“We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run,” scientist Roy Amara once said. It’s a wonderful way of remembering how we get caught up in hype but are short-sighted on long-term value. It also touches on why it can be so hard to prosper consistently by investing early in big innovations.
It seems perfectly logical to invest in the great innovations of the day. We too like innovation, and we are much more interested in electric vehicles, AI, and plant-based meat than a lot of other things. But often, we see this cycle play out: A startling innovation arises. Excitement builds, then turns into hype. When the hype isn’t fulfilled, disappointment follows. Investors suffer and lose interest. Yet many years later, the innovation really does change our lives in profound ways.
In a recent talk, investment strategist Richard Bernstein recalled how unbound optimism for the internet in the late 1990s led to sweeping statements about radical changes ahead. What is amazing, he said, is that everything people said about technology’s promise – and more — came true over the next decade. Yet information technology was the worst performing sector through the 2000s.
The point is that investing is not easy. Doing “A” does not always lead to “B,” even though that is what “should” happen. Too many things can intervene – and stories take a long time to play out. So what should investors do?
We believe there are many ways to succeed at investing, including ways that are not our way. But our framework always has rested on two pillars: Valuation and long-term thinking.
Valuation is what keeps us grounded. We believe there is a difference between price and value, and that we must focus on what we pay for what we get. We love great companies as much as everyone, but we care about price because ultimately, the highest returns come when you buy low.
Valuation is about understanding future cash flows. It is hard work to do – and it’s getting harder as the world becomes more complex. It’s not just a matter of looking for low price-to-book ratios. It requires deep dives into company fundamentals. Accounting earnings don’t tell us as much as they once did about a company’s prospects. Intangible assets like proprietary technology and brand are extremely important to understand. A company’s ability to allocate capital matters a lot, and so do competitive dynamics.
The other thing is that psychology remains very important in markets. Cycles of hype and disappointment have and will continue to wrong-foot many, which is why being able to think longer-term than the average investor is a source of tremendous advantage.
It’s important to remember that while stories are taking their sweet time playing out, a lot of meaningless chatter happens in the meantime. One of our favorite illustrations of short-term noise comes from Nate Silver’s book, The Signal and the Noise. The charts here plot the stock market’s future returns against their starting PE ratios. One year out, there seems to be no relationship at all between valuation and return — just a random scatterplot. But over time, a story does get told.
And that perhaps makes it fitting to end with a variation on the Roy Amara quote we started with (it’s sometimes attributed to Bill Gates): “Most people overestimate what they can achieve in one year and underestimate what they can achieve in 10 years.”