Stock Picking Is Like Time Travel

Tesla stock-bam! Apple -kapow! That sound you hear amid the market tremors is the future screeching back to the present, like the wail of the flux capacitor in Marty McFly and Doc’s DeLorean. Wall Street perfected this sort of time travel long ago: Successful investing is mostly about looking into the future and deciding what to pay for it today. But how do investors know where to look?

The equities side of Wall Street, including me, always writes off bond investors as automatons. Their business is straightforward: Bonds have a face value, maturity date and coupon. That’s it. The rest is math such as Macaulay duration, which is basically how long it takes to get paid back. Investors just guess future interest rates and the risk of default. How hard is that?

If only it were that simple for stocks. At its most basic level, the value of a company is the sum of all its future profits discounted back to today. But it’s tricky to pin down this value because the variables are all loosey-goosey: earnings, growth rate and a theoretical discount rate. Future earnings are at the whim of management, growth depends on the economy and industry trends, and the discount rate is based on inflation and that fuzzy thing called risk. In other words, every input to the value of stocks is elusive. That’s why stocks rise and fall by the minute.

It helps to think of stocks as having a focal length, like the lens of a camera, which is the point in the future investors are looking at. Stocks with long focal lengths have an area of high magnification, a smaller angle of view, and fewer things in focus. Amazon’s investors were willing to overlook low margins in the short term in exchange for a bountiful prize out there somewhere. A short focal length means investors don’t look too far and can see everything all in focus, warts and all, like General Electric . Stocks have a duration, but you can’t really measure it-you have to sense it, or feel how far out the market is willing to look. It’s the most confusing part of investing.

How far should you look? Typically-though things are rarely typical in investing-investors look between 18 and 24 months into the future and apply a price-to-earnings ratio on future profits. Today the market multiple is 16 times 2019 earnings, which is close to the average for the past several decades. Since 1990, forward-earnings multiples have been as low as 10 at the 2009 market bottom and as high as 26 in the 2000 dot-com boom.

But P/E multiples aren’t buy or sell signals. In periods of high growth and low interest rates, investors are willing to time-travel into the future and determine what’s plausible: a long focal length. But investing-based predictions of more than a few years can induce a dangerous complacency and risk a snapback.

When glitches happen-and they always do-that long view collapses: to next quarter, next month or even tomorrow. In 2008, the focal length of Bear Stearns and Lehman became “Can they make it through the weekend?” Uncertainty always pulls focal length in. Maybe Iraq rolls tanks into Kuwait. Maybe we get a totally unnecessary tariff war with China.

Long-term investors like me focus on big secular waves, while traders look at cyclical, even seasonal trends. Investors look out as far as their stomachs can handle and figure out what could go right. But you’d better be right if you take a long view. I remember hearing in the early 1990s that the Rothschilds were buying up real estate in Albany, N.Y., betting that high-speed rail would run to New York City in under an hour. Waiting for Godot.

Biotech investors are in neck braces from being whipsawed back and forth as the industry’s focal length moves in and out every few years. And then there’s Amazon. Last October’s $2,000 share price was 80 times forward earnings. Even down 20%, the stock is anticipating Amazon will earn $100 a share someday, or almost $50 billion. But when? Five years, or even longer?

Like Marty McFly, investors must be time travelers-and cynical ones. When valuations get crazy, instead of assuming all goes right, focus on what could go wrong. Are the seeds of destruction already planted? When everyone else has a long focal length, shorten yours. Don’t be the last one in.

The next wave of initial public offerings is coming, henceforth known as the “Pauls” (you heard it here first): Pinterest (or maybe Palantir), Airbnb, Uber, Lyft and Slack. All are almost guaranteed to have long focal lengths. As the predicted long-term value of the tech sector has shrunk over the past three months, like it or not, the Pauls have had about 20% shaved off their valuations and probably don’t even know it. Still, I’d wait for the glitch. And stocks always glitch-to the delight of those bond-buying automatons. Which reminds me, especially for Apple fans: Don’t forget the cockroach theory of bad news. You never see just one.