To start this writeup, we would like to mention that only seven companies in the S&P500 index account for 25% of total valuation, but on the other hand, only 7% of its earnings. These companies are Apple, Microsoft, Google, Amazon, Nvidia, Tesla and Meta, in case you’re wondering. In an extreme example, Nvidia alone has gained 209% this year and is now selling around 216 times the free cash flow and 42 times the annual revenue. This means that, at current rate, it would take 42 years of sales combined (all expenses excluded) only to achieve its valuation. History does repeat itself from time to time, and we are observing similar valuations as in the in the 1960s and 1970s, which later halved or decreased even more. In 2023, it has been the AI boom pushing valuations higher. However, in the last 10 years, investors and institutions have been looking for places to deploy cash, especially in stocks, because treasury rates have been historically low. In the last few years, we have seen huge growth in earnings and valuations. Behind the magnificent seven, the truth is different. For example, the equally weighted s&P500 index has only gained approximately 30% in the last few years, while the ‘FANG’ stocks have gained around 140%, leaving many hidden opportunities behind the scenes.
Treasury bills are now yielding around 4-5%, while the S&P500 is yielding 3,8% at current earnings (remember the 25% weight of the magnificent seven in S&P500), but the catch is that in the last 10 years, the treasury rates have been extremely low versus S&P500 earnings yield, so the risk/return profile has changed enormously. In other words, we could say that for many companies, the expectations are too high to justify these conditions.
Our conclusion is that while many investors are rushing into the same hype as in 2020 and 2021, we continue to discover even more undervalued and insufficiently researched companies globally. These findings offer much more appealing risk/return prospects when compared to the S&P500, treasury bills and bonds. Recently, we have found most of our best opportunities among small & midcap companies, with few exceptions in large-cap section.
Tawast Partnership
August 3, 2023
