Note from Managing Editor Allison Brickell: As Nicholas writes below, disruptive revolutions are nothing new in America. Time and again, investors have gotten caught in a vicious cycle of frenzied buying, sky-high valuations and inevitable crashes.
That’s why Nicholas is adamant that investors learn these lessons from the past. Because the cycles will happen again… and your money will be at stake.
“Please, God, just one more bubble.”
– Bumper sticker in Silicon Valley, circa 1999
Alphabet‘s (Nasdaq: GOOGL) Google disrupted advertising.
Facebook (Nasdaq: FB) disrupted the media.
Amazon (Nasdaq: AMZN) disrupted the shopping mall.
Disruptive revolutions are nothing new in America.
Canals, the steamboat and railroads disrupted transportation in the 1840s.
The telephone, electricity and steel disrupted communications and manufacturing in the 1890s.
Radio, automobiles and “moving pictures” disrupted Americans’ daily lives in the 1920s.
These disruptive technologies created generational fortunes. And they are why we still recognize the names Carnegie, Rockefeller, Ford and Edison today.
And it’s also the reason 100 years from today, investors will still recognize the names of Bezos, Gates and Musk.
It also explains why investors are keen to invest in the next disruptive technology – whether that is gene editing, Bitcoin or electric vehicles.
The average investor’s attitude?
“I want to get in on the ground floor because someone is going to make a lot of money out of this.”
Yes, early investors can make a mint investing in disruptive technology stocks.
But it’s worth remembering that the average mom-and-pop investor rarely gets a chair when the music stops.
Let me explain.
The Challenges of Disruptive Investing
Investing in disruptive technologies is not like investing in Walmart (NYSE: WMT) or Nike (NYSE: NKE).
Instead, it presents unique challenges.
First, disruptive technologies change the rules of the investing game.
Consider the investment philosophy of Warren Buffett and Berkshire Hathaway (NYSE: BRK-B).
Berkshire favors investing in the steady, dependable growth of well-established quasi-monopolies.
Berkshire’s investment philosophy is to bet against disruption.
Berkshire profits the most when we all drink Coca-Cola, use Gillette razors and shop at Costco every day.
It makes money when we do the same things the same way we’ve done them for the past 30 years.
Today’s most disruptive companies – say, Google, Facebook and Amazon – weren’t even around 30 years ago.
Yet they have changed our behavior more than drinking Coke ever could.
Revealingly, these three companies are now collectively worth seven times more than Berkshire Hathaway is.
Ironically, Buffett’s investment in another disrupter – Apple (Nasdaq: AAPL) – has proven to be his single best investment ever.
Second, you can identify disruption winners only with the benefit of hindsight.
Thousands of tech companies’ dot-com stocks went bust when the internet bubble burst. By the end of the downturn in 2002, stocks had lost $5 trillion in value since their peak.
Also, the brash upstart does not always prevail in disruptive technologies.
With annual revenues of $143 billion, Microsoft is an old codger by tech standards.
Yet the cloud – a disruptive technology – now makes up a third of its business. And that segment is growing at a 31% rate.
Microsoft co-opted a disruptive business thanks to its ability to change its corporate DNA.
And third: “Many are called. Few are chosen.”
Disruption is a fertile soil for story stocks. But most disruptive stocks will fail.
Whether it’s the “China miracle,” cannabis, cryptocurrency or artificial meat…
Investing in a disruptive technology always offers the promise of a shortcut to quick and effortless wealth.
Yet it rarely works out that way.
Disruption and Bubbles: Two Sides of the Same Coin
Disruptive technologies have seduced investors for centuries.
The siren call of “This time it’s different!” is difficult to resist.
After all, disruptive stocks offer a compelling story, a “pure play” on new technology and the prospect of endless riches.
All this at the click of a mouse.
Investors succumb to the promise of a “new era.” Conventional measures of valuation no longer apply. Yesterday’s “experts” are dismissed as unimaginative fuddy-duddies.
These investors ignore history at their peril.
Take the 1920s boom in aviation stocks.
Charles Lindbergh’s trans-Atlantic flight in 1927 drove the story of an optimistic future for aircraft companies.
The investing public wildly overestimated how quickly the industry would become viable and profitable.
The experts appreciated the importance of airplanes and air travel. They also knew the developments would take time. But the narrative of inevitability drowned out the experts’ caution.
In 1930, 124 firms raised more than $300 million through initial public offerings ($4.5 billion in 2021 dollars).
By 1932, 96% of this value had evaporated.
Investors at the peak of the aviation index would not see their principals return until the mid-to-late 1950s.
Whether it’s the British bicycle bubble of the 1890s, the aviation bubble of the 1920s or the dot-com bubble of the 1990s, each story of a disruptive technology bubble is unique.
And, yes, some investors made a fortune.
What remains invisible?
The fortunes lost by investors who bet on the wrong companies, the wrong technologies or the wrong entrepreneurs.
As Warren Buffett famously observed, “You never know who’s swimming naked until the tide goes out.”
Not all disruptive technology stocks are swimming naked… but most of them probably are.
So go ahead and invest in your favorite disruptive technology stock.
But keep your bet size small.
And make sure you set a trailing stop.
You can thank me later for saving you a fortune.
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