The hit rate is higher for huge expensive companies, suggesting that markets do have some signal. 23% of huge companies trading for more than 10 times sales have gone on to sustain 30% revenue growth. But that is less encouraging than it first appears. The flip side is that three-quarters of the time, it doesn’t play out. Three-quarters of the time, huge expensive companies don’t deliver the blazing growth now expected of Nvidia.
Valuations reflect expectations and in the investing world, high expectations can often lead to disappointment. If we take a long view of history, that’s often the patten and valuations are often highest just after a company has burned brightest. Now that is a recipe for disappointment and poor returns.
Beyond the magnificent seven
Fortunately, there is an alternative to chasing the leading lights. Look beyond the Magnificent Seven, and there are thousands of companies out there—many of which will have brighter futures than the market now expects. In 2023 alone, many good-sized companies returned more than Apple’s 48% return.
But the spotlight doesn’t shine on these businesses. It’s hard to tame the fear of missing out, especially when the companies leading the way continue to beat expectations quarter after quarter. But rather than crowding into giant companies that must continue to shine brightly just to hold their prices, we much prefer to invest in companies that trade at discounted valuations, and are trying to clear a lower bar. It is more rewarding to be there before their time to shine.
The important thing is that with such an uncertain backdrop, now is a critical time for investors to be open-minded and adaptive—as continuing to stick with past winners is no guarantee of success, especially when the valuations trend of the Magnificent Seven begin to strongly resemble the Nifty Fifty of the 1970s.
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