Joel Greenblatt, a renowned investor, advocates a strategy of minimising risk while maximising upside potential. He once said, “One way to create an attractive risk/reward situation is to limit downside risk severely by investing in situations with a large margin of safety. The upside, though difficult to quantify, typically takes care of itself. In other words, focus on the downside first when making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones” which emphasises prioritising capital preservation. This doesn’t mean avoiding risk altogether but rather pursuing attractive risk-adjusted returns.
This philosophy has always resonated with me, especially as I was talking to a friend of mine about the current market condition. One of his points stood out in particular: he argued that stock valuations no longer matter. Investors are achieving astronomical returns (100x) by betting on unprofitable AI startups and cryptocurrencies. Why fuss over traditional metrics if the market rewards pure speculation?
This brings to mind what John Kenneth Galbraith said in his book “A Short History of Financial Euphoria,” that financial markets often repeat their mistakes due to short memories. New generations, confident and unaware of past failures, see old pitfalls as new opportunities. It’s a pattern of selective memory—one that tempts us to forget history until a harsh market lesson unfolds.
I found myself questioning this. Does this mean we should completely disregard traditional valuation metrics?
After all, the phrase “this time is different” is often a sign of recency bias – a temptation to overlook history’s lessons until the market forces us to confront reality.
As Edward O. Thorp wisely put it, “In the abstract, life is a mixture of chance and choice. Chance can be thought of as the cards you are dealt; choice is how you play them.”
The same principle applies to investing. Ignoring valuation metrics can be a perilous gamble, particularly when the market’s irrationality is glaringly obvious.
If we disregard valuation, how will these companies sustain themselves when they remain unprofitable or even purely speculative?
The investment world that I know tells me that when you buy an asset below its intrinsic value — when the risk/reward is favourable — that’s often one of the surest paths to making money.
This thought reminds me of the words of Sir John Templeton, one of the most famous investors who once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” His timeless insight serves as a reminder of the cyclical nature of market irrationality today.
During periods of euphoria, valuations tend to be ignored, even as they skyrocket. Optimism dominates and fundamentals are overlooked. It’s in these moments that the crowd loses its ability to think rationally. Investors become reckless, blinded by the belief that the market will only continue to rise until a crash wipes out the majority of those fortunes.
Warren Buffett’s advice: ‘The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.” He’s encouraging us to think differently and not follow the crowd.
Consider the recent surge in the “Trump meme coin,” whose market capitalisation soared from zero to $70 billion in mere days — equaling that of established biopharmaceutical giant GlaxoSmithKline (GSK). This stark example underscores the current market climate.
Now is the time for careful risk assessment and strategic positioning – a time to distance oneself from the herd and mitigate overexposure.
While the market’s irrationality may persist for a time, I firmly believe that a disciplined and rational-driven approach remains key to long-term outperformance.
Our approach has always been to invest in high-quality companies with strong leadership and sustainable competitive advantages, all while ensuring an attractively asymmetric risk-reward payoff. In the end, sticking to your own principles is the only way to navigate the uncertain terrain of today’s market.
Awet Ghirmay, Head of Investment Research
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Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
