Buying Value and Avoiding Performance Chasing
By Randall J. Cloud
The public has a habit of buying stocks, asset classes, and mutual fund managers that are hot, in favor with, and being promoted by Wall Street and the financial media. With being told to stay home in 2020, the public has had more time to listen to the financial media offer short-sighted investment advice contributing to yet another growing speculative bubble with technology companies.
As a result, the technology companies have driven the S & P 500 Index, the NASDAQ Index, and U.S. Large Cap Growth asset class to record highs in 2020. The last time we saw a buying frenzy for technology companies was in the late 1990s with the Dot.Com Bubble.
Mistakenly, many are tempted with buying higher price stocks also known as growth stocks believing their action begets higher investment returns. This behavior of chasing performance ultimately reduces one’s life-time investment returns.
In contrast, our strategy is to buy what is out of favor with Wall Street and the financial media. The idea is to buy companies with lower relative prices compared to those with higher relative prices. Investment Returns at their core are driven by the relative prices paid for assets. The more you pay for the investment, the lower your profit will be when you sell.
With a closer examination, it turns out five technology companies are driving the indexes and the U.S. Large Cap Growth asset class to record highs. The five companies are Amazon, Apple, Facebook, Google, and Microsoft also known as “FAAMG” which is the close relative of “FAANG” which stands for Facebook, Amazon, Apple, Netflix, and Google.
As of August 31, 2020, this group of five companies soared in market value to represent an estimated 24 % of the total market value of the S & P 500 Index, 41 % of the NASDAQ index, 19 % of the DFA Total U.S. Market, and 11 % of the DFA Total Global Market. Furthermore, you will find concentrations of these five companies in all the U.S. Large Cap Growth mutual funds which have produced eye popping results during the past five years making investing look easy to the public.
These five companies as a group increased 49 % in market value for the year by August 31st, 2020 pushing the S & P 500 Index to a + 10 % return through August 31st, 2020. If we remove these five companies from the index, the remaining companies as a group declined by – 3.0 % in market value for the year as of August 31st, 2020. Using the recent growth rate for these five companies, the group would represent fifty percent of the total market value in the U.S. within five years. Is it reasonable to believe these five companies recent returns are sustainable?
History suggest you would be wise to resist the temptation to chase performance. By owning a Broadly Diversified Global Portfolio, you have captured the returns generated by these five companies, the S & P 500 Index, the Nasdaq Index, and the U.S. Large Cap Growth asset class over recent months. As important, you are positioned to capture the returns to come from those assets classes that have been out of favor in past months and years that were purchased at discounted prices.