Yahoo Finance Nvidia, Apple and other soaring megacaps are hiding a weak market
Consistently predicting short-term market moves is extremely challenging, even for investment professionals.
Some may attempt to profit from popular trends such as cannabis legalization, cryptocurrencies, electric vehicles or artificial intelligence, but successfully timing an exit can be even more difficult than identifying the right entry point. This is why those giving into the fear of missing out can do a lot of damage to a portfolio if you get the timing wrong.
The euphoria about various market segments can be quite enticing, though. For example, the percentage of S&P 500 stocks beating the index is at its lowest since March 2000, according to Michael Kantro, chief investment strategist at Piper Sandler Cos. This isn’t a surprise as the S&P 493 is only up one per cent this year versus an average of 40 per cent for the other seven stocks. Meanwhile, the energy- and bank-heavy S&P/TSX composite index is up just 2.4 per cent this year.
The herding into top-performing megacaps has been so prolific that it has sent multiples skyrocketing to incredible levels: Nvidia Corp. has a market capitalization of US$963 billion and trades at 38 times its revenue; Microsoft Corp. is valued at US$2.5 trillion and trades at 12 times revenue; Tesla Inc. has a market cap of US$612 billion and trades at eight times revenue; Apple Inc. stands at US$2.75 trillion with a valuation of more than seven times revenue; and Google parent Alphabet Inc. is valued at US$1.6 trillion and Meta Platforms Inc. is at US$671 billion, yet both trade at over six times their revenue. Only Amazon.com Inc., with a US$1.25-trillion market cap, is being left behind, trading at only 2.2 times revenue.
It’s understandable to assign higher revenue multiples to smaller and highly disruptive companies with exponential growth potential. However, the combined market capitalization of these seven companies now exceeds US$10 trillion, so how can they deliver such growth while defying the laws of diminishing returns, especially when they were unable to do so when they were smaller, more innovative and capital was next to free with interest rates hovering around zero per cent?
Over the past decade, Nvidia’s revenue has grown sixfold and yet the market is now giving it a 38 times multiple. Microsoft has grown revenue by 2.7 times with a current 12 times multiple, and Apple’s revenue has grown 2.2 times and yet it has a seven times multiple.
It isn’t as if this hasn’t happened before. Take Sun Microsystems Inc., which traded at more than 10 times its revenue prior to the bursting of the 2000 tech bubble. In 2002, chief executive Scott McNealy responded to the aftermath with a thought-provoking quote.
“At 10 times revenues, to provide a 10-year payback, I would have to distribute 100 per cent of our revenues to shareholders for 10 consecutive years in the form of dividends. This assumption assumes that I can achieve such an arrangement with our shareholders, that we have no cost of goods sold (which is highly unlikely for a computer company), that we have zero expenses (difficult with 39,000 employees), that we pay no taxes (also challenging), and that you, as shareholders, pay no taxes on the dividends received (which is illegal),” he said.
“Additionally, this assumption presumes that, with no investment in research and development for the next 10 years, we can maintain the current revenue rate. Considering these unrealistic assumptions, would any of you be interested in purchasing our stock at US$64? Can you fathom the absurdity of these basic assumptions? We don’t need any transparency or footnotes to recognize their implausibility. What were you thinking?”
In a seemingly repetitive cycle, we wonder if we will eventually be questioning ourselves again with a “what were you thinking?” moment. If you are tempted to say “this time it’s different,” we checked with ChatGPT and will leave you with its answer.
“By acknowledging the historical patterns and being mindful of the risks associated with disregarding them, investors can make more informed decisions and avoid potential pitfalls,” it said. “It’s prudent to exercise caution, diversify portfolios and focus on fundamental principles rather than getting carried away by the idea that the current situation is entirely unprecedented.”
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
_____________________________________________________________
If you like this story, sign up for the FP Investor Newsletter.
_____________________________________________________________
