Can a great business be a bad investment?

Over the past few months on Youtube, I have seen a bunch of videos from fintech influencers recommending stocks of Elective Vehicle companies. It looks a reasonable thing to do since very obviously EVs are the future of mobility. But that got me thinking that can investing in any EV stock guarantee a good return for investors, even if it’s a great business like Tesla? In the same breath, can investing in a rising industry successfully lead to a good investment for the individual?

My conclusion is that it’s not the case. And it’s an important mental model that every long term investor should keep in mind. I will talk about three examples to drive home this point.

Do valuable industries always create value for you?

First, let’s talk about investing in a highly valuable industry. For that, I’ll take the example of the airline industry. Air travel is an essential pillar of the modern global economy. It transports billions of passengers every year. Even in 2021 during the pandemic, airlines transported about 2.2 billion passengers and generated $470B in revenue globally. It’s such a critical part of the global economy that if airlines vanish today, the world will come to a halt.

And yet, as an industry it has bled losses for decades. In 2021, the airlines lost over $50B combined. Even prior to the pandemic, only a small minority of airlines made profits. Take the example of United Airlines, one of the biggest airlines in the US. In 2006, it posted a revenue of $5.18B and traded at a price of about $43 per share. Fast forward 13 years just prior to start of the pandemic in 2019, its revenue grew to $40B and the stock price was around $85. So even though the company grew by 700% in 13 years at a CAGR of 16.5%, the stock only doubled in 13 years at a CAGR of 5.5%. Most airlines didn’t even deliver that kind of return.

To some extent, the same can be said of the myriad of delivery and gig economy companies today like Doordash, Grubhub, and Uber. These businesses might operate in a very important and growing industry, but they may not be highly profitable businesses as their earning reports repeatedly tell.

Can you ride safely on waves of hot trends?

Next, let’s talk about a hot trend that did not turn out to be a good investing opportunity. There are many trends today like cryptocurrency or Electric Vehicles that have given birth to companies like Coinbase, Rivian, and Tesla. At this point, it’s debatable how big these trends could become. But let’s talk about a trend that actually played out really well. In the late 1990s, the internet was the big thing everyone was talking about. People realized its potential and invested huge sums of money in internet companies. And guess what? The internet turned out to be much bigger than what people imagined in their wildest dreams. It fundamentally changed the world. It’s one of the biggest things that has happened to human civilization in the last 50 years.

But even if you had correctly anticipated this trend and invested money in the late 1990s in internet companies, you could have lost close to 75–90% of your wealth in the dot com crash of 2000. The Nasdaq lost close to 40% of its value in 2000 and further 20% in 2001. One study by Vangaurd found that over 100M people lost more than $5T in the stock market in the US alone in the dot com crash.

This shows that even if you get a trend right and invest in it, you may still end up losing a lot of money. There’s just a ton of risk in it. First, you need to bet that the trend does come true. And then, even if it comes about, there is still a huge risk if your specific investments would actually deliver returns. So next time you think of investing in a trend that’s hot, remember this example.

But what about investing in a great business?

Finally, I want to share an example of what happens when you invest in a great business, but you still end up losing money. Let’s take the example of one of the few companies that survived the dot com crash and went onto become a formidable global giant: Amazon.

At the peak of the dot com boom, if you bought shares of Amazon, you could have purchased them at $4.7 at today’s price after adjusting for stock splits over the years. After the dot com crash, the prices dropped by 90% to 40 cents per share in just 18 months. After that however, Amazon went on to grow at double digits for the next decade. Its revenue grew by over 1000% in the next 10 years. And yet, Amazon’s stock price barely reached its earlier high in this time frame. It took Amazon’s stock 9 years to come back to it’s previous high, while the company grew at record pace and launches massively successful businesses like AWS and Prime. If you held the Amazon stock from 2000–2009, you would have made zero returns despite the company growing 10X in that time period.

I hope with these examples, it’s clear to you that a good trend, booming industry, or a great business does not automatically lead to a great investment. Don’t invest based on the basis of Half-truths and incomplete analysis. While a a growing industry, important trend, and great business are important ingredients, there’s a lot more that goes in doing the right investment. We will cover how to deeply analyze an investment opportunity in the future editions.

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To sum up this edition, sharing a tweet from one of my favorite writers. This is a great advice for anything in life, but especially in investing.