Investing is hard. Seeing a stock you own fall in price and resisting the itch to sell takes a strong stomach. Seeing stocks you find expensive soar without you is no fun, either. It takes discipline to tame the fear of missing out.
Today that fear centres around the market's obsession with artificial intelligence and the so-called "magnificent seven": Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, and Tesla. As a group, they are up over 50% year to date[1]. Standout winner Nvidia soared by around 180%, while Apple delivered the lowest return—a mere 31%. It doesn't surprise us that we have missed some big winners this year. We always do, even in our best years. We'd love it if every share we bought was a winner, but we are not trying to buy every winning share. In the last six months alone, at least 119 investable stocks have returned more than Apple's 31%.
Excluding the tech giants, that's sixteen other magnificent sevens, and we've owned several of those stocks. But the median stock in that group is valued at only $11.2bn. If a company of that size even doubles in price, it will contribute a grand total of 0.01% to the return of the World Index. In any period, there are lots of big winners, and lots that we miss. It is rare for them to be seven of the biggest companies on earth.
It's not all about the giants
But the magnificent seven are among the biggest companies on earth, and they have moved markets materially. Across the Orbis portfolios, we have favoured mid-sized companies over giants, international firms to those in the US, value over growth, and banks over tech. This year giants have squashed mid-sized companies, US businesses have beaten foreign ones, growth has outrun value, and tech has trounced banks. Yet our long globally-oriented strategies have nearly kept pace with their benchmarks. Idiosyncratic stockpicking matters, and while we have missed some headline grabbing winners, plenty of our lesser-known stocks have quietly thrived.
A few years ago, Nvidia was lesser-known, too— at least outside of gaming and crypto circles. AI enthusiasm sparked by ChatGPT has changed that. As the designer of the leading AI chips and the programming platform used to build software for them, Nvidia is seen as the biggest beneficiary of AI growth. The results are real—Nvidia's revenue last quarter was double the level of a year ago. For an already-huge, highly-profitable company, such rapid growth is astounding. Well done to them.
Having doubled revenues this year, investors expect the company to grow by at least 30% p.a. for years to come. The rub is, that growth potential is now clear to everyone! So those expectations are already reflected in today's valuation. The company has to deliver exceptional growth just to justify its current price.
Today that price is high. After a mad dash by brokers to increase their forecasts, the stock trades at 14 times estimates of sales for the next twelve months. That's 14 times the next twelve months' top line, before any expenses. When a big stock trades at these levels, commentators dig out a quote from Scott McNealy, former CEO of Sun Microsystems. McNealy reflected on the valuation of his own company, which reached ten times sales during the 2000 tech bubble. Having laid out assumptions that make it sound impossible to profit from a stock trading at ten times sales, he asked investors, "what were you thinking?"
Valuations matter
What investors were probably thinking (if they were thinking) is that Sun would grow very quickly. We've written before that paying ten times sales for a business is generally a bad idea. But it's not impossible for a company to live up to the sort of growth now expected of Nvidia. Just exceedingly rare.
Since 1990, only about 230 companies in the FTSE World Index have ever grown revenues by more than 30% p.a. over five years (a near-quadrupling of sales). That's 7% of the 3,400 relevant stocks that were in the Index. The feat is rarer still for already-huge companies. Only 45 businesses have ever delivered that kind of growth after cracking the top 200 of the Index, or just 6.5% of relevant companies that were ever that big. The hit rate is higher for expensive companies, suggesting markets do have some efficiency. 23% of huge companies trading at more than 10 times sales have gone on to sustain 30% p.a. growth. But that is less encouraging than it first appears. The flip side is that three quarters of the time, it doesn't play out. Three quarters of the time, huge expensive companies don't deliver the exceptional growth expected of them.
Nvidia's results in August this year were a reminder that it is hard to exceed high expectations. Having rocked the market with its results and outlook in May, Nvidia did so again. Sales and guidance both exceeded estimates by more than 20%. Yet the next day, the stock closed flat.
Valuations always matter, and they reflect expectations. The market's shrug suggests that much of Nvidia's future growth is already priced into the stock. To justify its current price, the company must deliver mind-bending growth. To hit brokers' price targets, its growth must accelerate from mind-bending to mind-blowing.
Maybe it will—its recent results have been stunning. But we much prefer to invest in companies that trade at discounted valuations and are trying to clear a lower bar. While the magnificent seven are great businesses, we've found several dozen companies that we believe will be more magnificent investments.
To find out more about our approach, and the importance of diversification in the coming decade, click here to download and read our full white paper.
Disclaimer
The contents of this communication have been approved for issue in the United Kingdom by Orbis Investments (U.K.) Limited which is authorised and regulated by the Financial Conduct Authority. Orbis Investments (U.K.) Limited and Orbis Investment Management Limited are members of the Orbis group of companies ("Orbis").
This communication does not constitute an offer, solicitation or recommendation to buy, sell or hold any interests, shares or other securities in the companies mentioned in it. Orbis has not considered the suitability of this investment against your individual needs and risk tolerance. You must not rely upon this communication or any part of it as investment advice and Orbis does not assume and will not accept responsibility or liability (whether arising in contract, tort, negligence or otherwise) for any error, omission, loss or damage (whether direct, indirect, consequential or otherwise) in connection with the information in this communication and disclaims any such liability to the maximum extent permitted by law. This communication represents Orbis' view at the date stated and may provide reasoning or rationale on why we bought or sold a particular security for a fund. We may take a different/the opposite view/position from that stated. This is because our view may change as facts or circumstances change. This communication has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Entities and employees of Orbis are not subject to restrictions on dealing in relevant securities ahead of the dissemination of this review. Past performance is not a reliable indicator of future results. When investing your capital is at risk.
[1] All performance figures as of 31st October 2023
