Hard to Pick the "Game Changers"

Image of newspaper headline "Perspective"

Can people reliably pick “the category killers”—those stocks that are game changers and create disproportionate returns? The odds are low, although many try. As the NASDAQ returns to its peak last seen in the tech bubble, Gene Hoots reflects on the performance of stocks like Amazon, E-Bay, Yahoo, and Cisco from peak-to-peak. The lessons are timeless.

For most people over 30 the technology bubble is now a faint, but bitter, memory.  For me, March 10, 2000—the peak of the tech bubble—seems like only yesterday.  Those of you who knew CornerCap at that time may recall that in that 1999 and early 2000 period we had been through five straight quarters of severe underperformance and we seemed to be headed for our sixth straight.  But thankfully on that day the bubble burst, and we at CornerCap began a transition from apparent ignorance to perceived brilliance.  That day marked the beginning of the end of the most traumatic experience of my investing career.

Some months later, I spoke at a local Rotary Club. I said that, as a rough guess based on history, it would probably take 16 years for the NASDAQ to recover to its peak value. From peak to bottom the NASDAQ lost 80%. My “forecast” was nothing more than a simple comparison to the Dow Jones Average which had peaked in 1966 and did not recover until 1982.  We are now only three months shy of my forecast of 16 years. The NASDAQ has briefly crossed that high water mark of 5,050, but as I write this it still remains slightly below that number.

During the technology bubble, I chose 13 of the larger Internet stocks and tracked their performance. They were all market darlings at the time.  The list did not include any tiny startups, most of which have since disappeared without a trace.

Every few years, I update the performance of that portfolio.  At the end of 2000, it had declined 54% from its peak on March 10, 2000.  Every one of the 13 stocks had a significant loss.

The accompanying chart shows the results for the last 15+ years.   Currently, the same stocks (adjusted for mergers and buyouts) is now up 75%, a 3.6% annualized return, including dividends. For comparison, the S&P 500 is up an annualized 4% for the period.

Chart showing returns of selected tech stocks

* VIAV was the new ticker after MSI and JDS Uniphase merged on 8/4/15; ** RF Micro Devices was acquired by Qorvo on 12/31/14, at which point we excluded the stock from the portfolio. See additional disclosures below on performance calculation.

But the meager return is not the whole story.  To have made any money at all, an investor would have had to pick the two big winners from the 13 stocks – Amazon and eBay. Excluding them, the other 11 stocks returned -50%.  A few of them have become worthless and others were bought out at a fraction of their former price. Who could've guessed which of these would become spectacular winners and which would become disasters?

The irony, and the lesson from this, is that part of everyone's prediction came true. The conventional wisdom was that technology would change the world. No one would disagree with that assessment as we look back over the last 15 years. Whole new businesses have been created using the technology and we live in a world that we could not have dreamed of then. So while the Internet was a world changing economic success, almost no investors were able to predict where to invest money so that they would participate in this revolution.

Warren Buffett pointed out in November 1999 that the technology industry had an historical precedent – the auto industry. There is no denying that automobiles changed all our lives in a huge way.  At one time, there were more than 2,000 auto manufacturers in America. Today there are only two of those original companies, just .1% survived.  Decades from now, we will likely be looking at a very similar pattern of winners and losers in the technology industry.

All this draws attention to one of the major principles of our investing strategy – Diversify. Don't get carried away with any given industry, thinking that it will dominate the world. Competition always forces businesses back to a result that is a regression to the mean.  Don't overpay for expected earnings that have not yet materialized. 

Note on Performance Calculation: To determine the return of the 13 stocks in the portfolio above, we did the following:

  • We calculated annual performance for each selected stock by geometrically linking the daily returns. Any dividends are reinvested into the stock (total return basis).
  • We then took an average of each stock’s annual return to derive the total portfolio return.
  • If a stock on the list was acquired, we rebalanced proceeds across the remaining portfolio following the date of acquisition.
  • We excluded stocks that made any acquisitions from entering the portfolio.