Warren Buffett made his billions using the classic 'value investing' strategy. But in a world of Tesla and Microsoft, it no longer works.
For decades, Warren Buffett has been the king of investing. But the strategy that made him the third-richest man on the planet is dead.
Buffett underperformed the stock market by 20 percentage points last year. And he missed most of the biggest success stories of the last decade like Amazon and Microsoft. He only bought Apple stock in 2017.
Why? Because Buffett’s strategy – the classic ‘value investor’ model – no longer works.
At its core, value investing makes a lot of sense. You only buy stocks with strong fundamentals and earnings.
But that strategy has a big flaw, according to Coinshares chief strategy officer Meltem Demirors. Speaking on the Off the Chain podcast this week, she said:
Here’s the issue [with value investing]. If you’re investing based on fundamentals, you would have missed Amazon. You would have missed Apple. You would have missed all the companies that delivered 98% of S&P 500 market growth over the last 20 years.
The stock market has shifted towards ‘growth investing’ which is much more difficult to quantify using traditional models.
Tesla’s latest parabolic run is a great explainer. The stock is now worth more than Ford and General Motors combined. Based on fundamentals, there’s no way Tesla should be the second-largest automaker on the stock market. But it is.
On the surface if you look at Tesla’s balance sheet, their cost of capital, revenues, how much they’re spending, their indebtedness. If you look at it through a fundamentals lens, it doesn’t look like a good stock – Demirors.
But there’s a missing element that value investing can’t calculate: innovation. You can’t quantify the world-changing impact of a company like Tesla and its share price reflects that.
Buffett’s Berkshire Hathaway portfolio is weighed down by laggards like Kraft-Heinz, Wells Fargo, US Bancorp, and Delta. Only Apple has delivered outsized returns for the Oracle of Omaha.
Problem is, when you live by a value investing dogma, everything looks overvalued. The classic “Buffett Indicator” is at the most over-valued level since the dot-com bubble. No wonder he’s on the sidelines with a record $130 billion in cash.
Many have suggested this means there’s a huge stock market crash around the corner. But what if there isn’t? What if this is a new era of investing – one that values growth potential, innovation, and star-power over fundamentals.
The last decade has seen the biggest experiment in central bank liquidity the world has ever seen. The Federal Reserve and central banks across the globe have pumped more money into the financial system than ever before.
Not only that, but corporations have been buying their own shares at an unprecedented pace. And at the same time, passive investing in ETFs has exploded, circulating money right back into the best-performing stocks. Active stock picking based on fundamentals has all-but disappeared.
These factors have created a self-fulfilling driving force in today’s stock market that a value investing template doesn’t account for.
Buffett is right about one thing. Stock prices are detached from reality and fundamental value right now.
If he’s right, then stock prices will ultimately crash and return to their fundamental levels.
But what if he’s wrong? What if we’ve entered an entirely new era of investing that models price differently?
How long can he stay on the sidelines while Berkshire Hathaway underperforms the stock market? Shareholders may start demanding answers when Buffett issues his annual statement on February the 22nd. Watch this space.