The Rich, the Richer, and Hotdog Stands. | Denewiler Capital
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Observations on the Market //

The Rich, the Richer, and Hotdog Stands.

Written by Greg Denewiler, CFA® // October 25, 2023

“The rich are getting richer, and the poor get poorer” — Corporate America has the same dynamic. Smaller companies claim they cannot compete due to limited resources and opportunities. Larger companies are accused of gaining near-monopoly status and engaging in unfair competition. Regulators attempt to stop acquisitions that are perceived to only strengthen an unfair competitive advantage, they are supposed to have the consumer’s best interest in mind. Over a century ago there were names like Vanderbilt, Morgan, Rockefeller, and Carnegie who became known as titans of industry. They were so successful that antitrust laws were established because of their dominance.

 

 

We now have new titans named Apple, Microsoft, Alphabet (Google), Amazon, and Nvidia. Together they represent $9.1 trillion in equity value as of Sept. 30th. Given all 503 companies in the S&P 500 total $37 trillion in market value, the dominance of these five companies has become clear. The statement: “The rich are getting richer” especially applies here. When five companies represent 25% of the value of all 500 companies, it begs the question: How much bigger can they become?

 

 

The group of five has seen their prices appreciate by almost 40% through the last 12 months ending September 30th, 2023. Considering that performance, it is rational to assume their profit picture also improved. In normal times, higher prices usually reflect higher profits, but these are not normal times. For the 12 months ending in June, the last reported quarter, profits did not grow, they declined by $10 billion. This raises the question, why have these stocks performed so well? It can probably be summed up in two words: artificial intelligence. Most investors perceive AI to be the next great investment opportunity. We have had the era of trains, automobiles, airplanes, penicillin, the internet, and other great transitions in the economy. Now it appears to be AI’s turn. Apple, Microsoft, Alphabet, Amazon, and Nvidia, all have strong footholds in AI. Microsoft appears to be the front-runner currently; however, the company is already valued at $2.5 trillion. Microsoft’s profits for the trailing 12 months through June were $72 billion, so the company has some high future expectations embedded in its current stock price.

 

 

If you had a hot dog stand that made $72 on a $2,500 investment, you might be a little nervous. If a new plant with 1,000 employees was opening in the neighborhood, you would be thinking the hot dog business is about to get much better. However, the next day you notice there are ten other hot dog stands that have moved into the neighborhood attempting to capture your bright future. You know you are going to benefit and there is an advantage to being the first stand in the area, but the spoils will not all go to you. This is an example of what is happening in the market currently. Everyone is trying to find a niche in the AI space and since the prospects are substantial, investors are willing to bid up any company that has a reasonable outlook. The five biggest players will probably earn at least their fair share, but the landscape will evolve in unknowable ways. The fabulous-five has another problem, they must be careful of their own success.

 

 

When your combined value represents 30% of the entire $26 trillion US economy, everyone starts to get nervous about your influence over the marketplace. Any additional growth from these five comes at the political risk of being broken up. It is the whole purpose of antitrust laws and consumer protection. Once you throw in the unknown fear of AI and the possibility of it having a bad sci-fi ending, it is hard to imagine that they have unlimited upside.

 

 

It is always a challenge to determine how much is a reasonable price to pay for growth. Unlike 2001 when many of the speculative technology companies were not even profitable, the current list of five superstars is extremely profitable. They have combined cash and short-term investments of $370 billion. Why they don’t pay out more in dividends is somewhat of a mystery, even as they continue to become richer. Are they good investments currently? It depends on how much better you think it can get for them. The good news is that prices are starting to appear attractive in other parts of the market, which have basically been left out of the gold rush. Even the robots and machines that go rogue will need other goods and services… they can’t live on themselves.

 

 

Maybe there is a movie script here …I will be back in a month.

 

Observations On the Market No.388