What is a New Paradigm?
In the investing world, a new paradigm is a revolutionary new concept, idea, or way of doing things that replaces the old beliefs or ways of doing things. This may stem from a political or economic event, a new finding in academia, new technology or innovation, a new business or business leader, or another important occurrence. New paradigm ideas or concepts are so revolutionary that many people believe it will change how we think and act going forward.
New paradigm draws its roots from the idea of a paradigm shift in science, in which technology or new findings completely change the way people think about or interact with a subject.
- A new paradigm is a new way of thinking or doing things that replaces the old.
- New paradigms in the stock world can mean great profit potential as investors pile into revolutionary new ideas.
- Investors in new paradigm ideas should tread cautiously as prices can become too inflated based on hype. When reality sets in, the real value of the company or companies may be significantly lower than its peak stock price.
Understanding a New Paradigm
Investors can watch new paradigms unfold before their eyes as they watch the stocks of companies that are on the frontier of innovation. A stock may soar based on its revolutionary way of doing things.
Investors need to aware though that not all new paradigms pan out or end well. While companies like Amazon Inc. (AMZN)—which saw the demand for internet shopping and capitalized on it—saw great success, not all companies do. The pharmaceutical sector is filled with companies "on the verge" of making great discoveries that could change the world or the healthcare system, yet many of the drugs or treatments they are making never get out of the developmental stage. Their stocks may (or may not) pop higher on speculative demand, only to fall right back to where it started it, or lower.
Investors who bet on the companies that really do start a new paradigm, or capitalize on a new paradigm, can make a lot of money over the long run, but finding those companies isn't always easy. These companies are often highly speculative, have negative earnings, and are misunderstood in their early stages. It is only during their later stages, once the price of the stock has moved up significantly, that most investors become aware of it and start to jump on. This can create a lot of volatility, making it hard for investors to stick with the stock(s) for the long haul.
Between 1997 and 2009, Amazon stock had seven drops of 60% or more, and the stock dropped by 95% between 2000 and 2001. Initially, the stock dropped by 46% after the initial public offering (IPO), then rallied from a low of $1.31 and has never seen that price again. Some early investors may have profited handsomely but would have likely been shaken out by the many severe drops well before the stock price eclipsed $2,000 in 2018.
While Amazon thrived coming out of the dotcom crash (2000 to 2002)—which was based on the new paradigm of the internet—many of the other "internet' stocks did not. More than 50% of the dotcom companies went bankrupt, and the 48% that survived through to 2004 did so at significantly lower stock prices. It took many years most companies to recoup the stock prices that occurred in 2000, and many still trade far below those levels. Amazon's stock price didn't move above its year 2000 high until 2016.
New paradigms are often followed by a reckoning because investors overestimate how much will change. They drive up valuations too high, and the prices fall significantly after reality sets in. Ultimately, companies have to produce profits to justify high stock prices. If the companies can't generate profits, no matter how novel their idea or product, investors will eventually grow wary and abandon the stock.
The Harvard Business Review often publishes pieces dig into paradigm shifts or new paradigms in the business and investing worlds. For example, “You Don’t Have to Choose Between Fast, Cheap or Good. Instead, Change the Paradigm” (April 2018) posits that, instead of compromising between two out of the three above values, leaders should instead focus on optimizing all of them. By being creative, using data, and modeling start-up behavior, the article’s authors argue that leaders should be able to re-think the way they make trade-offs. New ways of thinking, like this, can help investors frame various challenges such as which assets or asset classes to select for a portfolio.
Real World Examples of New Paradigms
The term "new paradigm" became a widely used phrase in the 1990s, as marketing firms and businesses began to use the term for almost any new product or campaign. It was notably used during the dotcom boom years. At times, it seemed that anything and everything involved with the Internet was described as a "new paradigm" or a "paradigm shift."
The years in the late 1990s were characterized by high-flying tech stocks that eventually crashed. From 1995 to 2000, the technology-dominated NASDAQ index rose from below 1,000 points to more than 5,000 points. Technology companies became a new paradigm for investors and analysts as their products and modes of thinking had the ability to fundamentally change the way that businesses operated and grew. The internet certainly did change things, but investors initially valued the companies too high. Their real value, at the time, was considerably lower than the peak prices investors drove these companies up to.
The Great Recession also provided a new paradigm for many investors as the notion of rooting out and supporting more sustainable investments came into the limelight. It became important to some investors and asset managers to consider environmental, social, and governance (ESG) factors when investing. As became evident with the housing bubble and crisis, complex financial instruments like mortgage-backed securities without sound underlying assets proved disastrous.