The phone rang. Mike unzipped his North Face, apparently unconcerned with the temperature even though was ten degrees below zero. He fished around in his pocket and pulled out the phone, grinning as he glanced at the screen.
“You’ll never guess where we are,” he said into the speaker.
“Where?” the voice at the other end said.
Mike looked around. “The top of Highline.”
A moment passed while the caller collected his thoughts. “You’re in Vail?”
“Not just in Vail … we’re on the mountain!”
“Your phone works there?”
The boy said the words I still couldn’t get past my lips. From the moment the phone rang, I could hardly believe my ears. Getting a call when you’re standing at the top of a mountain in Colorado may not seem like a big deal today. But this was 1994. Cell phones were expensive, few people had them and they barely worked in the city. Getting a call while standing cliff side in the middle of nowhere was unimaginable.
The 1990s were incredible years for innovation and development, not just for mobile tech, but for the Internet as well. Of course, at the time, cell phones were luxuries. The Internet was too slow to be entertaining and had little use beyond email. At best, most people figured it was just going to be another marketing channel for businesses—an alternative to advertising through television, radio and print media. But especially for those of us in our twenties and thirties, we knew something important was happening around us. We just didn’t know how big it was going to be.
*
Against that backdrop, Netscape made its debut. The company had a web-browser and was one of the first of its kind to help people get connected to the Internet. It was a big deal for the company to go public. Money managers fell over themselves, clamoring to get shares for their funds. And the big investment banking firms of the day had a party doling out shares to their favorite customers. But the company was less than two years old, and it was far from profitable. Investors didn’t really know what the company’s business model was either. Netscape was a strange new company in a rapidly developing market and the biggest question everyone had was how much the shares would cost.
Days before the offering, investors were expecting to buy shares for $14. But at the last minute, bankers upped the price to $28. Within minutes of the start of trading, the market for Netscape took off and that same day, shares traded into the high $70s before settling into the mid $50s by the closing bell.
On its face, the Netscape IPO might seem like an incredible success. After all, investors more than doubled their money in one day. But the founders of the company left a lot of money on the table by selling their shares for $28 when the market was willing to pay significantly more. The investment bankers responsible for the deal didn’t even come close to understanding what the company was worth, and it showed.
The challenge of knowing what an investment is worth is not unique to companies like Netscape. It’s a challenge that has confounded investors for hundreds of years and even with the advancements in technology and investment theory we have had, they are challenges we still face today.
*
On a normal day, stocks can gain or lose 2-3% as investors react to news. But lately, stocks have been more volatile, some gyrating 5-10% or more in a single day. By historical standards, this is a volatile market, and it has everything to do with the growing number of concerns weighing on investors’ minds.
The rising price of oil, a war in Europe, tensions with Russia and China, economic malaise in the US and the UK and inflation running at near historically high levels—maybe the market could shrug off one or two of these issues, but investors are obviously having trouble digesting all of them at once, especially when they are interrelated. All these issues affect corporate revenues, profits and ultimately the prices we are willing to pay for shares of their stocks. And inflation? Well, inflation makes it hard to answer the question “what is a dollar worth?” A dollar certainly doesn’t buy what it did 18 months ago, and if it’s hard to know what a dollar is worth, it’s equally hard to know what dollar-denominated assets like stocks should be worth too.
We expect the Fed will solve the inflation problem—it is their prime directive. This will answer the question of how high interest rates must go and should also give insight into the relative health of the US economy. Solving inflation won’t help solve the high price of oil or fix tenuous relations with trade partners, but even with a few answers, understanding the value of assets like companies and real estate becomes easier.
*
There are some things we can get away with as investors during exuberant times that we can’t when the future is cloudy. This doesn’t mean that we can be sloppy as investors because that’s never the case. But it does mean that when the economy is humming, we can own faster growing companies even if they aren’t very profitable. Companies in growth mode can plow much, if not all, of their profits into growing their businesses when they expect times to be good. That was the environment we enjoyed for much of the last decade.
When the economy slows, growth companies often must be less aggressive, focusing more on financial stability and corporate profits. We are in one of those environments now, and as you may have noticed, we have made a few changes to our portfolios to reflect this condition.
Earlier this year, we distanced ourselves from China—moves that made a tremendous amount of sense given the Chinese government’s unwillingness to play well on the world’s stage. More recently, we made a few changes toward companies with stabler balance sheets and cash flows, and less risk of declining profitability while the economic malaise continues. Among the incomers is Estee Lauder (EL), the quintessential upscale body care company that has shown resilience through even some of the toughest global economic conditions, Merck (MRK), a drug manufacturer with a pipeline of highly profitable and protected drugs, and Lam Research (LRCX), a semiconductor tools company that is unique in both its scale and its product offering. These companies have growth potential, but they are highly profitable and can absorb some trouble if it takes longer than wanted to get the economy moving in the right direction again.