In challenging years like the one we just experienced, it’s easy to take your eyes off the prize. For investors, the prize is finding long-term investment opportunities at a good value.
In a 1987 letter to Berkshire Hathaway shareholders, Warren Buffett stated that “in the short run, the market is a voting machine but in the long run, it is a weighing machine.” Nearly 35 years later, this simple metaphor still holds remarkably true. It implies that the fundamentals (e.g., earnings, cash flow, and growth), which affect a company’s long-term intrinsic value, may be overlooked in the short-term. Instead, an overemphasis on current economic conditions, sentiment, and news flow can lead to unjustified mispricing.
When there is significant uncertainty in the world, like we are experiencing today, it’s rational to gravitate toward safety and stability (if one can find it).
Afterall, why would we put energy into something that is five, ten, or even fifteen years away when there is so much to worry about in just the next couple months? The same is true for security valuation. The valuation premium the market assigns to future growth changes dramatically in the short run. Right now, large stable companies that pay cash dividends are more attractive to investors than small high potential but “risky” companies despite a much higher expected return. This valuation differential has a strong correlation to economic conditions - the worse current economic conditions are, the bigger the price dislocation becomes. This dislocation creates incredible long-term investment opportunities for those willing to go against the grain and be a bit contrarian.
At Fire Capital, we like to invest in well run companies, with great products and services, that have strong secular tailwinds behind them. This approach provides our analysis process with a margin of safety because even an average company in a rapidly growing industry can provide investors with good returns. Alternatively, a company operating in a low growth or shrinking industry puts a greater emphasis on company specific execution and gaining market share. That is why we commit time to finding and understanding long-term secular growth themes that will persist through good and bad markets.
Investing in secular growth themes requires a different mindset and discipline compared with attempting to predict what will happen next in the short run. Once we identify an appealing prospective theme from an investment perspective, we look for signals to confirm or deny that the theme is still intact. Some signals may be strong, others are weak, but all are important. When identifying exciting themes to analyze further, ideally there is some combination of necessity, technological advancement, positive capital flow, and government or regulatory support that indicate a structural shift is sustainable over a long timeframe. These are important attributes that help distinguish a secular growth theme from a short-term trend or fad.
As we build investment strategies, we place a lot of attention into gaining proper exposure to our favorite long-term themes. Throughout this year we will shed deeper insight into three of our top investment themes that we find increasingly attractive given the market selloff and other recent material developments that has strengthened our conviction in these areas. One considerable development driver to highlight is that an estimated $1.5 trillion of new government spending is set to be injected into system in the coming years. Over the past 14 months, the Infrastructure and Jobs Act, the CHIPS and Science Act, and the Inflation Reduction Act were all passed into law. All three bills augment the opportunities in each of our three highlighted themes.
Technology is advancing at a more rapid pace than ever before. During the pandemic we experienced the hype in certain areas, just to see them crash back down to earth. It’s common to dismiss new technologies or audacious ideas as unrealistic, but as we’ve seen time and time again human ingenuity finds a way to amaze us. The implications of disruptive innovation create a greater rift between future opportunities and risk that cannot be ignored.
Global leaders are looking to undue trade relationships that took their predecessors decades to establish. Post pandemic, corporations are pushing to de-risk their supply chains by focusing more on domestic options. Political rhetoric and government policy is increasingly taking its cues from past success, leaning more and more on nostalgia to rally their constituents. These structural shifts will take years to playout, but new opportunities are already becoming apparent.
The importance of access to reliable energy sources was never forgotten, but fallout from 2022 has put it back into focus. This was highlighted in the market with the Energy sector ending the year as the only positive sector in the S&P 500 (+59%). The necessity for more energy supply will drive future innovation in both traditional and clean energy for years to come.
Note: Click here to read our more detailed write-up on this topic.
Michael is the founder of Fire Capital Management.