🧠 Why Mega Caps Are Dominating

Welcome to Long-Term Mindset, the Wednesday newsletter that helps you invest better.

Today’s Issue Read Time: <3 minutes

Lesson: Megacaps and AI
Timeless Content: A wealth manager’s personal holdings
Thread: 10-K Diver explains cash versus profits
Resource: Ramit Sethi’s perspectives on diversified portfolio
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Friends,

We’re roughly halfway through 2024. The theme for the stock market this year is undeniable: it’s the year of the mega-caps — especially NVIDIA. If you combine the chipmaker with the six most valuable companies on U.S. markets not named NVIDIA (Microsoft, Apple, Alphabet, Amazon, Meta, and Taiwan Semiconductor), the group is worth nearly $16 trillion.

To put that in perspective, this group is up over 50% in just one year’s time. If you weren’t invested in a handful of these companies, you’re likely lagging the market by a wide margin.

Before now, many would have considered such growth impossible: “Once companies reach a certain size, there are limits to their growth, right?”

For now, that turns out to be exactly wrong. And there are a few reasons for that:

Artificial intelligence (AI) is expensive: Much like Zoom in March 2020, NVIDIA’s technology was in exactly the right place at exactly the right time. That allowed it to charge top dollar for its graphics processing units (GPUs). This caused margins to explode while sales were booming. It also meant that only a few other players had enough cash to pay for these chips. Everyone else has largely been on the outside looking in — and the market knows it.
Valuations were reasonable to begin with: If you throw out NVIDIA (which was just beginning to boom), the rest of the six largest companies were very reasonably valued in June 2023. On average, they traded for less than 20 times operating cash flow.
Expectations are sky-high: Few would deny that we could be in an AI-induced bubble. That means expectations are reaching a point where they could be exceeding what’s reasonable. Over half of the gains from these companies (not including NVIDIA) have come from simple multiple expansion.

None of this means you should get out of these stocks. Take the long view. Many of these companies — while not cheap — are not outrageously priced. They are also in impressive financial shape.

Over the long term, the important thing is that the valuation and the real-world results (free cash flow, net income, etc) have to grow in reasonable lockstep.

When that’s the case, there’s no limit to how much these players can grow.

– Brian Feroldi, Brian Stoffel, & Brian Withers

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One Simple Graphic:

One Piece of Timeless Content:

Ben Carlson, portfolio manager at Ritholtz Wealth Management LLC, shares how he manages his own money. Warning: It’s boring! As he says, “Boring works for me because I think boring wins over the long run.”

One Thread: