Since early March, the stock market has been far more driven by fear than fundamentals, which has led to what I believe to be a bubble in stocks perceived as being “safe.” When you pay 50% too much for a stock, a simple reversion to the mean can cause disastrous permanent losses of capital. Conversely, when you buy a stock at a large discount to intrinsic value, short-term mark to market losses can be reversed through the same phenomenon, which is a staple benefit of value investing.
Fear can be a self-fulfilling prophecy for weaker companies, as we have seen with the likes of SVB Financial, Signature Bank, and First Republic. First Republic almost certainly would have survived had the bank-run that they suffered in the midst of the March panic, not deal what turned out to be a fatal blow. This investor anxiety has shifted money from value stocks towards Big Tech and Consumer Staples, to the point where I’d argue those are the areas where the biggest risks now lie, due to the extreme multiples. The always enjoyable Charlie Bilello had a great Twitter post highlighting these extreme multiples:
P/E Ratios…
Church & Dwight $CHD: 59
Clorox $CLX: 50
Estee Lauder $EL: 48
Brown-Forman $BF.B: 43
Colgate $CL: 42
PepsiCo $PEP: 41
Costco $COST: 36
McCormick $MKC: 36
Walmart $WMT: 35
Keurig Dr Pepper $KDP: 35
Hershey $HSY: 33
Lamb Weston $LW: 30
Coke $KO: 28
Procter & Gamble $PG: 27
Mondelez $MDLZ: 27
Sysco $SYY: 27
Kellogg $K: 26
Target $TGT: 26
S&P 500 $SPY: 24
Remember, these are not fast-growing enterprises but instead are stable with quality cash flows that for the most part, are somewhat recession resistant.
On the Big Tech side, AAPL is trading at 28x earnings, while MSFT is trading at 33x. These are very rich multiples, and while the companies are extraordinary, there is very little margin for error. To provide some context, these multiples are about 50% higher than their averages. Most of the stocks we own at TTCM, are trading at single-digit to low double-digit P/E and P/FCF ratios, while also paying very high and sustainable dividends.
During the short-term, the stock market is a popularity contest, and it is very common for large disconnects between price and value. Over time, those disconnects revert towards the mean, which is why value investing has produced the best returns over history. I’m confident we will see that occur once this immediate fear subsides, but it definitely is a period of heightened anxiety in financial markets.