Value investing
Some fine companies will lose their way
There is no doubt that in the last ten years the famous group of tech stocks known by various acronyms such at FAAMGN have had an oversized impact on the total return of the S&P 500. Everybody knows of Facebook, Apple, Amazon, Microsoft, Google and Netflix.
With the benefit of hindsight we can say for sure that if we had over weighted our investments in these companies we would have had done very well. There are some who say that if you had missed these companies your returns would have lagged the S&P 500. The thinking goes that the only way to make sure your portfolio includes these outperforming stocks is to invest in an S&P 500 index fund.
In this post I want to explore one idea: Do we need to identify future FAAMGNs in order to achieve a superior return from our stock market investments?
The 80-20 rule
Life is strange. It has been noticed over the years that some 80% of consequences often come from 20% of causes. It’s usually called the 80-20 rule but also goes by the name of the law of the ‘vital few’ or the principle of ‘factor sparsity’.
Let me give some examples. The percentages are rough approximations. The richest 20% of the world’s population generate about 80% of the world’s income. In fund raising, typically 80% of dollars raised come from 20% of the donors. Businesses often find that 80% of sales come from 20% of clients. In public safety, it is typically the case that 20% of the hazards account for 80% of the injuries. Here’s one for health buffs. 20% of physical training exercises seem to have roughly 80% of the impacts. And here’s one for today’s environment. 20% of infected individuals seem to be responsible for 80% of transmissions.
I haven’t done the math but I would guess that something like 20% of stocks have an outsized influence on S&P 500 movement. In other words, it is entirely possible that the law of the ‘vital few’ does apply to investing. So, it’s not surprising that the FAAMGNs with in the order of 20% index weighting, will have an outsized impact. But, do we need to invest in the FAAMGNs to succeed in our investing?
Future FAAMGNs
One thing we can say for certain is that today’s FAAMGNs, that is today’s ‘vital few’, will not be the ‘vital few’ 20 years from now.
In 2000 the largest companies by market capitalization were Microsoft, Cisco, General Electric, Intel and Exxon/Mobile. Go back another 20 years, before the internet and the digital revolution, and the list looks quite different again.
In simple terms, you would think a sure-fire approach would be to buy an S&P 500 index fund. You get the current crop of FAAMGNs and will certainly get the future ‘vital few’.
But, if you buy an S&P 500 index ETF today, no doubt you will be over-paying for many of the stocks in the ETF, think TESLA. And some of the current FAAMGNs will also be overpriced. You can also be sure that some of the S&P 500’s largest companies will fade in years to come. You’ll get the good but you also have to live with the bad.
So, how do we get the good and avoid the bad? Are we better off working to identify the FAAMGNs of the year 2030? What are our chances of picking future FAAMGNs? In thinking about this we know that there are lots of investors who bought one or more or even a handful of the FAAMGNs 10 or 20 years ago and rode them to success. Many of these investors will credit themselves with great foresight. And some might just have been that smart. But, I’m inclined to believe that most were simply lucky. I say this because 20 or even 10 years ago, nobody really knew how things would turn out for these companies. And today, nobody knows which stocks will be the FAAMGNs of 2030.
Get rid of FAAMGN envy
I have never tried to identify and invest in future FAAMGNs. It isn’t necessary. Some investors faced with the 80-20 concept simply throw up their hands and go for an index fund.
We need to be reminded, the S&P 500 is an index and not a well-crafted and managed portfolio. It not only contains some very fine companies but also a good number that well past their prime. It is hopelessly over diversified and not well balanced. Some of today’s fine companies in the index will lose their way.
The approach I have taken over the years is to invest for the long haul in a concentrated portfolio of superb companies that are bought at bargain prices. It has worked for me for decades. I do own one of the FAAMGNs that I bought on March 2, 2020 at a good price. The purchase was made using my normal investment process. The price was very attractive.
If you think you have heard this before, you have. It is the approach followed by Warren Buffett and several other investors who follow the investment policies laid down by Benjamin Graham, Philip Fisher and their modern disciples.
Conclusion
I think investors can easily get hung up on FAAMGNs. There is a simpler way.
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One’s investment process is what Ben Graham called ‘principles of operation’. To read further about this take a look at the Motherlode Part 4: Principles of Operation
The chapters in that part are:
26. Buying with a margin of safety
27. Sound Principles of Operation
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Check out the Tags Index on the right side of the Home page that goes from ‘accounting goodwill’ to ‘wisdom of crowds’. This will give readers access to a host of useful topics.
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There is also a Table of Contents for the whole Motherlode when you click on the Motherlode tab.
Want to dig deeper into the principles behind successful investing?
Click here for the Motherlode – introduction.
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