Factsheet Commentary : June 2020

Fear of Missing Out (FOMO) seems to be chasing American tech stocks to dizzying levels while UK markets languish. The performance of the top five companies listed on the S&P 500 – all technology companies – has effectively kept the US market afloat this year. 

In the first seven months of 2020, the Amazon share price has appreciated 71%, Apple is up 44% and Microsoft grew 30%. Lagging behind was Facebook, up 23% and Alphabet, up 11%. All told, these five behemoths now account for over 25% of the S&P 500’s combined market capitalisation. Spare a thought: just five names, i.e 1% of the index constituents, now account for over a quarter of the index’s total value. From another perspective, Apple and Amazon’s combined market cap of $3.42 trillion now exceeds the combined value of the FTSE All Share and the AIM All Share. 

Just before the coronavirus took hold in the West, Apple, Amazon, Microsoft and Alphabet were selected among the top five reader picks in the Financial Times’ annual stock picking contest. Facebook was the 8 th most popular choice. While this demonstrates remarkable foresight among Financial Times readers, it also confirms how crowded these trades have become. Can this trend continue or is the current cheery consensus indicative that we are close to a peak? 

While we agree that these tech stocks are solid businesses and have become part of our daily lives, we feel that these market darlings have become just too popular, distorting the market. 

As investors, we should differentiate between a good company and a good stock. Let’s take Microsoft as an example. During the dotcom boom, the shares reached $59 in 1999, before crashing back down to earth, along with all of the other tech stocks. Over the next 17 years, Microsoft got bigger and stronger – its cumulative sales and profits were $995bn and $250bn respectively, average EBITDA margins were 39% and average ROCE was 29%. However, it was not until late 2016 that its shares finally got back to the $59 level. While investors earned dividends in the interim and the business performance was incredible, the stock went nowhere – for 17 years. This happened because investors overpaid for a cheery consensus.

We continue to evaluate our investment opportunity set, separating the winners from the losers. Our first rule is to avoid buying mediocre businesses – even if they appear to be temptingly cheap. Our second rule is to stick to quality businesses that will emerge stronger over the next 12-18 months – while ensuring we do not overpay. Entry price matters when it comes to both – return on capital and return of capital, i.e. safety of capital. 

Due to the current environment of uncertainty, markets are oscillating wildly and the sentiment pendulum swings from one extreme to the other – on a daily basis. One needs to stay patient and cool. It sounds simple, it isn’t easy.

Sterling Investments Management Ltd
Lynwood House 2-4 Crofton Road,
Orpington, England, BR6 8QE

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