Does the “hot hand” exist? Some think it does. Others think it doesn’t. If I had any doubts, they were put to rest on a cold night five years ago at the Capitol One Arena in Washington D.C.
In early 2016, I was invited to a game between the Golden State Warriors and the Washington Wizards. I got to the arena 30 minutes early and noticed something strange. The game was sold out, yet few people were walking around the concourse. Thinking nothing of it, I grabbed a beer and went to find my seat. When I entered the arena, the crowd was entirely focused on one thing….Steph Curry’s warm up routine. It has since become the stuff of legend, but at the time it was just starting to garner attention. He started with layups then moved to mid-range jumpers, three pointers, and finally to half court shots. He remained remarkably consistent. It actually appeared as though he got better the further he got away from the hoop, which carried over into the game scoring 51 points and hitting 75% of his three pointers.
Curry continues to amaze to this day. Since that cold night in D.C., he has averaged 43% from three point range and more than 28 points per game. At the age of 33, he might be having his best season yet. In April alone, he made 96 three pointers, obliterating the prior record of 82, and shot 46.6% behind the arc. During this stretch, he averaged 37.3 points per game, scored 30 points in 13 of his 15 games (also a record), had five 40 point games, a 50 point game, and made 10 or more three pointers in four games. This past weekend, he scored 46 points in the Warriors regular season finale to cement himself as the NBA’s 2020-2021 scoring leader. In doing so, he put himself in elite company as one of just three players who have won multiple scoring titles, MVPs, and titles (the other two are Michael Jordan and Kareen Abdul-Jabbar).
So, does Curry get “hot” or has this stretch been a fluke? If it is the former, does it mean the “hot hand” must exist? Well…..yes and no. Yes for people like Steph Curry...not necessarily for the average Joe. Let me explain.
The Hot Hand
Last year, Ben Cohen published a book titled, “The Hot Hand”, profiling the nature of streaks. He concludes that,
“Yes, the hot hand is real. There are certain situations in which you can take advantage of the hot hand, but there are also scenarios in which allowing the hot hand to guide your behavior can be disastrous. It can be just as costly to indulge the hot hand as it is to ignore the hot hand.”
My take is that if you find a superstar like Steph Curry when they have the hot hand, ride them. However, since superstars are the exception and not the rule, it is common to mistake a fluke streak for a hot hand, which means a material reversion to the mean is likely coming.
So, why are superstars able to stay hot while others fizzle out? It appears to be due to a combination of confidence, risk, and competition.
Superstars vs. Mere Mortals
When people feel like they are getting the “hot hand”, their confidence rises. When their confidence rises, they take more risk and face stiffer competition. When they take more risk and face stiffer competition, their odds of success typically fall. It is no wonder most people revert to the mean. The key word here though is “most”. While us mere mortals inevitably cool off and revert to the mean, superstars like Steph Curry often thrive under these circumstances and their outperformance can persist for long periods of time.
Sports are the most obvious example because athletes are constantly in the public eye and their track records are highly visible. In addition to Steph Curry, think Wayne Gretzky in hockey, Tom Brady in football, Tiger Woods in golf, and Serena Williams in tennis. They are bonafide superstars.
Superstars simply get better as things get more difficult, risks rise, and the competition increases.
Finding the Steph Curry’s
In the wake of the COVID-19 pandemic, several sectors of the economy appeared to “get hot” on the belief that the “future was getting accelerated”. This led to an immediate increase in investor expectations for nearly every SaaS, big data, e-commerce, and digital company. As a result, in 2020 even a monkey could have thrown a dart at a page filled with hundreds of these stocks and made a lot of money. Given the rise of Robinhood and retail trading, this is essentially what happened.
This said, what we just experienced will likely prove to be one of those mistaken “hot hand” moments for a lot of companies and investors. While there is no doubt that COVID-19 accelerated the future and that SaaS, data, and e-commerce will likely transform the economy the way the three pointer has transformed the NBA, it will not create an endless number of superstar companies. Remember, for every Steph Curry there have been hundreds (if not thousands) of good, but-not-great shooters, and even more flashes-in-the pan.
Today, we are in the midst of a pretty material correction in nearly all of the stocks that appeared to get hot as a result of the COVID-19 pandemic. As a result, the market may be presenting an opportunity for patient investors who can identify and separate the Steph Curry’s from the the pack.
Dealing with the Hype
Billy Gurley of Benchmark Capital recently highlighted the phenomenon surrounding the SaaS businesses when answered a question about “overhyped sectors”. He explained that,
“The most overhyped sector tends to be whatever has been working most recently because that is where people tend to get lulled into believing it is always going to be this way. Take a sector like SaaS, which has been working. Some say it is overhyped, but it is not like it is imagined. It is real. Everything that is happening is real, but that does not mean every company can trade at 30 times sales. Not all of them can have the dynamics of a company like Snowflake where the net dollar retention is off the hook and the pricing model is perfect relative to its usage. Not all of them have that and so what you might see in this category is a bit more discernment.”
If Gurley is right, and I believe he is, this is a time for investors to focus heavily on separating the superstars from the good-but-not-greats and the flashes-in-the-pan. While valuations still matter, if Gurley is right that a company like Snowflake is SaaS’s version of Steph Curry, its 50x revenue multiple today will matter a lot less a few years from now than a 30x revenue multiple will for the good-but-not-great companies. The reason? Because the odds are much higher that a superstar like Snowflake will be able to sustain the hot hand, while others will have cooled off significantly.
Superstar Companies
As an endowment investor, we do not track individual companies and their stocks on a daily basis. However, we do get to meet a lot of managers that do. In doing so, we see countless differing opinions on what constitutes a superstar company. From their observations and some of my own, here are a few of the characteristics they possess:
Can maintain (or even improve ) their performance as the risks and competition increase (Curry)
Can generate strong operating performance that is able to endure even as the rules change (Gretzky)
An ability to perform well during benign market environments, but truly shine in moments of extreme euphoria or pessimism (Brady)
Periods of supreme dominance (Tiger and Serena)
So, if these are some of the key qualities of a superstar, how and when do they reveal themselves? Often during periods like today when there is a shock to the system.
Shocks to the System
Something interesting happens when a shock to the system accelerates the future. It initially provides a wave of opportunity for many companies to ride as they jockey for pole positions. However, when the tide reverses, it often reveals the companies that will become the major winners, while exposing the ordinary and underperforming ones --- i.e., your superstars, the good-but-not-greats, and the flashes-in-the-pan. If this current shock is is anything like prior ones, I would be looking to (a) focus on separating the superstars from the pack, (b) sizing up positions in companies that have the greatest likelihood of staying hot, i.e, sustaining above average growth for a decade, and (c) materially trimming or cutting bait in those that are most likely experiencing a fluke run.
Doing so could generate strong returns for years to come if an investor manages to identify the future superstars. While this is undoubtedly easier said than done, selloffs like this tend to be the early moments that eventually define long-term greatness.
"He's never been better, I can say that. He's been great for a long time, though, so it's hard to say he's at his best now because he's been like this for years. Just an incredible season and I'll just leave it at that: He's never been better than he is right now."
— Warriors coach Steve Kerr said when asked if this was the best season of Curry's 12-year career