Overinvestment that harms shareholders can be great for others.
Investor Warren Buffett surpassed $100 billion in net worth on March 10, according to the Bloomberg Billionaires Index, but his investing track record isn’t perfect. One of his famous quips is about the frequently money-losing airline industry, which has twice cost him a bundle. “Think airlines,” he wrote in his letter to shareholders in the 2007 annual report of Berkshire Hathaway Inc. “Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
Let’s take that joke more seriously than Buffett intended it. True, if airplanes had never been invented, Buffett wouldn’t have lost money on airline stocks in the 1980s, and again in the 2020 recession after he’d waded back into a sector he’d vowed to avoid. On the other hand, the world wouldn’t have had rapid long-distance travel and freight delivery. A trip from Los Angeles to Tokyo would still be a dayslong boat ride. So thank heaven there was no time-traveling capitalist with an anti-aircraft gun present at Kitty Hawk when Wilbur and Orville were working on getting aloft.
Why bring this up now? Because Rob Arnott cites Buffett’s line in an article this month warning investors about electric vehicles, whose marquee inventor is not Orville Wright but Elon Musk. “Big Market Delusion: Electric Vehicles” is by Arnott, partner and board chairman of Research Affiliates LLC, the mutual fund and exchanged-traded fund manager; Lillian Wu, vice president for research at Research Affiliates Global Advisors (Europe) Ltd.; and Bradford Cornell, a valuation expert at the Anderson Graduate School of Management of the University of California at Los Angeles.
Arnott et al. don’t call on capitalists to shoot the tires out of Musk’s next Tesla model, but they do warn, “In the highly competitive and capital-intensive auto industry, the January 2021 valuations of electric vehicle manufacturers are simply not sustainable over the long term.” Bloomberg covered their warning in a news story on March 10.
They’re right that investors might save money by avoiding electric vehicle investments. But the world would be poorer for it. The money that EV manufacturers are raising in initial and secondary offerings is being poured into R&D and manufacturing. The cash infusion is putting electric vehicles on a short path to becoming mass-market products that will be not only greener than internal-combustion vehicles, but also cheaper and more reliable.
The fact that Tesla shares have gotten expensive is leading investors to put money into smaller entrants such as NIO, BYD, XPeng, Li Auto, Nicola Motor, Electro Meccanica, and Arcimoto. To Arnott, that looks like trouble because it will be impossible for all of those companies to meet expectations. Fair. But to an outside observer—say, someone who’s concerned about greenhouse gases or just wants a cheap, zippy car that doesn’t stop at gas stations—the spreading of bets across multiple entries seems like a very good thing.
There’s a long history of investment crazes that have left shareholders and lenders licking their wounds but have benefitted society as a whole, dating at least as far back as the British railway mania of the 1840s. “There were trustworthy quantitative measures to show investors (who included Charles Darwin, John Stuart Mill, and the Brontë sisters) that there would not be enough demand for railway transport to provide the expected revenues and profits” Andrew Odlyzko of the University of Minnesota wrote in 2010. “But the power of the revolutionary new technology, assisted by artful manipulation of public perception by interested parties, induced a collective hallucination that made investors ignore such considerations. They persisted in ignoring them for several years, until the lines were placed in service and the inevitable disaster struck.”
The key phrase is “the lines were placed in service.” The railroads may not have made money for their original investors (sorry, Darwin), but they were eventually put to use. The rail lines that crisscrossed Great Britain helped make it the world’s first manufacturing superpower.
The journalist Daniel Gross covered this well in a book called Pop! Why Bubbles Are Great for the Economy. Unfortunately for him it was published in 2007 just as the popping of the housing bubble contributed to the deepest recession in the U.S. since the Depression of the 1930s. Still, he documents other investments of lasting value that were born in bubbles, including fiber-optic networks in the 1990s.
That’s not to say every investment boom benefits society. Some houses built in the early 2000s in the U.S. that couldn’t be sold had to be torn down, even ones“appointed with granite counters, luxury bathtubs and dual-pane windows.”
Gary Gorton of the Yale School of Management and Guillermo Ordonez of the University of Pennsylvania provide a framework for thinking about this question in a paper called “Good Booms, Bad Booms,” published in the April 2020 issue of the Journal of the European Economic Association. They say that investment booms are triggered by technological advances and are fueled by lending, much of which is short-term and collateralized. The more investment there is, the less productive each additional dollar becomes. Eventually lenders start to worry that the collateral they received is no good. They yank their funding, companies go bust, and there’s a crisis. That’s a bad boom. In a good boom, the technological advance that got the boom going continues to bear fruit, so lenders never panic and “the credit boom ends, but not in a crisis.”
It’s too soon to make a call on whether electric vehicles will be a good boom or a bad boom, but even a bad boom isn’t all bad. The knowledge of how to make more efficient motors and higher-capacity batteries will remain even if the companies that developed that knowledge go kaput.
Startups create new ideas and prod old companies to innovate. In contrast, when Buffett invests in tech, it’s generally in well-established players such as Amazon.com Inc. and Apple Inc. Nothing wrong with that, but metaphorically shooting down the Wright brothers’ plane is no boon to society.