Cathie Wood is one of the most well-known, most-followed investors in the world. People frequently note changes in exchange-traded funds (ETF) from her company Ark Invest, including the Ark Innovation ETF (ARKK -0.26%).
For Wood, Ark Invest has developed a loyal following for an obvious reason. As Wood recently told Fortune, Ark Invest's research is "the best in the world."
Image source: Getty Images.
I personally own many Cathie Wood favorites, including Zoom Video Communications, Roku, and Bitcoin. But I disagree that Ark Invest has the best research in the world. In my opinion, it's lacking one crucial component. And it's something that all investors should fervently strive for.
3 big assumptions with Wood's investing style
Ark Invest starts with a thematic approach to investing. The team smartly tries to determine which secular growth trends will dominate our world over the long term. Some of Ark Invest's favorite themes are autonomous driving, machine learning, and blockchain technology.
Investment decisions are also based on an economic theory known as Wright's Law. This "law" posits that every time production doubles, costs decline by a constant percentage. This can lead to predictable efficiencies of scale that Ark Invest uses to forecast the future economics of the business model.
Finally, Ark Invest believes the stock market is inefficient for several reasons. Among them, its analysts believe investors think too short term. By contrast, Ark Invest is thinking about the next three to five years.
In summary, Ark Invest's research believes the market doesn't account for major innovations or understand how the economics will improve for companies in those industries. Therefore, seemingly expensive stocks may actually be cheap when projecting into the future. This is why Wood believes that Ark Invest's research is the best in the world.
1 glaring hole in Ark Invest's research
There's a lot of overlap with Ark Invest's philosophy and that of the Motley Fool, especially when it comes to taking a long-term approach. And naturally, if you're buying and holding stocks for the long term, you should be concerned with the trends that will define the future. So, I'm not attacking Ark Invest because there are some solid principles guiding it.
However, research from Ark Invest seems to lack one crucial element: a healthy sense of what could go wrong. And for this reason alone, I don't believe Ark Invest's research is the best in the world.
This apparent lack of risk awareness is illustrated in multiple ways. For a simple example, Ark Invest believes Tesla stock will go up nearly 800% by 2027 in a worst-case scenario. In my opinion, if a worst-case scenario is that good, you may have just missed a thing or two about what could go awry.
Here are some questions investors might ask to improve on Ark Invest's philosophy:
- Why do some growth stocks lose to the S&P 500 over the long haul?
- Does Wright's Law always lead to better profits for shareholders?
- Are counterarguments being adequately considered?
Berkshire Hathaway's Warren Buffett has earned the right to weigh in here. After all, growth in Berkshire Hathaway's book value is currently outpacing growth in the net asset value for the Ark Innovation ETF.
ARKK Net Asset Value data by YCharts
Buffett's thoughts on growth and investing
At the heart of Ark Invest's investment philosophy is an emphasis on growth. But Buffett appears to think about growth in a more nuanced way.
In his 1992 letter to shareholders, Buffett wrote, "It's true that growth often has a positive impact on value, sometimes one of spectacular proportions." And this spectacular growth is what Wood is after. But Buffett points out that growth doesn't always create shareholder value.
Buffett's perspective was confirmed in a 2006 study from Boston Consulting Group when it looked at top stocks during a nearly 20-year period: "Just because a company has above-average growth does not necessarily mean it is delivering above-average shareholder value."
Wright's Law and efficiencies of scale don't always point to better profits for the business. Indeed, good profit margins often invite competition. Higher competition oversupplies the market with product. And the law of supply and demand means that prices come down and profit margins contract, despite efficiencies of scale.
As author Morgan Housel writes, "There is an iron law in economics: Extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard-to-predict ways."
Ark Invest's long-term vision of where the world is headed is certainly crucial in investing. But complexity increases when predicting future economic realities in light of the trends. But that's kind of the point. And it's why investors need to foster a healthy sense of what can go wrong.
To do this, I think the easiest place to start is by listening to people who have different opinions than your own. Here's what's great: If your opinion is correct, you have nothing to fear from a dissenting voice. However, by listening to dissenting opinions, you may just discover ways to improve your own investing style or to bolster a particular investment thesis.
Either way, listening to counterarguments from others will improve your research as you try to identify top stocks to invest in for the long haul.
