There is a prevalent school of thought in investing circles that since value investing is all about buying cheap stocks for less than they are worth, investors should focus their attention on small and mid-cap stocks. Many individual and professional investors alike believe that looking at large cap stocks is a waste of time because these companies are well-followed and therefore more efficiently priced, making it hard for an investor to have an edge.
This line of thinking is deeply flawed for three key reasons and can lead to investors missing out on some sizeable returns.
1. Investing isn’t physics (or rocket science). A larger company doesn’t generate a stronger gravity field that prevents its price from escaping its intrinsic value.
2. The market may be “dumb” but it is (usually) not blind. Any “hidden” information that an investor believes may give them an informational edge (and is not inside information) is most likely already known to the market regardless of whether it is a $500 million or $500 billion market cap company. Some investors may have better insights, but that’s a completely different edge.
3. Buyers of large cap stocks are human, too.
Consider this: yesterday, Apple (Nasdaq: AAPL) reported its results for the December quarter. It was a strong set of results that beat broker consensus, but nothing spectacular, and the company acknowledged it still faced challenges ahead. Yet, overnight, Apple’s share price was up over 6%, adding a cool $40 billion to its market cap. In fact, since its 52-week low in May 2016, Apple’s market cap has increased by $180 billion. How is it that the world’s most valuable, and arguably most widely-followed, company can see its intrinsic value increase by the GDP of New Zealand in eight months, or $40 billion in one day?
The answer is that Apple’s intrinsic value has most likely not moved anywhere near that much. Instead, the market’s short-termism most likely drove Apple’s share price significantly below its intrinsic value. A long-term value investor didn’t need hidden information to know that Apple was an absolute bargain at $90 a share. The market was offering this extremely high quality business at a price that implied Apple’s revenue would shrink at a low single digit rate for the rest of time.
If a value investor with a long investment horizon had bought Apple shares when the price languished in the $90s, they would be sitting on a 40% to 60% annualised return today. Not a bad return on the largest of large caps that money can buy.
Both Montgomery global funds own shares in Apple.
P.S. Here is a table of the top 10 stocks in the S&P 500 Index, showing the 52 week high and low prices and the corresponding swings in market cap. You can draw your own conclusions about whether large caps can throw up attractive value opportunities.
(Note that actual 52 week high / low market caps will vary because of different volume of shares outstanding at the different dates.)