Tech stocks, “Big Tech” or the “Magnificent Seven” – the same the names get more stupid, the riskier investing in their stocks becomes. Many do not see it this way. For the bona fide investor these are core investments of their portfolios with great future potential. However, a critical look back at history tells us that the risk / reward ratio is not favorable. Size does not equal safety.
Summary and key takeaways from today’s Weekly
– It is tempting to rush into an existing hype or frustrating not to be participating in “clear” upward trends.
– However, especially regarding the tech sector, one should be cautious – the more so, if valuations already include a huge premium and success is set in stone.
– I clearly prefer a different approach: limited downside, but decent-to-high upside – mainly outside of the tech sector.
My longer time readers know that besides questioning common narratives, I pretty much like to have a look at historical events and developments. I am trying to extract something valuable and to mix it into my own stock ideas.
Everyone knows the saying “history does not repeat, but it rhymes”.
I fully believe in it. The reason is that human behavior and certain patterns stay the same. Only the protagonists change.
I think this is key to understand, especially in investing.
My members know that I am not a fan of the big technology stocks, because all my ideas so far have been stocks of companies with market caps below 100 bn. and the majority even below 50 bn. (USD, EUR, GBP, chose what you want), i.e. a tiny fraction of where the biggest of the big tech names currently trade.
Among them, so far, is only one tech stock.
Assessing historical patterns and looking at them from a risk / reward perspective, there is little incentive to invest in those stocks even if it hurts to watch them advancing further. Not only am I thinking that the returns could be disappointing.
I am not even sure these companies will continue to be of the same relevance like today, effectively being even high-risk investments.
Quite the opposite of what a core holding should be.
Today, I am going to present some historical precedents which raised serious doubts inside of me whether Big Tech (or Mag7) will continue to play the dominant role like in the past.
It is a reminder of not to rush after the hottest stocks, memes and topics – even in the case that I should be too early with my call.
Also, better do not to choose solely based on the size of the market cap.
Not only because in most current cases a success is already priced in, effectively increasing the risk for a coming underperformance to let the lagging operations “grow into the valuation” – but also, because historically the pioneers often have not even made it to the finish line.
Yes, you read correctly. Or they end up somewhere in no-man’s land. Both are not favorable positions to place a bet.
This time’s different?
I am going to present a few things you should know and at the end explain which sectors I favor instead. You can see from the average performance of my stock ideas that swimming against the tide is worth it – in case you know what you’re doing.
The average total return of my best stock ideas is +13.7%, easily beating the S&P500 and the iShares MSCI World ETF.
as per 06 December 2023 market close
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The risks of being among the biggest
Being big is great – you have economies of scale, either great or even huge market dominance, you cannot be taken over by a competitor and also everyone is buying your stock so that barely anything can go wrong.
Or can it?
In the past, I have already written about sector rotations on several occasions (see here, here, here, here and here), but today I am going a step further. By opening up the history books, we can look at two more topics, namely the top 10 by market cap and how technological disruptions unfolded.
The first is done rather quickly.
Here is an overview of the ten biggest stocks at the beginning of the last decades, respectively at the end of 2019. You will notice many familiar names, others, however, could surprise you.
We also know that from the last column, the Chinese stocks already disappeared, while the US names got dramatically bigger and others like Berkshire Hathaway (ISIN: US0846701086, Ticker: BRK.A), Tesla (ISIN: US88160R1014, Ticker: TSLA) or Nvidia (ISIN: US67066G1040, Ticker: NVDA) joined the ranking.
You will quickly see that no decade ended the same like the prior one.
I am not talking about maybe just the constituents having a slightly different order next time – this has never happened in history.
Using history as a precedent, it is highly unlikely that the majority of today’s dominating names (by market cap) will be back at the end of 2029.
Potential reasons are several-fold.
You can have mergers, like in the case of Exxon and Mobil in 1999 or breakups like in the case of AT&T (ISIN: US00206R1023, Ticker: T) in the early 1980s.
Another possibility is that an entire sector (2000 tech and media bubble) or even country (1989 Japan) can concentrate the majority of capital on them in such a manner that everything and beyond is already focussed on them and thus priced in.
Such exaggerations finally burst and it takes time, if at all, to reach the former levels again – by the way on a nominal basis, inflation-adjusted is another topic. Japan has still not reached its all-time highs even on a nominal basis; you should also factor in currency devaluations as a foreign investor.
Even though many claim that the Japanese market rose greatly during 2023 – better look at the USD or EUR performance, if you’re (likely) from outside the rising sun.
What is also important to understand in this context is that bubbles burst when everyone and their neighbor are invested. It has nothing to do with mysterious and mighty speculators or short-sellers with fat fingers that by the way have never been found and presented to the public.
Let’s be honest: how high are the odds for Big Tech (or Mag7) to continue their run?
They all have earnings multiples of around 30x or more (with the exception of Meta (ISIN: US30303M1027, Ticker: Meta) ) and they are so big that it is only a question of time until their growth stops. In the case of Apple (ISIN: US0378331005, Ticker: AAPL), this has already happened.
They need disproportionately more and more effort and capital to grow operationally. And ever more and more buyers to lift their stocks.
Tech bubbles are pretty common. There have been various exaggerations involving different new technologies in history – just think of railroads, radios, the first cars… The innovations are still around in one form or the other. But…
The last reason and certainly harder to exactly foresee is simply that companies lose their dominance – for whatever reason. At least I do not know a company that was dominant in the 1920s or even 1960s to be still in the same role today.
To be honest, I even have difficulties in finding a name from the 80s. Exxon might be an outlier, however, it is way behind the big tech stocks.
Whether it is due to simply not growing anymore and falling behind on a relative basis, by becoming irrelevant like Lucent and IBM (ISIN: US4592001014, Ticker: IBM) or by going bust like Kodak – a drop-out of these ranks is likely going to result in a disappointing underperformance of the stock which is the opposite of what investors in the biggest names aim for.
I, for my take, prefer to rely on historical patterns and boring valuations either with very low or no expectations at all for a surprise to the upside – not on blank beliefs / hopes.
Below, I put in two screenshots from Twitter / X (I deleted the names to not discredit anyone).
The first asks a stupid question whether Alphabet (ISIN: US02079K3059, Ticker: GOOGL) is a buy, just because the stock is down by 6%.
On the second shot, you can see someone being optimistic, because the future valuation of Nvidia does not look so bad for him. To put it into context, Nvidia would need to grow 3–4x (i.e. 200–300% in total) in its underlying business, based on the earnings multiple, to justify its current valuation. Maybe it could achieve it in five years, maybe only in ten – who knows?
Where is the upside potential? Do you want to buy something where the next decade is already baked into the valuation?
Even if Nvidia’s underlying business indeed grew further – the valuation will hold them back at some point, if history is correct.
Not to mention that we are talking about a highly cyclical business.
source: Twitter / X (both)
We know how the Nifty Fifty (big concentration of pretend quality stocks where “nothing could go wrong“ like Kodak, Polaroid, IBM, etc.) of the late-1960s and early-1970s ended up…
If you’re still convinced that this is no problem with today’s representatives, what about this: Did you know that many early pioneers and success stories in tech historically and suddenly disappeared?
We know there’s currently much hype about AI.
We can see it in the ultra-bullish sentiment for certain stocks which only seem to know one direction. The winners seem already to be set in stone and untouchable.
Pesky grumblers like me are laughed at as not understanding what’s behind the rush.
Therein, however, lies the danger. I also heard young kids talking about Nvidia and AI when I went for a walk, recently…
If we look at a few examples of the past, caution is advised.
First of all, one should not assume that such disruptive forces suddenly arise and stay on an instant basis. There are ups and downs, good decisions and silly decisions, luck and bad luck. And there’s competition.
The process of implementing a new technology happens over time.
From an investment perspective, it is almost impossible or let’s say unlikely to pick the future winner.
When a new trend began, the future winners have never been the big companies of that time.
Let that sink in, before I give you examples.
New, innovative companies and mid-sized ones that maybe acquire relevant assets (like Apple did with the touch functionality before it brought out the iPhone) make the race on new tech. This applies to gaming consoles, PCs, peripherals like printers, the internet, semiconductors, first cellphones and later smartphones, portable music and more.
Early inventors and pioneers of the first two – gaming consoles and PCs – were names like Atari, Commodore, Sinclair, Xerox (ISIN: US98421M1062, Ticker: XRX), Simon, LINC and also of course IBM and Apple (but very shaky and long-term). Of course, there were many more, but you understand. Who’d have picked the right one?
And even though IBM grew in the 1980s into a dominant role while Apple was facing bankruptcy, the former, “Big Blue”, later also had to leave the playing field.
With laser printers, Xerox was the inventor (in the polish language, the company’s name is used as a verb for doing a copy) and IBM also for a brief time played a strong role. In the commercial mass market, HP (ISIN: US40434L1052, Ticker: HPQ) made the first step forward. Brother Industries (ISIN: JP3830000000, Ticker: 6448) and Canon (ISIN: JP3242800005, Ticker: 7751) from Japan followed suit.
Again, picking some of the first movers did not result in a long-term success.
The internet: any AOL, Mosaic, Netscape, ICQ or Yahoo still in use on a grand scale? Before Google came up, Yahoo was the dominating search engine. I also remember names like Lycos or Fireball (however, I do not know whether there were such stocks).
Semiconductors: Intel (ISIN: US4581401001; Ticker: INTC) has massively lost and suffered over the last years by first missing on the mobile revolution entirely and then even losing tech leadership in its home base. What about Fairchild Semiconductor, Motorola, Zilog, National Semiconductor or Sun Microsystems?
Cell and smartphones: You certainly know the pioneers Motorola and later Nokia? IBM also had a first smartphone! Later came Palm and Blackberry. Sharp made the first cellphone with a camera. Great!
Portable music: Does anyone have still a Sony Walkman? I know this example is a bit odd, as Sony was and is more than just this. But you see that successful products come and disappear again.
While the underlying trends are likely to continue to develop and become more relevant – we are using automobiles, cell phones, computers, the internet – it is by no means sure who wins the race of a new evolution. What is likely, however, is that the early pioneers have no guarantee, even a high risk, of becoming obsolete.
If history is right, there will be a LOT of disappointed investors who never bother to look at history. Many are not free of bias and greed.
I am relaxed watching this current and any future hype to shake out.
These are the sectors where I see opportunities
Due to my fundamentals and valuations influenced drive to look for promising stocks that feature limited downside and decent-to-high upside, it is not a surprise that “my” playing field is somewhat different.
Here are the sectors – in no particular order – where my best stock ideas for my members currently come from:
- offshore energy
- tech (yes, one tech stock, even)
- industrial (special situation)
- a REIT in a dying subsector
- a few out of favor consumer picks
My approach, in many cases contrarian, of mixing a driving background story (a catalyst for a re-rating), an easy to understand business model, strong finances and a conservative valuation with low downside, but enough upside, so far proved to be the right one.
As can be seen from my frequent updates (especially in my free newsletter), the average performance is way above the benchmarks. Without a single Big Tech / Mag7 stock. I claim that due to the high quality and not having to carry around many of the ballast the indexes have, such a selection also contains less risk than ETFs or richly valued stars of today.
In my last two reports for my members (Premium PLUS and Premium, each), for example, I shared one stock where I think the price dropped way too much. Luxury for a (at the minimum) 50% discount? You can have it. What about an almost forgotten tech stock with 1/3 of its market cap in net cash?
It is tempting to rush into an existing hype or frustrating not to be participating in “clear” upward trends.
However, especially regarding the tech sector, one should be cautious – the more so, if valuations already include a huge premium and success is set in stone.
I clearly prefer a different approach: limited downside, but decent-to-high upside – mainly outside of the tech sector.
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