The Iffy Fifty

This month, our sister company Allan Gray Proprietary Limited celebrated its 50th anniversary. To have thrived for so long is an inspiring achievement, and a testament to the legacy of our founder, Dr Allan Gray.

Much has changed since 1973, but as others have observed, the market environment in 1973 has parallels with the current one. Both feature the widespread belief in an anointed collection of stocks seen as inevitable winners for decades to come. Today it is the Magnificent Seven group of US tech giants. In 1973 it was a group of fifty US companies viewed as “one-decision” investments—once you decided to buy, you never needed to think about them again. Before they crashed, bringing the S&P 500 down by 45%, they were called the Nifty Fifty.

History may not repeat, but it does (almost) rhyme. Meet the Iffy Fifty of 2023.

The table updates an analysis we first did in July 2020. At the time, the market’s leading lights were called the FANGAMs, after Facebook (now Meta), Apple, Netflix, Google (Alphabet), Amazon, and Microsoft. Having benefitted magnificently as other companies suffered during lockdowns, many of the FANGAMs looked fully valued. But they were not the most bubbly stocks in the market. We looked for a dubious echelon of more expensive stocks with worse fundamentals—companies with higher price-to-revenue valuations than the stars, but with slower growth and lower margins. We found about a hundred of them, which we called the Heady Hundred.

Remarkably, the Heady Hundred have performed well since then, which invites one of two interpretations.

One possible interpretation is that aiming for richly priced stocks with underwhelming fundamentals is a good idea. On this view, high prices are not a risk, but a signal to lean into, because the market correctly, grasps that the future will be better than the past, but underestimates the scope of the improvement. Over short horizons, this can work, and it is the intuition behind momentum investing, or simply buying whatever has performed well recently. Over long horizons, however, chasing stocks that are richly priced for their fundamentals tends to end in tears.

The other interpretation is that we are still in or have swiftly returned to a bubbly environment. This is far more consistent with what we see looking across global markets. The FTSE World Index is nearly back to its record high, and now trades at 22 times expected earnings, despite interest rates that have risen from near-zero to 5%. So we decided to run the Heady Hundred analysis again, using today’s stars as the bar.

We found fifty stocks—the Iffy Fifty—that trade at richer price-to-sales valuations than the Magnificent Seven, despite having worse growth and profitability.

In aggregate, the Iffy Fifty are not bad businesses, having grown revenues at a double-digit rate over the past decade with healthy margins. But at 13 times revenues and 46 times expected earnings, they are eye-wateringly expensive. To us, that looks risky, particularly when dozens of shares, including some we own, offer much better fundamentals and much lower prices. The rich valuations of the Iffy Fifty suggest that the recent bubble is far from deflated.

And while the Iffy Fifty look like minnows next to the tech giants, they are not small. They are valued at a total of $2.2 trillion—roughly the size of the whole UK stockmarket.

That comparison is telling. The UK market trades at just 2 times revenues and 14 times expected earnings, while offering a 3.6% dividend yield. That is much more appealing to us as a hunting ground. And the UK companies we have found are even cheaper, in sectors spanning aerospace, energy, retail, and consumer staples. All of the Orbis Strategies that can own UK shares hold more than their benchmarks.

That is to say nothing of the attractive mid-cap stocks we discussed last month, or Japanese and Korean banks which trade at price-earnings multiples you can count on your fingers. Even in US tech we have found compelling ideas—but in unloved semiconductor manufacturers trading at low valuations.

World stockmarkets still offer plenty of opportunities. We just feel no need to own every stock in them.

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