Apple Inc (NASDAQ:AAPL) becoming the first company to notch a US$2trn market valuation has brought renewed attention on the upper echelons of the market.
But as the growth Apple and the 'FAAANM' group of stocks (Facebook, Apple, Amazon, Alphabet, Netflix and Microsoft) has blown the dial on traditional valuation measures, many investors are unsure about whether at current levels the stocks are must-have or should not be touched with a barge-pole.
What's more, is the dominance of this group perhaps masking an attractive underbelly of other companies below them?
Heavyweights and contenders
For context, the record high for the S&P 500 this week has really on the back of this group of just six stocks, with FAAANM the past 12 months has generated a US$2.9trn increase in market cap, or 74% of the market cap gain for the S&P as a whole.
Removing those six companies, the market cap of the S&P 500 is no different now from where it was in late January 2018 at just under US$21trn.
My favorite picture..— Alessio Urban (@AlessioUrban) May 30, 2020
The economy is so bullish for 6 stocks.. pic.twitter.com/tNotDHThxI
In the trillion-dollar zone, or the ‘tera-caps’ as some call them, with Apple are Amazon.com Inc (NASDAQ:AMZN) and Microsoft Corp (NASDAQ:MSFT), at either side of US$1.6trn, and Google owner Alphabet Inc (NASDAQ:GOOG), all the way down at US$1.05trn.
Next in the Nasdaq list and a big investor favourite of late is Tesla Inc (NASDQ:TSLA), though at US$350bn is affirmably in the second rank of giants.
The electric carmarker is on the verge of being added to the S&P ranks, though, with the extra implied boost liquidity that should bring.
Warren Buffett’s investment company Berkshire Hathaway Inc (NYSE:BRK.A) at almost US$500bn is worthy of mention due to its size but, apart from almost a quarter of its value coming from a huge stake in Apple, it does not have the tech va-va-voom that seems likely to double in size in the medium term.
Wilson suggests chip makers like near US$300bn Nvidia Corporation (NASDAQ:NVDA) and sub-US$100bn rival Advanced Micro Devices Inc (NASDAQ:AMD) as ones to watch, with the caveat that “they have already had a massive run up and are still a fair bit off the $1trn mark”.
Ahead of these are tech dup PayPal Holdings Inc (NASDAQ:PYPL) and Adobe Inc (NASDAQ:ADBE), which have both more than doubled over the past two years, as if that even means anything on the Nasdaq these days.
How did we get here? And will it last?
At the top end the valuations are so eye-waveringly massive, in absolute dollar terms and also in terms of price/earnings ratio, price/sales and other metrics, that it makes it hard for many old school investors to even contemplate.
It almost makes no sense to value these companies on fundamental terms.
Apple, which has not grown operating earnings in more than two years amid a highly competitive smartphone market backdrop where volumes are falling, yet has added US$1trn of market cap.
And Russ Mould, investment director at AJ Bell, says Tesla is even more of a mystery.
“I don’t get Tesla at all when its market cap is more than that of Toyota which has more than 10x the revenues,” he says, acknowledging other factors specific to this stock, including a massive short squeeze, the effect of an influx of new investors taking advantage of ‘free trading’ trend sparked by Robinhood and the view that Tesla is more about autonomous driving than it is about EVs.
Some analysts say it is quite plausible that 'tera-caps' and the broader technology sector could retain their leadership as long as attractive market fundamentals remained.
Other investors argue that backing the dominant tech names is a means of “paying for safety”, though Wilson questions this approach.
“If everyone is paying more for safety, then the asset class becomes increasingly less safe as a result if things turn sour,” he says.
“Take bonds, the traditional haven – how ‘safe’ are they at these levels and with such paltry returns?
“So, when everyone is ploughing into a handful of tech stocks because they offer relative ‘safety’, the one characteristic that makes them so appealing is lost.
"The strength of passive investing and passive funds means this is a self-fulfilling bubble, a vicious circle where the more the stock goes up in the likes of Apple or Microsoft, the more money needs to be allocated to it.”
Does the Nifty Fifty offer a historic parallel?
A different way of looking at it is described by Howards Marks of Oaktree Capital, who a few years ago wrote: “The things with the most obvious merit become the things that everyone likes. They’re also likely to be the things that are most likely to be pursued and highly priced and thus the least promising and the most treacherous.”
Marks cited the Nifty Fifty stocks in the 1970s, which were seen as the ultimate safe harbour at the time, though investors were routed along with everyone else in the 1973-74 bear market.
“In each case, the merits were too obvious; the investment ideas became too popular; and asset prices consequently became dangerously high,” is the Marks take.
Looking at the FAAAMN stocks, Mould adds: “The multi-trillion price tag for just six companies suggests investors are pretty much assuming that they will remain dominant forever – something that the technology industry’s history suggests might be unlikely.
“Facebook and Alphabet’s current advertising woes suggest nothing can be totally taken for granted in the near term, let alone the long term.”
What could upset the Apple-cart?
But he acknowledges that even if you do accept the view that valuations are getting dangerous, “that still begs the issue of what could lead to the sort of disappointment that persuades growth-hungry investors to move on, especially if customers still seem happy to pay for the services on offer — or accept access to their data as payment in kind, in certain cases?”
Regulation could be one possible source of difficulty, with Amazon, Apple, Alphabet and Facebook recently raked over the coals in Congress and tax and antitrust authorities calling for action.
A Democratic sweep of the White House, House of Representatives and Senate in the election later this year is possible in the event of a landslide.
This could, in theory only, usher in a period of tighter scrutiny and regulation, to the potential detriment of shareholder returns, said Mould.
“A break-up of the FAAANMs seems unlikely,” he adds. “Though when Microsoft was hauled up before Congress in 1998 on anti-trust grounds it had to open up and back off and let others into its chosen markets, such as browsers and that allowed newcomers to thrive, so competition developed.
“The same could happen again.”