Boyar Value Group 3Q17: Stay Clear of FAANG

Smart Money

Boyar Value Group 3Q17 Letter, October 31, 2017


  • Currently suffering an acute case of FAANG envy. Have not felt this disconnected to the stock market since the height of the dot-com bubble
  • During the height of the dot-com bubble, valuations accorded to many tech companies could not be justified utilizing any commonly used analytical methodologies, so analysts devised a brand-new set of metrics, such as “eyeballs,” and largely abandoned tried-and-true methods such as P/E and P/B
    • Analysts frequently uttered the words: “It is different this time.”
  • As of mid-September, FAANG (Facebook, Apple, Amazon, Netflix, Google) accounted for approximately 40% of the S&P 500 gains this year
  • Netflix currently has a market cap of $83Bn, which equates to a P/E of 195x; compare that to Time Warner, which owns HBO (among many other valuable assets) and has a market cap of ~$77Bn and a P/E of 16x
  • Tesla
    • Fundamental analysis is being replaced by hopes and dreams with little in the way of substance
    • Tesla requires repetitive capital raises to fund persistent capital losses and this necessitates bullish analysts and holders to keep the stock aloft with projections of imagined earnings from future products while ignoring the existing business, which continues to lose vast sums of money
    • Tesla de-emphasizes earnings under GAAP to make results look better and much of Wall Street blindly follows along (for example, stock options are widely distributed to employees as a form of compensation, diluting the holdings of existing shareholders, yet they are never counted as an expense)
    • After last bond offering, nearly $10Bn in debt stands against $5Bn in equity for a company that burns through billions of dollars each year (# of shares outstanding rose to 165 million this past June, up from 140 million a year earlier)
    • Enjoys a market cap of $57Bn, slightly less than GM’s $65Bn; TSLA loses billions of dollars, while GM earns over $900 million a year; GM delivered about 10 million vehicles globally last year, or more than 27,000 a day; Tesla delivered 84,000 vehicles last year and expects to deliver 500,000 next year, a sizable leap; Tesla shares up 57% this year while GM have advanced 30% during the same time frame
  • Value investing is mired in one of its worst stretches on record, prompting concerns that this investment style, favored by generations of fund managers, might be losing its relevance
    • Value stocks have significantly lagged behind growth stock counterparts this year, extending a gap that has persisted in many of the years since the end of the GFC
    • Since the Great Depression, notion that a new paradigm would replace value investing has repeatedly surfaced – until now, always ended poorly; we see no reason why this time should be any different
  • Market’s attraction to high-flying stocks punished value investors in a similar fashion during the dot-com bubble. Growth stocks beat value peers toward the end of 2 major bull markets that peaked in 2000 and 2007, before large market selloffs reversed the trend, putting value ahead
  • NASDAQ gained 85.6% in 1999, the largest annual % gain for a major market index in US history – but during the following 30 months, index plunged 78%
  • Beginning to experience that same lonely feeling as stocks like Tesla and Netflix have become market leaders and our style of investing has underperformed. History will once again repeat itself and purchasing companies at discounts to their private market value will prove to be the best way to invest over the long term

Thoughts About the Market

  • Over the past 5 years, index funds have outperformed vast majority of active managers
  • We think this cannot go on forever. While indexing is efficient and currently effective, there has never been a very good investment idea that hasn’t been taken to a foolish extreme
    • “What the wise man does at the beginning, fools do in the end” – Warren Buffett
  • Indexing seems to presume that all companies should be purchased regardless of their current valuation and future business prospects. As indexing grows in popularity, valuation spread between great and mediocre companies should continue to narrow
    • This development ought to bode well for value-oriented stock pickers
  • 5 largest companies within S&P 500 and Nasdaq 100 generated the bulk of the market’s returns during the current year: this can partially be explained by the significant inflows that index funds experienced over the same period

History Tells Investors to Stay Clear of Apple Shares

  • Recent Wall Street Journal article penned by Colin Barr shows that historically, it has been prudent for investors to steer clear of the most valuable US company
    • S&P 500 listed company with the largest market value has steadily lagged behind the broader index over the past 45 years, accumulating a deficit of more than 8,000 percentage points
  • Decision to buy the most popular US stock – which at various times has meant AT&T, Alphabet, Cisco, Exxon Mobil, Altria, GE, IBM, Microsoft, or Wal-Mart – has almost invariably cost investors significant sums
  • More likely, the large cap (a cumulative gain of 8,773% for the S&P 500 total return index vs. 700% for the largest stock group) points to the limits of prospective returns on investments that have already appreciated significantly
    • Momentum is a powerful thing, but eventually, the law of large numbers starts to work against you
  • If history is any guide, probably a good time to sell Apple. Since Apple represents almost 4% of S&P 500, a selloff in the name could be a future drag on that index
  • 4 out of the 5 largest S&P 500 stocks currently are the tech firms often extolled in the press and on Wall Street for their supposed alacrity as “disrupters” of the competition (up at least 17% this year)
  • Analysts continue to expect AAPL shares to soar, and why not?
    • Despite having posted a 14% annual return since 2012, shares still trade at a discount to the overall market
    • Even so, company’s value implies some hefty expectations. With almost $800Bn in market value, you could purchase the entire S&P small-cap index and still have some $90Bn in walking-around money (we think we would rather own the latter)

How Valuable is a Unicorn? Maybe Not as Much as it Claims to Be

  • Uber is said to be worth $62.5Bn; Airbnb is valued at $31Bn; Elon Musk’s SpaceX Technologies is valued at $21Bn; Pintrest at $12.3Bn
    • “Unicorn” companies – a term for private companies that are said to be worth more than $1Bn
    • These valuations may be a bit of myth – or perhaps wishful thinking
  • Big mutual fund companies like T. Rowe Price and BlackRock have aggressively begun investing in unicorn companies in recent years on behalf of public investors, helping to increase the valuations even further
  • In 2015, Appdynamics issued a Series F round with special terms for certain investors, including “a provision offering a 20% bonus in down IPOs”, meaning one that fell in price
    • Legg Mason, already an investor, then revalued its shares in the company at a higher prices, “despite not being eligible for the 20% bonus”
  • SpaceX: “SpaceX’s value actually fell in 2008” while its reported valuation went up. Researchers said investors that year “were promised twice their money back in the event of a sale, with that claim senior to all other shareholders”
    • This guarantee increased the price those investors were willing to pay for SpaceX shares but did not alter its true value

Image Source: Birch Gold Group