Why 'Magnificent Seven' FOMO can be a serious NO-NO for investors

Investors allocating to equities in 2024 could be forgiven for casting a longing look at some of the spectacular returns at the top end of the US market in 2023; the ‘Magnificent Seven’ tech stocks of Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla returned 111 per cent for 2023 calendar year, compared to 24 per cent for the broader S&P 500.

In the same way that it’s hard for an investor to resist selling an underperforming stock during a downturn, it’s also difficult to sit on the outside, looking in, while an overlooked stock or sector experiences tremendous gains.

But it’s this fear of missing out (FOMO) that can prove most dangerous to investors, and it takes considerable discipline to tame this fear according to Orbis Investments.

*Read Orbis Investments’ whitepaper ‘Sunrise on Venus: Investing for the Next Decade’ here.

In a recent blog post, Orbis highlights the stratospheric rise of artificial intelligence (AI) chip designer Nvidia, and the hyper-positive view the market has taken on its earnings potential in a world gripped by the potential of AI.

“Nvidia is the biggest beneficiary of AI growth,” Orbis states, noting that the stock value increased 240 per cent in 2023. “The results are real – Nvidia’s revenue last quarter was double the level of a year ago. For an already-huge, highly profitable company, such rapid growth is astounding.”

For investors, the problem with the Nvidia proposition is that most of this tremendous growth potential is already reflected in the current valuation. The company would need to deliver something like 30 per cent year-on-year growth for five years to justify its current valuation, Orbis notes. Anything less than this extraordinarily high benchmark, and an investor diving in at today’s price would go backwards.

To put the market expectations for Nvidia into context, Orbis points out that only 230 companies in the FTSE World Index have ever grown revenue by 30 per cent of 5 years since 1990, which is only 7 per cent of the 3,400 relevant stocks on the index. “The feat is rarer still for already-huge companies. Only 45 businesses have ever delivered that kind of growth after cracking the top 200 of the Index.”

None of this means that Nvidia won’t achieve the “mind-bending growth” the company must deliver to justify its valuations, Orbis adds. It is nothing if not well positioned to do so.

But valuations matter, and for contrarian investors like Orbis, finding companies that combine growth potential with value displacement is a much more attractive proposition.

In the last six months alone, Orbis points out, at least 82 investable stocks have performed better than Microsoft, which at 37 per cent for 2023 marks the low watermark for the Magnificent Seven group. “Excluding the tech giants, that’s ten other Magnificent Sevens, and we’ve owned several of those stocks.”

For behemoth companies that have already experienced massive growth such as the seven tech giants, a continuation of huge valuation increases will be difficult to maintain. For mid-sized companies, however, there remains tremendous potential for growth – if you can find the right ones. It wasn’t that long ago that Nvidia was one of these companies.

It’s hard to exceed high expectations. A salient reminder was given recently, when Nvidia’s sales and guidance went 20 per cent above estimates. Typically, this would cause a company’s stock to skyrocket, at least temporarily. Nvidia’s price remained flat.

The lesson for investors here is that while you may be missing out, trying to get in late will likely compound that sense of loss. Low bars are much easier to hurdle.

“While the Magnificent Seven are great businesses, we’ve found several dozen companies that we believe will be more magnificent investments,” Orbis stated.