Written by: Fred Semmer, CFA | Senior Research Analyst
Echoes from the early 1970’s sound a cautionary note about today’s biggest tech stock leaders.
Take a second and recall the last large discretionary purchase you made. Think television, a car, or if you are lucky, perhaps a vacation. Was there a scenario in which the purchase price was not a consideration? Of course not! It is hard to envision buying something without at least deliberating whether it is worth the price you are paying. However, such a scenario played out in the US stock market a half century ago. With the current run in technology stocks, might history be repeating itself?
During the “Nifty Fifty” era of the late 1960’s and early 1970’s, there was seemingly no limit to the price investors were willing to pay for a collection of 50 of the larger US growth stocks. Iconic firms like Xerox, IBM, and General Electric were technological powerhouses, had tremendous growth runways via globalization, and were viewed as buy and hold forever stocks, regardless of their price. If all of this is sounding familiar, it is to us too. It is said that “smart people learn from their mistakes, while wise people learn from other’s mistakes,” so let us learn from others’.
Xerox, a company so dominant it became a verb, is a perfect specimen. In the early 70’s, Xerox disrupted traditional printing methods, developed two-sided copying machines, and introduced the world’s first personal computer, all in less than five years. In awe of its innovative prowess, its dominant market position, and growing profits, investors bid up Xerox’s price without regard to valuation. At its peak in 1972, it traded at about 49 times earnings, an alarmingly high level given that the most recent 20-year average is about 15.5. Despite growing its revenues from $1.6 billion in 1970 to $8 billion in 1980, its stock price fell 71% peak to trough. In fact, Xerox’s stock would not recover to its peak 1972 price for 24 years. Twenty-four years, even after growing revenues 5x over the course of a decade!
IBM, a juggernaut in the computing space, was similarly regarded as a “set it and forget it” stock. With an estimated 70% market share, IBM’s mainframe computers helped put a man on the moon. In 1971, IBM developed both speech recognition technology and the floppy disk. Imagine inventing the precursor to the flash drive and Amazon’s “Alexa” in the same year! With a story like that, price was irrelevant, and investors were willing to purchase IBM at 39 times earnings. From its peak in 1973, IBM’s stock fell nearly 58% and would not breakeven until 1982 despite more than tripling its revenues over that period. It is a similar story as you move down the list of the remaining nifty fifty, with Wal-Mart being the primary exception.
Bringing it back to the present, it is easy to justify the current run of many of these tech companies and Covid-resilient businesses if making a comparison to a period like the dot-com bubble of 20 years ago. After all, in contrast to that prior era, where a company did not even need any revenues to be a stock market success, many of today’s tech and Covid-proof leaders are dominant businesses and generate substantial cash flows. It is easy to understand the lesson from the tech bubble; be wary of investing in a company with no business model. The more subtle and often elusive takeaway from the Nifty Fifty era was that even stocks of great businesses can result in poor returns if purchased at the wrong prices.
It is tempting to invest in companies that have seemingly unassailable businesses. However, the characteristics that make these companies so appealing are often the same as those that lead to dangerously high valuations. Moreover, even though outstanding companies often warrant premium valuations, they are still subject to forces largely outside of their control: disruptive technologies, Federal regulation, or even a Covid-type macro-economic event. But the price you are willing to pay is in your control. And just as in the Nifty Fifty era, now, and always, the price you pay to purchase a stock matters even if the fundamentals of the business do indeed turn out to be unassailable.