I have to give George Soros credit for one of the most insightful quotes about investing I’ve ever read. It goes like this:
Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend and step off before it is discredited.
This isn’t the easiest idea to get one’s brain around. I’ve mulled it for a long time. Soros isn’t talking about outright lies and deceptions. You’re not going to make big money by figuring out that inflation data is rigged or that the unemployment rate covers up a lot of people who are unemployed, underemployed, or underpaid.
No, I’ve come to the understanding that what Soros is really talking about is how investors interpret and invest in economic trends.
Let’s take a look at the Internet bubble from 1999 to 2000 as an example. The Internet was growing up fast. Local phone companies were laying fiber-optic cable as fast as they could. Internet retailers were popping up like mushrooms. Computer sales were going ballistic.
And the U.S. economy was enjoying incredible growth. Productivity numbers were incredible and corporate profit margins were ballooning because people could get so much more work done. Documents that once would take a day or two to ship could be scanned and emailed in a matter of minutes…
I don’t know how well you remember that period of time. But there were some really amazing predictions being made based on the future of the Internet. Our Fed Chief Alan Greenspan pondered at the time that maybe the U.S. economy would enter a golden age of prosperity where productivity gains would continue far into the future. Fixed costs for businesses would fall as more business was done over the Web. And we’d all benefit as billions of people got online.
Turns out it was all a lie…
Not the Internet part, of course. The Internet itself has grown pretty darn close to how people expected it would 16 years ago. It’s everything else that was a lie.
Productivity has not continued to grow. Corporate profit margins haven’t, either. More and more business gets done on the Internet, but we definitely do not have a golden age going on…
The Sweet Lies of the Internet
It was we who were lying. Investors, analysts, economists, politicians — we were the ones who created the lie, and we retold the lie to ourselves until we believed it.
This is what George Soros is talking about.
His observation is based on an understanding of how hope and expectation drives stock prices and the market in general. Going back to the Internet bubble example, investors used some really basic back-of-the-envelope calculations to come up with some wild valuations for Internet companies.
It was easy to project huge revenue and earnings growth when Internet use was in its infancy. All you had to do was assume Internet use would triple (true) and that people would spend more and more time online (also true). And so a particular company’s revenue would also triple or more in a year or two.
Obviously, this is the point — where individual companies see massive revenue growth that continues long into the future — that the lie is revealed. Companies just don’t grow like that. Neither do economies. Or trends. And when you find companies/economies/trends that are being driven by excessive hope and unrealistic expectations, well, you can make a whole lot of money.
Most recently we’ve seen the Big Lie about shale oil companies revealed. The lie was that the ever-growing demand and the lack of significant new discoveries would support oil company valuations forever. Wrong. All it took was for the Saudis to boost production, and it all fell apart.
We’ve seen it with gold stocks. Remember when the Fed’s QE was going to unleash Zimbabwe-like inflation, the dollar was going to crash, and gold was going to $5,000 an ounce? Yeah, it didn’t work out like that…
There are many, many other examples. Solar stocks in late 2010. Chinese stocks in 2011.
Right now, I’m looking at a $300 billion company that I think is exhibiting the exact same qualities as these other “lie” stocks…
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I’m Looking at YOU, Facebook
Right now, Facebook is worth $322 billion. You could buy two Disneys with that. Or you could buy Wal-Mart and have $100 left over…
Yes, investors think Facebook is very valuable. And it’s pretty easy to make the case that Facebook is worth $300 billion. I mean, it has 1.3 billion people logging into the website every month. If each of those people is worth just $5 a month in ad spending, we’re talking about $78 billion in annual revenue.
And Facebook’s revenue has indeed been growing at a pretty good clip. In 2013, the company did $7.8 billion. In 2014, it hit $12.4 billion. Last year, it jumped to $17.9 billion. This year analysts say $26 billion, and next year it will do $35 billion in just 12 months. So it’s on pace to hit $78 billion in revenue in maybe 2020…
And the thing about Facebook is that its overhead is not that big. Yes, the company invests in its business… a lot. But it doesn’t have to spend for each new user it gets. And so margins are terrific and earnings per share grow exponentially, nearly 200% quarter over quarter. That’s amazing.
Right now, Facebook is sitting in the sweet spot of the new advertising model. As we watch newspapers die and network TV struggle with advertising dollars, it’s like all that money is going right to Facebook and a few other prime Internet sites.
As an ad platform, Facebook seems perfect. People talk about their favorite restaurants, where they vacation, what kind of car they have, clothes they wear, beer they drink, and so on — it doesn’t take a lot of imagination to think you can learn just about all there is to know about consumers from the data that comes in on Facebook.
No wonder advertisers are lining up to put their ads on Facebook. It’s the Holy Grail of consumerism. At least, so long as those 1.3 billion keep logging into their accounts…
My girlfriend is an avid Facebook user. She stays connected with friends, family, and her community volunteer stuff through Facebook. But she just deleted the Facebook app from her smartphone because the app is doing some creepy things…
We were taking about something the other night, and then an ad for the very item showed up on her Facebook account. Was Facebook listening? It seems it might have been.
There’s a lot of speculation that the Facebook app can access your phone’s microphone and listen to your conversations, pick up on keywords, and send you ads.
Like I said: creepy.
You can’t call this an invasion of privacy, exactly, because users sign the user agreement and agree to let Facebook do whatever it wants.
Still, I think there’s going to be backlash. People do not like to think that companies are spying on them. And that’s exactly what Facebook is doing. I think more and more people are going to get bored with Facebook itself and get irritated at its invasive practices.
And I think it’s happening right now. This time next year, I bet you Facebook is worth a lot less than $300 billion.
Until next time,
Until next time,
Briton Ryle
@BritonRyle on Twitter
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
