The "Good Company is a Good Investment" Fallacy (EP.174)

It sounds reasonable to say that investing in the most popular companies would produce the best returns, but this is just not how asset pricing works. Today on the show, we unpack the ‘good company is a good investment’ fallacy. Before diving into the main topic, we kick off our discussion on the subject of index funds with Robert Wigglesworth’s Trillions. From there, we share some updates about custom indexing and home buying in Canada, along with the immense valuation of Tesla as well as Elon Musk’s net worth. This acts as a great segue into the focus of today’s show: a so-called good company has high historical returns, strong earnings growth, strong forecasted earnings growth, and high prices. But just because the good companies have done well historically, this does not mean they will continue to be a good investment. In fact, there is a premium that says that higher-priced stocks earn lower returns than lower-priced stocks and value stocks. We unpack several papers that explore the concept that it is the lesser-known companies that tend to have better returns. We also get into how growth extrapolation, the skewness effect, and the big market delusion plays into the good company is a good investment fallacy. Our discussion concludes with the idea that investors are better off paying attention to expected returns rather than falling victim to extrapolation errors. Tune in today!

 

Key Points From This Episode:

 

• Introductory comments: modifications to the show, listener feedback, and more. [0:00:30.2]
• Book review of the week: Trillions by Robert Wigglesworth. [0:08:28.3]
• News updates: custom indexing, Tesla valuation, homebuyer gifts, and more. [0:12:23.2]
• Introducing today’s topic: the ‘good company is a good investment’ fallacy. [0:19:30:9]
• Investing in good companies is irrational because of how asset pricing works. [0:20:44.7]
• The threat that crypto and decentralized applications pose to good companies. [0:21:50.5]
• Higher-priced stocks earn lower returns than lower-priced and value stocks. [0:24:40.3]
• Findings from papers exploring glamorous stocks and investor bias. [0:27:21.2]
• The problem of extrapolating growth too far into the future. [0:34:07.1]
• Behaviour patterns of lottery-like stocks with high expected skewness. [0:37:17.4]
• Declining prices and the big market delusion. [0:39:51.1]
• The high prices and low expected returns of the NIFTY 50 companies. [0:44:05.2]
• What the Fama French Five-Factor Model has to say about how assets are priced. [0:45:30.2]
• Talking Cents: Questions about the price we pay for riches. [0:46:50.2]