Alarming Concentration at the Top

Clearly the past few years have been good for the FANMAG group + Tesla. Are these stocks likely to continue to run? They are solid companies with great narratives, but investors are beginning to wonder if they are trading at reasonable prices today. We pose the question, how would a significant mega-tech pullback in this small group of names affect client portfolios?

  • A group of seven popular widely owned stocks: Facebook, Amazon, Netflix, Microsoft, Apple, Google, and Tesla (the “FANMAG+ group”), have a weighting of almost 18% of the Russell 3000 Index (a good proxy for the entire U.S. stock market, in our opinion) as of March 22, 2021. At that date, the FANMAG+ group traded at an Enterprise Value to Sales ratio of about 9.7X, a rich valuation about three times higher than the Russell 3000 Index’s ratio of 3.2X.
  • The top 100 stocks in the Russell 3000 Index represented over 56% of the total index weighting on March 22, 2021 even though they only accounted for about 3% of the index membership. So the other 2900+ stocks which represented about 97% of the constituents in the Russell 3000 Index (again, a good proxy for the U.S. stock market) represented less than half of the index’s weighting.
  • We think weakness in a highly concentrated group (like the FANMAG+ group) with a high representation in a given index leads to easier relative performance conditions for a stock picker. When performance is driven by just a few very large, very popular names, it can lead to significant headwinds or tailwinds to the relative performance of stock pickers because the index will be heavily influenced by the movements of these select few. What has been a headwind for the relative performance results of value managers over the past several years has recently turned into a tailwind recently as the FANMAG+ group has slipped.
  • If the FANMAG+ group were to drop 10% (only 7 stocks), the bottom 75% of the index constituents (about 2300 stocks) would have to increase about 20% for the Russell 3000 Index performance to remain flat.

We think these circumstances may be even more exacerbated for the S&P 500 which is a more concentrated index with the FANMAG+ group representing an even larger weighting.

Our value strategies are made up of companies that have, in our opinion, strong balance sheets and good underlying fundamentals and strong prospects. And we think portfolio valuations are still attractive today. Our All Cap Value and Focused Small Cap Value strategies traded at an Enterprise Value to Sales ratio of 1.7X and 1.3X, respectively on March 22, 2021.

We categorize each holding into a Core Value or Deep Value “sleeve.” We believe our Core Value businesses are wide-moat industry stalwarts while our Deep Value investments are in opportunistic high alpha-generating companies. Today, for our concentrated All Cap Value and Focused Small Cap Value Strategies our Deep Value weight is at/near all-time highs.

Since 9/30/2020 the stock market has begun rewarding value companies over growth and we feel like a pullback in popular, heavily owned stocks may lead more investors to rethink whether reasonable valuations really matter. Our answer is a resounding yes! Value—what you receive for what you pay for—always matters. And we believe we are still receiving solid future potential returns for unassuming prices in our stocks today.