High-growth stocks that miss expectations get punished severely. In contrast, low-growth stocks that merely meet low expectations only slightly underperform, but the 50% of them that deliver an upside surprise massively outperform. This creates a favorable asymmetric risk/reward for betting on low-expectation companies.
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Compounding has positive asymmetry. A stock can only lose 100%, but it can gain multiples of that. This means a portfolio with one stock compounding at +26% and another at -26% doesn't break even over time; the winner's gains eventually dwarf the loser's total loss, leading to strong positive returns.
While a strong business model is necessary, it doesn't generate outsized returns. The key to successful growth investing is identifying a Total Addressable Market (TAM) that consensus views as small but which you believe will be massive. This contrarian take on market size is where the real alpha is found.
Top growth investors deliberately allocate more of their diligence effort to understanding and underwriting massive upside scenarios (10x+ returns) rather than concentrating on mitigating potential downside. The power-law nature of venture returns makes this a rational focus for generating exceptional performance.
To achieve above-average investment returns, one cannot simply follow the crowd. True alpha comes from contrarian thinking—making investments that conventional wisdom deems wrong. Rubenstein notes the primary barrier is psychological: overcoming the innate human desire to be liked and the fear of being told you're 'stupid' by your peers.
Historically, small-cap companies grew earnings faster than large-caps, earning a valuation premium. Since the pandemic, this has flipped. Large-caps have seen astronomical earnings growth while small-caps have lagged, creating a rare valuation discount and a potential mean reversion opportunity for investors.
The asymmetrical nature of stock returns, driven by power laws, means a handful of massive winners can more than compensate for numerous losers, even if half your investments fail. This is due to convex compounding, where upside is unlimited but downside is capped at 100%.
Applying industry-average growth rates to an emerging category leader is a critical mistake. A business like Shopify, with a powerful flywheel and network effects, is a power law winner that defies regression to the mean of its stagnant competitors. Its performance is simply not comparable.
Financial models struggle to project sustained high growth rates (>30% YoY). Analysts naturally revert to the mean, causing them to undervalue companies that defy this and maintain high growth for years, creating an opportunity for investors who spot this persistence.
![David George - Building a16z Growth, Investing Across the AI Stack, and Why Markets Misprice Growth - [Invest Like the Best, EP.450] thumbnail](https://megaphone.imgix.net/podcasts/8da7dbd8-ceeb-11f0-941c-ef83bcdd4c9f/image/d44107bc94719f78fbe91befb141073e.jpg?ixlib=rails-4.3.1&max-w=3000&max-h=3000&fit=crop&auto=format,compress)
When analyzing a true market disruptor with a long growth runway, the bigger analytical error is being too conservative. A forecast that is too low and prevents an investment is more damaging to long-term returns than an overly optimistic one that is later adjusted. The goal is to "get it right," not just be safe.
Academic studies show that company growth rates do not persist over time. A company's past high growth is not a reliable indicator of future high growth. The best statistical prediction for any company's long-term growth is simply the average (i.e., GDP growth), undermining most growth-based stock picking.