and growth remains a sensible strategy. The temporary underperformance of these shares is frustrating, but it does not change the underlying quality of the companies. Strong companies with good products, competent management and solid finances will prove their value in the long term. The trick is to look beyond the current market noise and stick to a well-thought-out strategy.
History shows that quality always wins out over speculation in the end. The question is not if, but when the market will come to its senses. For patient investors who are willing to swim against the tide, the current situation may prove to be an excellent investment opportunity in retrospect.