They’re always watching. They know where you went on the weekend. They know every search query you’ve ever made. They know your buying habits, and what all of your friends are doing. Big Brother is watching.
I’m referring to four US tech giants — Apple Inc. [NASDAQ:APPL], Alphabet Inc. [NASDAQ:GOOGL], Amazon.com, Inc. [NASDAQ:AMZN] and Facebook, Inc. [NASDAQ:FB].
But they do more than just monitor every move you make. They also dominate emerging industries like self-driving cars, artificial intelligence, and commercial space travel.
Soon they could end up taking over every industry. No company will be safe. As reported by The Telegraph:
‘…the tech giants have started blowing money on an epic scale. From challenging the car industry, to virtual reality glasses and watches that double up as computers, or TV series that don’t even have a script, the tech barons have embarked on a colossal spending spree from which the returns are likely to be meagre.’
But what’s not meagre are the returns you could have made on all four companies this year. Take a look at the graph below. Throughout 2017, they’ve climbed up without any trouble.
[Click to enlarge]
Had you bought all four at the start of 2017, your average return would be 26.79%. Not bad in six months. Amazon and Facebook were the best performers, both climbing more than 30% year-to-date (YTD).
So why not throw your lot in with them? Surely they’d make great investments if they continue to become leaders in multiple industries?
Yet, right now I don’t think you should buy any of them.
When looking at stocks don’t buy assumptions
It’s not that I don’t recognise they’re all phenomenal businesses. They are. But buying a phenomenal business, even at a high price, will still limit your returns. This is because they have to grow even more to outperform lofty expectations.
Let’s use Apple as an example. It is the cheapest among the four. The stock trades on a price-to-earnings (P/E) ratio of 17-times earnings. Meaning, investors are willing to pay $17 for every $1 of earnings.
This doesn’t mean much on its own. To get an idea of whether this number is low or high, we can compare it to Apple’s historical average.
Over the past five years, Apple averaged a P/E of 13.6-times earnings. Therefore, compared to its five year-average, Apple looks expensive.
You can thank index investors, along with others who buy and hope for growth, for Apple’s expensive price tag.
While the stock has climbed tremendously throughout the year, the underlying business hasn’t improved all that much.
CEO of Aitken Investment Management, Charlie Aitken, agrees. While he believes Apple is a great business, he wouldn’t think of buying the stock right now.
‘Make no mistake, Apple is a solid company, but its move this year is utterly unjustified on fundamentals. The stock has added $US240 billion in market cap and is up 29 per cent year to date. Apple is simply not a $US240 billion better business than it was on January 1.’
It’s almost as if investors are buying an assumption. They’ve flooded into US equities, hoping growth is just around the corner.
So what happens when that growth turns out to be lower than expected? Well, you’ll likely see investors rush out of the stock. Many will end up getting out for a loss.
What’s the alternative?
Buy stocks that you know are cheap. I’m not necessarily talking about stocks with low P/Es. I’m talking about an 80-year-old strategy that demands significant assets backing up your investment.
When it comes to investing go where the competition isn’t
There’s one thing the share market has in mass supply — earnings-focused investors. If you look at a company’s earnings and share price, you’ll notice they both move together.
Take a look at the graph below. It shows the net income (orange line) and share price (white line) of BHP Billiton Ltd [ASX:BHP] over the last five years.
[Click to enlarge]
No wonder investors are so eager to predict future earnings. Doing so can give you the ultimate advantage.
The problem is, no one can do this accurately. That’s why earnings forecasts are always subject to forecasting error.
I’m not saying you shouldn’t look at earnings. If a business has no long-term earnings prospects, then you’d be wise to steer clear.
But a sole focus on earnings puts you in the same boat as millions of other investors trying to do exactly same thing.
Why not go where there’s less competition? Why not focus on something that’s real, and base your analysis on the assets of the business?
Minimise your risk to maximise your returns
Imagine you could buy a company trading for less than its net assets. Meaning, you could buy a stock for less than its total assets minus total liabilities.
Even better, imagine you could buy a company for less than its net current assets. Meaning, you could buy a stock for less than its current assets minus total liabilities.
Sound too good to be true?
After the 1929 Wall Street crash, the market was full of these opportunities. As reported by Forbes:
‘A study made at the Columbia University School of Business under the writer’s [Benjamin Graham] direction, covering some 600 industrial companies listed on the New York Stock Exchange, disclosed that over 200 of them–or fully one out of three–have been selling at less than their net quick assets.
‘Over fifty of them have sold for less than their cash and marketable securities alone. In the appended table is given a partial list, comprising the more representative companies in the latter category.’
These are investments that Benjamin Graham, the father of value investing, prefers. From 1936–56, Graham’s investment firm posted annualised returns of about 20%. During the same period, the board market returned something like 12.2% annually.
But can you still find these opportunities today? Simple answer: yes.
As at 26 June, 2017, there were 325 stocks trading for less than their net current assets in the US. In Australia, there were 73. In London, there were 46. And in Canada, there were 69.
So while they might not be as plentiful as they were in the 1930s, they’re still out there.
But of course, not every stock trading below its net current asset value is a winner. Some of these companies will destroy their own value by selling assets just to stay alive. These are the companies you want to stay away from.
But to me, it’s not the returns that make this strategy so attractive. It’s the focus on risk. Graham’s approach is all about minimising your downside risk. He reasoned that if the company was wound up tomorrow, he’d still make money. Because he bought stocks for less than their net current assets, he’d be entitled to more than he paid.
So you could join the herd and rush into US tech giants. But as I mentioned above, you could pay far too much for expectations of growth. Instead, why not go where the competition isn’t, and know you’re getting more than you paid for?
For Markets & Money
PS: Value guru Greg Canavan has a similar approach. He digs for out-of-favour stocks waiting to surprise the market and skyrocket up.
In his advisory service, Crisis and Opportunity, Greg takes advantage of temporary crisis situations. Through his analysis, Greg is often able to find stocks which can return 30–40% regardless of what the market is doing.
To learn more, click here.