Superstocks built to surge

The year is 1972. In the US President Nixon has been re-elected by one of the biggest margins in history, Apollo 17 becomes the sixth manned mission to land on the Moon and a group of 50 companies - the Nifty Fifty - are leading the US stock market into the stratosphere. For the first time the Dow Jones Industrial Average, an index of 30 huge companies, breaks through the 1000 mark.

Back in the early 70s, investors believed large, popular companies that had grown profits and dividends year after year - think Coca-Cola, IBM, Polaroid and Xerox - were “one-decision” shares to buy and hold forever. 

By January 1973, Apollo 17 had become the last time men went to the moon as budget costs force NASA to switch its attention to the space shuttle. Americans were beginning to doubt their president as two of his aides were convicted for conspiracy, burglary and wiretapping following the Watergate scandal. And the Dow Jones Industrial Average had dropped 10% - It was the beginning of a stock market crash.

Two years later, after a worldwide recession triggered by spiralling oil prices and an embargo on oil shipments from Arab producers to the US, the Dow is at 577; 45 per cent below its peak. It’s the second-worst crash of the 20th century and among the big casualties are the companies in the Nifty Fifty.

Nifty Fifty shares were so popular their prices became unhinged from the profits the companies earned. Investors only bought them because their prices kept rising.

The new nifty fifty

Almost 40 years later some fund managers foresee a new generation of superstocks: a new Nifty Fifty. Bill Mott, manager of the PSigma Income fund, who earned the nickname Mr Income in his 30-year stint at Credit Suisse, has identified the return of the Nifty Fifty as one of the themes guiding the composition of his fund this year.

He predicts a decade of poor global growth. “Those companies that can grow their earnings faster than average in a bracing, but not impossible, environment will be re-rated,” he predicts.

Mott thinks global consumer staples companies promise the best trade-off between growth and economic risk because they depend less on economic policy in the West and more on the inevitable growth of a westernised middle-class in emerging markets.

“What we’re looking to own in that space are consumer staple companies that are providing everyday products, whether it be toothpaste, disposable nappies or dishwasher powder for newly purchased dishwashers,” he says.

Coca-Cola multiples

Value investors, who buy shares when they are cheap, tend to be sceptical about anything nifty because popular shares are often expensive.

In his book, Margin of Safety, value investor Seth Klarman describes the Nifty Fifty as a recurring fad. He warned shareholders in his Baupost fund of a new craze in 1998: “Just as in the early 1970s,” he wrote in a letter to shareholders, “there has been a stampede to own a Nifty Fifty: several dozen widely admired companies seeming to promise an investment utopia of safety, stability, steady growth and liquidity. Once again, no price is regarded as too high to pay for these characteristics.”

Investors latch on to trendy brands, new technology or sheer size, and assume companies will dominate and earn outsized profits indefinitely. Consequently, they’re prepared to pay more than they should for the shares, which Klarman describes as attaching “a Coca-Cola multiple to a Cabbage Patch concept”.

Cabbage Patch Dolls were ubiquitous in the 1980s but their appeal has since diminished.

Few companies prosper and endure like Coca-Cola, a fact that led Warren Buffett, perhaps the world’s greatest investor, to label Coca-Cola and Gillette “inevitable”. Managed correctly, such companies are so sound that an investor can truly buy and hold them forever.

However, for every inevitable, Buffett, who owns shares in some of Mott’s picks, including Tesco and Coca-Cola, told Berkshire Hathaway shareholders in his 1996 letter: “There are dozens of ‘impostors’ - companies now riding high, but vulnerable to competitive attacks. Considering what it takes to be an inevitable, Charlie [Munger] and I recognise that we will never be able to come up with a Nifty Fifty or even a Twinkling Twenty. To the inevitables in our portfolio, therefore, we add a few ‘highly probables’.”

How to get a Nifty Fifty

If Buffett and his partner Charlie Munger can’t stuff their investment company with inevitables, how can a private investor safely invest in nifty companies?

One approach may be to buy funds such as Mott’s and Monson’s that appear to be buying nifty companies while they are cheap, and trust they’ll not make the same mistake past fund managers made, should history repeat itself.

But once the Nifty Fifty gathers momentum, and index funds and exchange traded funds are forced to follow, it could become unstoppable.

“In the last Nifty Fifty, no small-cap manager, no active manager, no growth manager could keep up at all. You just had to buy and hold these stocks and they steamrollered everything else,” Monson recalls.

Mott says last year was marked by a dramatic recovery in economically sensitive companies which were priced for an Armageddon that never happened because governments took extraordinary measures to mitigate the recession. The stronger companies - the new Nifty Fifty - have been left behind.

“Of course, if they get to outrageously expensive levels we would look to sell them, but I think there is the opportunity for them to deliver good earnings growth but also for the shares to be re-rated upwards. I think there’s a possibility of that double-whammy.”

The stats bear Mott and Monson out. They run income funds that, in addition to holding Nifty Fifty-style shares, also contain high-yielding companies that are, by definition, cheap. Neither fund is expensive. In April, the average prospective p/e ratio of all the companies in the PSigma Income fund was 11.5 compared with 12.7 for its FTSE 350 benchmark. Sarasin Global Equity Income fund’s current p/e ratio is 12.5 compared with 16 for the MSCI World index.

Another approach is to search for Buffett-like probables: companies that are probably high quality and ought, as a group, to beat the market as long as we don’t get carried away and pay too much for them.

By keeping to the discipline of buying the best companies at the cheapest prices, you should ignore trends in the global economy and the financial bubbles they drive. For the Nifty Fifty advocates anticipating those bubbles is more important.

Now here’s a fantasy for you and not one you’d necessarily wish for:

It’s 2015. President Sarah Palin has cancelled the first manned mission to Mars as the global economy emerges from the second leg of the great recession.

By insisting on quality, strength and value, some investors are prospering again. They lost money in the crash of 2012 to 2013, but not as much as investors who bought the original Nifty Fifty and forgot to be thrifty.


Your Comments

Doesn't the rise of index funds also create positive reinforcement for those stocks in the index? I don't think they were around as much in the early 70's.