Adding a New Name to Our Buy List
+ news on buybacks, and what we should learn from market-cap weighted outperformance
Welcome to another weekly digest to stay informed about everything that matters most to quality growth investors!
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Topics we’ll go over in this episode:
Widening performance gap between market-cap and equal-weight ETFs
Luxury stocks
Buyback news
Deep dive Otis: two graphs that show why it’s a Tortoise
What’s on our buy list - a new serial acquirer
Widening performance gap between market-cap and equal-weight ETFs
It isn’t something new, but it’s accelerated even further over the past week: the widening return dispersion between the equal-weight versus market-cap weight indexes.
While some are complaining and hoping for the market to crash (to see relative outperformance, while - at the same time - losing money), there’s quite a lot to learn from concentration. Letting your winners run, instead of watering the weeds.
As we wrote last week: earnings growth, consistency, solid balance sheets… that’s what we expect from our companies. And we should let our best picks thrive.
We enjoy watching paint dry.
In other words, we don’t care about the relative short-term performance. In fact, the more you monitor your short-term return profile, the likelier it will be for you to experience underperformance or even absolute losses. It’s something to accept and take advantage of.
People who had forgotten they owned stocks typically achieved above-average returns, based on a Fidelity study. With the world constantly changing, it’s a tough task to pick stocks and put them in your coffee can, but just consider this example highlighted in Lindsell Train’s April commentary:
If the folks at S&P left the original 1957 S&P 500 alone, instead of swapping in/out names, they would've beaten their own index… That’s even before the impact of trading costs. That’s what we’ve addressed in our post on Factor Investing: the implementation and implied rotations oftentimes lead to a notable underestimation of costs, making the gross alpha become a zero or even negative net alpha…
As the debate on Nvidia’s (potential) overvaluation is heating up, index investors should cherish its outperformance. And even stock-pickers who don’t own any Nvidia are likely to come to appreciate the positive outlier return potential for some of their overweight quality growth positions.
What could become increasingly detrimental to passive investing returns is the fact that the market-cap products are forced to buy more of the same assets at ever-increasing valuations. For investors putting capital to work periodically, volatility in forward returns does matter.
With Nvidia set to take the second spot from Apple, it will spark a massive combined trade worth more than $20 billion. Based on the ETF's (the XLK ETF) current size and calculations by Business Insider, about $11 billion is set to purchase Nvidia stock, while the sell-down of Apple will amount to about $12 billion. The massive trade is slightly below the average daily trading volume value of both stocks, so while the trade swap could spark some swings in prices, it is likely to be well absorbed by the market.
They’re price agnostic.
AQR’s Lasse Pedersen offers an additional perspective on passive churn, noting that mechanical changes within an index may ultimately give active management its aggregate edge, given its ability to price-set when transacting and hence add value over a price-taking passive participant.
That’s where the rational quality growth investor has an edge: being conscious about valuations that make sense (even after you’ve incorporated conservative growth based on ROIC, overall sector size, cyclicality…). That’s not necessarily buying at low-teens multiples; even a low-twenties EV/NOPAT can still deliver mid-teens IRRs, just as long as the consistent growth is there.