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Three Things: Trillion Dollar Stocks

August 06, 2020
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Hi everyone, I hope your summer is going well.

We just wrapped up July and Phoenix set a record for "Hottest Month on Record"... Some records are fun to break, others are not. This one isn't.

Speaking of hot, there are a few stocks that are on a ridiculous run and I'm getting a lot of investor interest in making calculated bets by owning a few single stocks. This isn't something I typically recommend, and I wanted to outline some reasons why. 

If you're feeling some FOMO (Fear of Missing Out) when you see the massive returns of big name stocks, this email is for you. 

Enjoy, 

Adam 

 

Thing #1: Left in the Dust

The stock market has recovered from the March lows, right? 

Not really. 

5 stocks have carried the way and many of the rest are still feeling the pain of a badly damaged economy.... Those five stocks: 

Microsoft
Amazon
Google
Apple
Facebook


... Together they represent about 1% of the companies in the S&P 500 Index, but more than a quarter of the market value of all companies in the index. 

To say these companies are "on a nice run" might be the understatement of the year. Using the running analogy, these companies would be the equivalent of Usain Bolt

Here is an absolutely staggering visual from Goldman Sachs: 

The above chart shows something amazing: 

The "stock market" has not recovered; instead, a handful of companies worth around 5 trillion dollars have dragged the entire market out of the trenches. 

(In fact, this chart is a few weeks old, so the dispersion is likely to be greater now.)

At this point, it may be helpful if I answer the #1 burning question you may have: 

Question: Why can't I just own those 5 best performing stocks? 

Answer: 

Wouldn't that be great? Here's what an ideal strategy would look like: 

Step 1: Identify the stocks before they have their giant run

Step 2: Sell them when their run ends

Step 3: Find the new stocks poised to go on a big run

Step 4: Repeat indefinitely. 

These 4 steps sounds easy but they're pretty much the most difficult thing to do consistently as an investment manager.

Any manager who claims to be able to do this for you is naive at best, and grossly misleading at worst. 

If you've been following my emails and philosophy, you know that I often convey the failure of investment managers to be able to do the above 4 steps. Specifically, active stock picking US stock mutual funds have outperformed their benchmark index only about 20% of the time over the last 10, 15, and 20 years (source: Dimensional). I wrote about this extensively in my May 12th, 2020 blog post which surveyed the mutual fund landscape (here's a link to that blog)

After all, if we're choosing just a handful of stocks there is a much higher chance of us selecting one of the 495 subpar stocks in the chart above, rather than the 5 big winners. 

Your brain will tell you it's easy and hindsight bias will convince you the path to where we are today was 'obvious'. That's okay, it's just being human. 

Thing #2: Let's talk about Apple's stock split

The news hit last Thursday: "Apple is engaging in a 4-1 stock split."

Yep, the news broke and then the price popped (and is still popping as a write this). 

...but the future is undetermined.

Because the future is undetermined, I'll provide some context about stock splits. 

First, a stock split is simply window dressing. Let me explain... 

Let's say some company has 1 million shares outstanding of stock at $1,000/share. This company is worth $1 billion dollars. If the company undergoes a 4-1 split, then it no longer has 1 million shares outstanding, it has 4 million shares outstanding and the shares are no longer $1,000 each, they're $250.... 4 million shares x $250/share is still $1 billion. The company's value hasn't changed. 

You see, splits don't change anything about a company’s underlying fundamentals: 

Earnings are unaffected.

Profitability is unaffected.

iPhone sales are unaffected.

...However, splits can perhaps lead to interest from smaller investors because cheaper shares feel more accessible. Yet, it should still (theoretically) be difficult for smaller investors to band together to significantly influence the share price more so than the larger investors who control most of the volume of a company's stock.... But combined sentiment does matter, as we're seeing in the price behavior of Apple post-news-of-the-split. 

In the case of Apple, investors who own the stock will receive 3 additional shares after the market closes on August 24. These shares will value at 1/4 of the value of the stock before the split. The stock will then begin trading, post-split on August 31. 

Apple’s has enacted stock splits in the recent past. In 2014, they engaged in a 7-1 split. 

Here's the thing about all of this: 

Stock splits aren't 'free money' and there are no guarantees that a stock price will continue to climb after the split just like there are no guarantees that a stock will climb before a split. 

Apple said in the release it approved the split to make “the stock more accessible to a broader base of investors.” 

Apple is making this statement as if many smaller investors can't buy many shares of Apple stock unless they can afford about $400/share, so they're cutting the price by 1/4. 

This is where it gets really interesting.... The market is currently pricing in a big flood of new buyers of the stock (i.e. the stock is rising over the last couple days on this news), but on many platforms today you can buy fractional shares of stocks, which kind of eliminates this reasoning for the split. This didn't exist in years past, but today you can own 1/4 of a share of Apple by simply opening up an account at a custodian that allows for fractional share purchases and buying as much as you'd like, regardless of what the share price is.  In short, innovation has already democratized much of this market. 

Only time will tell what will happen, I'm not forecasting the stock to go up or down or sideways, but I do think it's worth noting that the fundamentals haven't changed; buyer/seller behavior has. 

When in doubt, when it comes to stock splits just remember this pizza drawing I made last week.... 

Thing #3: You may already own more of these companies than you realize

As investment advisors, we have to be very careful to avoid anything that could sound like a specific recommendation in an email like this one. It's my duty to make sure I fully understand an investors intent, comfort with risk, and overall financial condition before making a recommendation. 

With that said, I do want to outline some specific, well-diversified investments which I am comfortable recommending in situations after I understand the investor thoroughly. 

The reason I'm highlighting these funds? Because well-diversified funds are likely to already own some of the stocks you may be feeling like you're missing out on: 

Fund: DFA US Core Equity 2 Portfolio (DFQTX)

This is a US stock market fund which, as of 6/30/2020, held 2,730 US stocks. Small companies, large ones, and many in-between. 

Again, as of 6/30/2020, this well-diversified fund comprised of: 

5.52% Apple (AAPL)

3.85% Microsoft (MSFT)

2.30% Amazon (AMZN)

1.14% Alphabet (GOOG A and C Shares)

1.07% Facebook (FB)

13.88% TOTAL Estimated Exposure to AAPL, MSFT, AMZN, GOOG, & FB

(more on this fund, including disclosures, here)

Fund: Vanguard Total Stock Market (VTSMX)

This fund is also very well diversified within the US Stock Market. As of 6/30/2020 it held 3,501 US stocks. 

Within the fund, we see the following allocations to these big names: 

5.00% Microsoft (MSFT)

4.70% Apple (AAPL)

3.80% Amazon (AMZN)

2.70% Alphabet (GOOG A and C Shares)

1.80% Facebook (FB)

18.00% TOTAL Estimated Exposure to AAPL, MSFT, AMZN, GOOG, & FB

(more on this fund, including disclosures, here

If you were surprised at how concentrated a well-diversified fund may be in just a handful of companies, you're not alone.

...So here's what I want you to consider: 

Would it feel better to have a portfolio where you owned these individual stocks outside of a fund and you could watch their meteoric rise separately from your diversified stock fund? 

Put differently, using the Vanguard Total Stock Market fund as an example (again, this IS NOT a recommendation), would you prefer to carve out 18% of your portfolio and buy five companies, attempt to ride them until they top out, and then sell to buy new companies?

We know how difficult this can be to perform repeatedly, but I know it can be tempting. 

We can also be confident knowing that there are some amazing investment opportunities within the other 3,456 stocks within the invest-able US market, but they're nearly impossible to capture without taking a broadly diversified approach. 

To be clear, there are no wrong answers, I'm just looking to point out that you may not be missing the party by not owning these companies directly, and that a more diversified approach may help investors to partially capture the current movement while also positioning them for the "next hot thing", whatever that may be. 

I'll leave you with this: 

The merits of diversification are well-documented, but times like these can make it seem hard to stay committed to segments of a portfolio which may feel like they're getting left behind. This is normal.

Just like we have to avoid following the herd when everyone panics and sells their investments during a downturn, we have to avoid the temptation to follow the herd as they pour savings into certain segments of the market. It's all the same.

Stay disciplined, my friends, and be sure to reach out if you have any questions or want to chat about this. 

Be well, 

Adam Harding, CFP

480-205-1743

(Diversification does not guarantee returns or eliminate risk of loss. There are risks to investing, nothing in this email is considered investment advice. It's just about education, okay?)