Just over two decades ago, Josh Wolfe co-founded Lux Capital, a New York City-based venture capital firm dedicated to investing in science and technology firms developing ideas with the potential to change the world. The year was 2000, and the dramatic growth of the internet over the previous decade had created a bubble that was beginning to burst. Over the next few years, the NASDAQ would drop by more than 75% as a slew of heavily-hyped tech startups plunged into failure, humbling the recently overconfident industry.
The lessons of the dot com bubble stuck with Wolfe, who developed a skepticism of hype and a passion for finding businesses with solid balance sheets and healthy cash flow. But today, Wolfe sees many of the same psychological forces enveloping tech firms and the broader investor class. The YOLO investing process, most closely associated with the subreddit wallstreetbets, has pumped stocks like GameStop to the moon and pushed people all in on fad coins like DogeCoin. But for many people, it has also replaced the investment process, popularized by one of Wolfe’s idols, Warren Buffett, of a slow and steady search for good business fundamentals.
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“To The Moon is not fundamental analysis. It is an inducement. It is an encouragement of belief. And the only thing that is fueling that rocket ship To The Moon is the credulity of others,” Wolfe told Motherboard. “These are all pressure tactics weaponized to induce people to be greater fools. And it's almost like a pyramid scheme: Get the next people in, and those people have every incentive to tell their friends, Yeah, I just made, you know, 20-50 percent in a day, and you got to get in on this. But they're not gonna be ringing the bell at the top and saying, It's time to sell. Because when we’re there, it's a rush to the exit. And that's when you see mass downturn.”
The market today reminds Wolfe in many ways of the same forces that were so prominent at the height of the dot com boom, and perhaps no single person better encapsulates the moment than the world’s richest man, Elon Musk. Motherboard spoke to Wolfe about the worrying signs he sees, and the downside of prioritizing hype over fundamentals.
The conversation below has been lightly edited for clarity.
I'm really interested in this idea that creating a profitable business is less important to a lot of modern companies and investors than hype and narrative. I wonder how you started to come to see that. How did this happen? How did we get here?
What was that word that you used that starts with a P? Profit? That's such a weird word. I haven't heard that in so long.
People are saying that value investing is dead. That Warren Buffett and Charlie Munger are dead. They are not dead, and these ideas are not dead. They are timeless ideas. They are ideas that say that a business today is the present value of its future cash flows; that a business has a competitive advantage when there's something structural in its supply, or its brand, or its pricing power, or its ability to have a monopoly on intellectual property or government licensing. There's real things that make real businesses. And the value that you provide to the customer is then in the pricing power that you have and in the margins that you make. And contrary to the scarcity of the word today, profits are a great measure of the value that you provide to people.
Probably my favorite example—notably, they are both in pursuit of space—is Bezos and Musk.
In Bezos’ case, you have somebody who did one equity issuance, raising less than $60 million when they went public, and then went from a $300 million market cap or whatever it was to $300 billion. And now, a trillion. He did that by solving a problem that we had, maybe one we didn't know we had, which is that we want what we want, and we want it now at ever lower prices with ever more choice and convenience. And we're willing to pay for that. For sure, there were externalities of that, like the decline of Barnes & Noble or local, certain businesses, but consumers have a choice and could decide No, I prefer to wait longer or pay a price or have less choice. We've all collectively decided we want lower prices and more choice and faster service. Amazon has compounded capital the way a great business should. It's not as widely studied, because you don't have the sycophantic fanboys.
You contrast that to the poster child of technological hope, environmental mission, and selling stock as a product. Elon has parlayed an almost religious movement of true believers to fund losses. This is a business that's never really made accounting profits, let alone actual cash flow. Amazon did all of that, generating internal positive cash flow. Tesla has just burned cash. I joke that Elon should not just be seen as a great engineer and great entrepreneur. He should be seen as the greatest investment banker in the history of capital markets. He raises more money on an annual basis than the Mormon Church does. And it's just an amazing phenomenon. To me, he was the poster child of true belief and credulity and not caring about whether the company made profits. It was about the mission, and then it became about a rising stock price. And then it became, again, about facing off critics. Those, to me, are polar opposites of what you would want to study in learning what is a great business.
I think a lot of people took the Elon playbook and basically said, If I just promised the moon, I can get too big to fail, I can just keep raising money as I raise expectations. And if I raise expectations, fundamentals don't matter. The only thing that matters is expectations. And if I can keep leading people—or in some cases misleading them—then it'll keep working if I don't get caught. And if I do get caught, in the case of Theranos or in the case of Nikola [Editor’s note: the electric-truck maker that paid a $125 million after the SEC charged the company’s founder with misleading investors over social media], maybe you pay a fine or you have your day in court, and maybe Theranos founder Elizabeth Holmes is found guilty or maybe the zeitgeist of the day surprises and she's not. But so far, there has been really no great penalty for people whose relationship with the truth is less than ideal.
My next question is, who cares? We have the lowest number of unemployment claims in 50 years. By a lot of barometers, the economy is doing well. Maybe inflation is transitory. What's the concern here?
Nobody cares when you're out on the ice and everybody's having fun and they're serving hot chocolate and you're skating and everybody's cheering. But when people start plunging into the icy depths and are getting hurt or killed, that's when people care and when it matters. When stocks are only going up, everything's fine. This happened in ‘99 and 2000, until the successes led people to borrow, in some cases extravagantly on margin, to invest more. It was all just one big party and then when the punchbowl got taken away, people suddenly woke up, as though it was the Ishiguro novel The Buried Giant, and said, Wait a second, these companies are gonna run out of cash.
The reason that it matters is at some point, somebody is left holding the bag. Today, you have record numbers of CEOs selling their stock. A great indicator markets are bad is when, at peak prices, companies are buying shares to continue to prop up their stock. And maybe the incentive structure of their CEOs is based on their share price. The only thing that mattered was pump the stock. And if you're along for the ride, that's great. But when the CEO starts selling—now $10 billion in Musk’s case and billions of dollars in many other cases—the people left holding the bag are the people that were last in.
The tragic thing would be if those people are lower income or lower-middle income people that shouldn't be gambling or speculating, but they see all of their friends making money, their stock portfolios getting bigger, and they are lured deeper and deeper at the worst time. A market reckoning may not be a single 20 percent or 30 percent drop in a day. With 1999’s dot com boom and the 2000s busts, there wasn't just one tragic day. It was roughly two years of a near 80 percent deflation. And then another 12 years for that to recover if you were still in the markets. But you think about the losses, let alone the indebtedness that people had during that time, it was painful. And you have not seen, in nearly half a generation, mass layoffs, bankruptcies, suicides—all the things that come from terrible, tragic financial downturns.
As I've said to our limited partners, inflation has already been here for a very long time, not in the classic economic GDP numbers, but in asset prices. It matters not just that asset prices are inflated, but because I actually think we'll see a scenario where the poorest will be hit the hardest, as few fuel and food and basic consumer staples see rising prices, when consumers’ incomes or portfolios are hit the hardest. You're going to have this almost bifurcation of lower declining prices at the high end of stuff that nobody really needs, and rising prices of the stuff that people do need. It's gonna be a potentially painful situation when Wall Street is potentially seeing the bubble deflated and people clinging to hope that their portfolios will come back.
It seems to me that this concept of To The Moon that's popular amongst retail traders is of a kind with what you're talking about with Elon Musk. And it seems in a lot of ways, his mentality towards the economy has been replicated on the subreddit wallstreetbets and those sorts of places. A lot of these people are often under 30 years old and have never dealt with a crisis before. They don't understand that, at some point, they might very well be the people that end up losing everything.
I'm more concerned about the people who have dependents or mortgages, and everything has been working. In some cases, they might have had a job that maybe wasn't so great. And they decided to quit it because they're making more money speculating in crypto or speculating in the stock market and maybe even levering or buying on margin to do that.
To The Moon is not fundamental analysis. It is an inducement. It is an encouragement of belief. And the only thing that is fueling that rocket ship To The Moon is the credulity of others. There’s always a case for optimism, optimism of human ambition and capability of great technological and scientific discoveries. But if your main argument for owning an asset is that other people will own it, not because it has intrinsic value, but because there’s a greater fool—i.e. let's just hype it up and pump it and promote it until more and more fools get in—eventually, the smarter people that induced the fools are leaving them as the bag holders. That to me is the great inequity. To The Moon is a constant encouragement of people. These are all pressure tactics weaponized to induce people to be greater fools. And it's almost like a pyramid scheme: Get the next people in, and those people have every incentive to tell their friends, Yeah, I just made, you know, 20-50 percent in a day, and you got to get in on this. But they're not gonna be ringing the bell at the top and saying, It's time to sell. Because when we’re there, it's a rush to the exit. And that's when you see mass downturn.
Look, my business is a speculative business. My day job is investing in scientists and entrepreneurs who truly want to make an impact and competitively bring cutting-edge crazy technologies to market. We pride ourselves on saying, We believe before other people understand. And we always want them to agree with us, just later. But we want the people that we're backing to develop real technology and real businesses that are solving real problems with margins and economics and cash flow so that they don't have to constantly promise new investors: We're going to do this and then this and then this, so that they can constantly raise money. But you have entire asset classes and investment theses and ETFs and portfolios that are built on nothing more than narratives about disruption and innovation and belief. It is, by definition, faith and religion, and I find that to be extremely effective and extremely dangerous.
You started Lux Capital at around 2000, is that right?
We were born focused on crazy cutting-edge material science, physics, and chemistry when everybody was chasing dot coms. We basically said this is going to end really badly. And when it does, we want to be a venture firm that is not focused on optical networking, which was the infrastructure layer back then, or the dot coms.
It's amazing today watching and benefiting as a consumer, from Jokr and Gorillas and these under 15-minute delivery services, because I lived during the Kozmo.com and UrbanFetch moments, when you would order something and a dude would bring you your one-dollar drink with a hot chocolate chip cookie and a T shirt and a CD with a wrap on it, and you could order something again seven minutes later, they would do the same thing. Those companies went bust. That idea is back, and it's being funded again. As a consumer, I think it's brilliant. As an investor, I think these things are going to crash and burn again.
But yes, we were born in the tail end of this dot com mania, watching money being spent on ice statues peeing vodka at parties and the Bacchanalia of excess. Today, there is an excess of excesses, and it's not a prediction. It's observable. It's right in front of your face. So we decided then to focus on areas that we thought were neglected and scarce. And that would be my admonition today is, when the shit hits the fan, you want to be in the other room, and you want to be focused on stuff that other people haven't yet found.
How much does this remind you of 1999?
A lot. I mean, you look at the level of the NASDAQ in the public markets. You look at the composition and the absence of breath in the market between the giant leaders of the NASDAQ and the large number of smaller companies starting to diverge from it. You look at Cathie Woods’ ETF and the number of companies that are now in bear market territory. And you look at the rationale used by promoters back then, and it was about this qualitative, you-must-believe nonsense about eyeballs. And today, it is these hokey flap doodle-filled inducements around disruption and innovation. The number of brokerage accounts being opened. The people that are quitting their jobs that would have gone to med school or law school or consultancies or regular jobs and are all either starting companies or becoming day traders. I feel like I've time traveled 20 years, back to February of 2000.
You look at Woods’ portfolio, like you said, or you look at the performance of tech IPOs this year—how they're trading today versus when they opened—and it does seem like there's evidence, if you want to see it, that something already could be happening.
And remember, technologies change and companies change and markets change and governments change. But just human nature is a constant. The things that drive greed and fear, the things that have us moving in herds, the information cascades that infect each other into bubbles and busts. It takes time for people to change their mind. Most of the behavior over the past few years has been buy the dip. Well, people might be buying the dip right now. People think that this is a short-term aberration. But when the dip keeps dipping lower and lower and lower, eventually you realize the frog is fried after enough boiling water.
It's surprising to me how few people use terms like irrational exuberance these days.
Which itself is a great measure. I can tell you that—if we are correct that a downturn may be imminent, that there will be massive dislocations—you will see people running as they did in ‘02 to re-learn and re-read the wisdom of decades of Buffett letters and take accounting classes and understand what an income statement and a balance sheet and a cash flow statement are and how they flow together. And it won't just be about To The Moon and higher stock prices. That’s just an entirely cheerleading-, narrative-driven inducement of people to get in the pool, and you're starting to see stuff float in the pool.
You've talked about this concept of price versus value. And I wonder if you could elaborate on that.
The famous quote that I cling to is that price is what you pay and value is what you get. This was something that the critics used to talk about with Tesla. The only thing that the believers would say is Stock price, bro. Meaning, look at the stock price. You’re wrong. It keeps going up.
But the only thing the stock price measures is what other people believe. It doesn't measure fundamental value or intrinsic value, which is something you can look at by analyzing a balance sheet or an income statement and seeing what the actual performance of a business is. You have companies that are losing more money with every sale they make. Meaning they have negative gross margins, and the more they sell, the more money they lose. They have to raise more money. You could show that you're growing sales 50 percent or 100 percent, and you could be losing 75 percent or 125 percent. So, price is only a measure of belief and expectations. Fundamentals are a measure of value. That discrepancy between fundamentals and expectation is where great investors are made.
Historically, when you had active investors in the market, you could short overly excessive expectations—which were either typically affiliated with fads or frauds or things that might face technological obsolescence—and you could be long the things that were ignored and unsexy but were great businesses, because they had really good fundamental value and really low expectations. And a lot of great investors over time just made that pairs trade. They would go long great companies, and short the crowd favorites that eventually would come back to reality.
Going back to religion: Religions only exist based on the strength of their believers. And as soon as people stop believing in a god or religion, it disappears.
We started this conversation by talking about the religion of Elon Musk. Do you get the sense that he's sort of using these people or that he truly believes in this?
My instinct is—in the same way that a good Sunday morning preacher gives people a community and hope—he has, in the case of SpaceX, delivered real teams of people that have delivered technologically, competitively advantaged engineering marvels. There's very little to criticize about SpaceX. (Notably, it's a private company.) In the case of Tesla, you have millions of customers that are very happy. You have a minority of customers that feel like they were misled. And you have an entire tribe of investors that are true believers and a minority of people that are saying the emperor has no clothes. I don't know what Elon truly believes. But I know that that number of true believers in Elon and the messages that he's been putting out are not going anywhere. And I would say I massively underestimated the power of religious belief.