This paper seeks to discredit the “quality & growth at any price” thesis underpinning many of the market’s leading growth firms. Kailash intends to review and provide evidence of the following:
• The Collision of Arithmetic & Over-Optimism: The valuation of the US market’s largest growth firms has eclipsed the confines of arithmetic reality
• Nothing Nifty About the Fifty: Like Howard Marks1, Kailash shares the belief that legendary academic Jeremy Siegel’s view that the 1970’s Nifty Fifty were overvalued by “…a very small margin”2 is a misleading and dangerous concept
• Buying Things Well, Not Buying Good Things: The view “it pays to worship fundamentals even when all assets are going up in price”3 is of critical importance when market manias become focused on a select few firms like today
Jeremy Siegel published an article in 1998 stating that the “Nifty Fifty” were “properly valued at the peak” as the stocks performed nearly as well as the S&P500 over the ensuing 25 years. The paper described the Nifty Fifty as “high market capitalization stocks…” that traded at “…50, 80 or even 100 times earnings” representing “the world’s preeminent growth companies.”
This definition is important. Acknowledging there never was an official “Nifty Fifty,”4 Siegel used a list of names published by Morgan Guaranty Trust. As Siegel stated of the 50 stocks he analyzed: “the 25 stocks with the highest P/E ratios yielded half the subsequent return as the 25 stocks with the lowest P/E ratios.” As evidenced here, the fact that valuation created a 2:1 return advantage within a group of 50 richly valued stocks is, in our view, the most valuable component of his paper. Accordingly, Kailash uses the 25 most expensive stocks within the 50 largest firms in this paper to verify the magnitude of the pricing error driving markets today.
Figure 1 below shows that the market cap of the Largest 25 Growth firms have never in history been as highly valued relative to GDP as they are today.