If you look deeper under the hood of the stock market, you’ll see that there is a significant dichotomy between bytes stocks and atoms stocks. The atoms are losing to the bytes, badly. If you compare performance of the S&P 500 (SPY) traditional market-capitalization index – the one you see in the news – to its less-known cousin, the S&P 500 equal-weighted (RSP), you’ll see a significant disparity in performance.
In the market cap-weighted version, the top five stocks (all five are members of FANGAM gang – Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), Google (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT)) now represent 21% of the capitalization of the index (the last time this happened was 1999) and thus account for 21% of the returns. In RSP these stocks have a weight of 1% (they’re just 5 out of 500 stocks).
Just as any propaganda needs a certain germ of truth to grow from, so do bubbles. The FANGAM are incredible companies (germ of truth), and they function better in the virus-infested world (another germ of truth). But at the core, their existence is grounded in the world that is built of atoms, not bytes.
The Nifty Fifty stocks come to mind here. Those were the fifty stocks – the who’s who of the 1960s –that made America great (then): Coca Cola (NYSE:KO), Disney (NYSE:DIS), IBM (NYSE:IBM), Philip Morris (NYSE:PM), McDonald's (MCD), Procter & Gamble (PG) … the list goes on. Though today we look at some of them as has-beens, in the ’60s and ’70s the world was their oyster. Coke and McDonald's were spring chickens then, spreading the American health values of diabetes and cholesterol (okay, maybe I’m being too hard on them) across this awesome planet.
Although it was hard to imagine in the ’70s that any of these companies would not shine forever, they are a useful reminder that even great companies get disrupted. Avon (AVP), Kodak (KODK), Polaroid, GE (GE), Xerox (XRX) –all were Nifty Fifties, and all either went bankrupt or are heading towards irrelevancy.
In the 1960s and early 1970s these stocks were one-rule stock – and the rule was, buy! They were bought, and bought, and bought. They were great companies and paying attention to how much you paid for them was irrelevant.
Until.
If you bought and held Coke or McDonald's in 1972 (or any other Nifty Fifty stock), then you experienced a painful decade of no returns; in fact, at times you were down 50% or more. Coca Cola was as great a company in 1974 as it was in 1972, but the stock was down 50% from its high. Okay, Coca Cola was trading at 47 times earnings in 1972. But even a company like Procter & Gamble that was trading at “only” 32 times earnings in 1972 was down almost 50% in 1974 from its 1972 high. It took until the early 80s – a decade – until investors who bought Nifty Fifties at the top broke even – and this applies to almost all of them.
Another issue: If you held many Nifty Fifties for 20 years, from 1972 to 1992, they would have delivered a decent (10%-plus) return. This sounds great in theory; however, most people would have run out of patience after a decade of no or negative returns and thus not have been around for the fruits of the ’80s decade. In other words, shareholders who bought the stocks in 1970 were not the ones who benefitted from the returns in the late ’80s.
Today the Nifty FANGAM has turned into one-rule stocks – buy! (irrespective of price). If you did not own them over the last decade, your portfolio had an enormous headwind against it.
But what the Nifty Fifties showed us is that company greatness and past growth are not enough. Starting valuation – what you actually pay for the business –matters. The great companies will still be great when their stocks are down a bunch and they have a decade of no returns. Dividends aside, stock returns in the long run are not just driven by earnings growth but by what the price-to-earnings does as well. If price-to-earnings is high, it’s mean reverts – declines – chipping away at the return you receive from earnings growth.
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