What is a New Paradigm?
In investing, a new paradigm is a revolutionary new concept or way of doing things that replaces old beliefs and 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 are so revolutionary that many people believe how we think and act going forward will fundamentally change.
New paradigms are rooted in the idea of paradigm shifts, 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 track companies that are on the frontier of innovation. A stock may soar based on its revolutionary way of doing things.
Investors need to be aware, though, that not all new paradigms pan out. While companies like Amazon (AMZN)—which anticipated 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 world-changing discoveries, yet many treatments never leave the developmental stage. Their stocks may (or may not) pop higher on speculative demand, only to fall right back to where they started, or lower.
Investors who bet on the companies that really do start a new paradigm, or capitalize on one, can make a lot of money over the long run, but finding these companies isn't easy. These companies are often highly speculative, have negative earnings, and are misunderstood in their early stages. It is only during later stages, once the price of the stock has moved up significantly, that most investors acknowledge the paradigm shift and start to jump on. This can create a lot of volatility, making it hard for investors to stick with new paradigm stocks 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 its initial public offering (IPO) before rallying off its lows of $1.50 per share. 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 $3,500 in 2020.
While Amazon thrived coming out of the dotcom bubble—which was based on the new paradigm of the internet—many of the other internet stocks did not. Many dotcom companies went bankrupt, and those that survived did so at significantly lower stock prices. It took many years for dotcoms to reclaim price levels achieve in 2000. Amazon didn't definitively move above its year 2000 high until 2009.
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 weary and abandon the stock.
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.