Giverny Capital commentary for the second quyater ended June 30, 2024.
The Polarization Of Returns For The S&P 500 Continues
The same story with the stock market from 2023 has continued so far in 2024, with the S&P 500 being propelled by only a few stocks. We discussed this in detail in our last annual letter to our partners but it’s relevant to come back to this once again.
After the first two quarters, the S&P 500 has posted returns of approximately 15%. However, the same index with the same companies weighted equally for each company would have generated a return of only 5%. This is also the approximate return of the world’s major indices (the MSCI EAFE returned about 7% and the S&P/TSX about 6%).
The top five largest companies within the S&P 500 generated an approximate return of 35%, primarily due to the 149% increase of Nvidia, which became the second largest in the world (after Microsoft) as far as its market capitalization.
Here is an update on the performance and stock market valuations of the top five companies within the S&P 500:
The only company we own from this group is Alphabet (and it’s also the one with the lowest market valuation at 24 times estimated 2024 earnings). The other four are trading at price earnings ratios (P/E) of more than 30x.
So five companies out of the 503 making up the S&P 500 represent nearly 29% of the weight of the entire index and have generated more than half of the S&P 500’s gain after the first two quarters of 2024. Their weighted average market valuation is 37 times earnings—such valuations for the largest companies in the US is a rare phenomenon and has not been sustained over the long term.
This polarization of mega-cap stocks paints a false picture of the overall market valuation of the S&P 500. The current P/E of the S&P 500 is about 23x, well above the historical average. However, if we exclude these five companies, the average of all the other 498 companies in the S&P 500 is about 17x—much more in line with historical averages. There is therefore a 20-point difference in valuation between the top five companies of the S&P 500 (37x) and the balance of the other 498 stocks (17x).
Yet, it was not a disaster for the rest of the stock market and a 5% increase over six months is quite satisfactory and roughly in line with the historical average. What is abnormal is the performance and valuation of a few companies with a disproportionate weight in the S&P 500 index.
That being said, I don’t want to denigrate the performance of these five companies, on the contrary. Their combined economic achievements are almost unparalleled in the history of capitalism. There is a genuinely phenomenal economic performance behind these fabulous stock returns.
Nevertheless, it is important to realize that when you buy a company today at its current price, you are not buying its past but its future (past performance having rewarded past shareholders). And that’s a lot to ask of the future for a very large company (more than $1 trillion in market cap), when investors pay more than 30 times current earnings.
Consumers Are Cautious
Retail sales results since the beginning of 2024 tend to show a clear decline in organic sales—a trend that is widespread around the world. Very few retailers have been spared, including those that sell luxury goods which have sometimes shown resilience in difficult times. Whether in North America, Europe or China, the average consumer is under pressure. In addition, many retailers are facing an increase in shoplifting, even sometimes from store employees. The difficulty for retailers to maintain revenue growth is amplified by a declining profit margins. Infl ation, along with labour shortages and the ease of escaping prosecution by shoplifters, exacerbate these challenges.
It’s also been difficult for several restaurant chains. Even McDonald’s saw its organic sales decline during the second quarter. To boost sales, McDonald’s recently started offering $5 trios (McValue Trios in Canada for $5.79).
As always, the economy operates in cycles and things will eventually return to normal. In the meantime, it is difficult to weigh whether the problems of some of our retailers are cyclical or structural in nature. Of course, we are monitoring the situation closely while keeping an eye on the long term.
Results Of Our Companies
Five Below had a difficult quarter, with organic sales falling 2% and overall revenues growing 12%. While its EPS fell slightly in its earnings release, the company subsequently announced that its organic sales were down more than expected for the current quarter and it estimated that its full-year 2024 EPS would contract by at least 10%. The company’s CEO also announced his departure, and an interim president was appointed, leading to a sharp decline in the company’s stock. We are obviously disappointed with these results. We have spoken with the Chairman of the Board and continue to monitor the situation closely. The good news is that the company has an exceptional balance sheet, with no debt and about $300 million in excess cash. It has the resources to invest and improve its operations.
Heico Corp (NYSE:HEI) had a strong quarter, with revenue rising 39% (thanks to a major acquisition) and EPS climbed 17%.
Bank of America Corp (NYSE:BAC) had a better-than-expected quarter. EPS fell by only 6% compared to last year—a good result given the pressure on net interest margins across the banking industry.
Starbucks Corp (NASDAQ:SBUX) continues to suffer from lower consumer spending. Revenues fell 1% and Adjusted EPS decreased by 7% in its most recent quarter. Organic growth is down significantly in China. Indeed, while the number of Starbucks locations in China increased by 13% to 7306, revenues fell by 11% with organic sales down 14%.
Meta Platforms Inc (NASDAQ:META) (Facebook) had an exceptional quarter. Revenues climbed by 22% and the number of users continued to climb (by 7%). The price per ad increased by 10% and EPS grew 73%.
Bank Ozk (NASDAQ:OZK) was one of the few banks to achieve profit growth in the second quarter, with its EPS increasing by 3%. Our Arkansas bank is highly profitable—with a return on assets of 1.9% this quarter and an efficiency ratio of 33%—and its stock trades at market valuations that we consider low (with a P/E of about 8x). The Board of Directors approved a new $200M share buyback program (a strategy we enthusiastically support).
M&T Bank Corp (NYSE:MTB) also had a good quarter. Although EPS was down from last year (when profitability had been abnormally high), the bank exceeded analyst estimates. Provisions for bad loans have also fallen sharply. The return on assets was a solid 1.3% and the return on equity was over 15%. The company plans to (finally) start buying back shares again in the second half of the year.
The turnaround that began with Bob Iger’s return to Walt Disney Co (NYSE:DIS) continued in the last quarter. Revenue increased 4% and EPS grew 35%. The streaming division has (finally) become profitable. In addition, the movie “Inside Out 2” is a big hit and “Deadpool & Wolverine” is on track to gross more than $1 billion in theater sales. The company is now forecasting a 30% increase in earnings per share for the current fiscal year.
Fiserv Inc (NYSE:FI) had another good quarter with a 7% increase in revenue and an 18% increase in adjusted EPS. The company also raised its guidance for the year.
Charles Schwab Corporation (NYSE:SCHW) had a mixed quarter. The good news is that new assets have increased by 17% in just one year. Interest income, however, fell by 6% and income grew by only 1%. Adjusted EPS fell 3%. What affects Schwab is the allocation of its clients’ assets: the company continues to see bank assets (with high interest margins) decline to the detriment of money market funds (with lower revenues for Schwab). As a result, despite a significant increase in assets under management, margins continued to decline during the quarter. What is important is that Schwab’s economic moat appears to us to be intact and that the company continues to gain market share at a rapid pace. We believe that its margins should eventually stabilize.
Carmax Inc (NYSE:KMX) had another challenging quarter, with sales falling by 7.5%. The finance division grew with profits rising 7%, but the company’s overall EPS fell 16%. The company did take advantage of the weakness in its stock price to buy back $107 million of its shares during the quarter.
Dollarama Inc (TSE:DOL) saw its organic sales increase by 5.6% and its revenues rising by 8.6% in its most recent quarter. EPS increased 22%. The profit share of the Dollarcity division, located in South and Central America, increased by 68% during the quarter. This division is becoming increasingly important for Dollarama with now 547 stores and a contribution of about 7% to its profits.
Progressive Corp (NYSE:PGR) increased its insurance premiums by 18% in its most recent quarter. Its underwriting margins reached an incredible level of almost 14%. EPS was up sharply (from $0.75 to $3.94). We expect EPS of approximately $11.90 for the year, nearly double those achieved in 2023 ($6.11).
Edwards Lifesciences Corp (NYSE:EW) had a somewhat disappointing quarter. Sales increased by 7%. The good news is that sales of its new product called Transcatheter Mitral and Tricuspid Therapies (or TMTT) increased by 75%. However, sales of its fl agship product Transcatheter Aortic Valve Replacement (or TAVR) increased by only 5%, which disappointed Wall Street. EPS increased 6%. It’s not a disaster, but still below our expectations.
Installed Building Products Inc (NYSE:IBP) reported revenue increasing 7% and EPS rising 8%.
NVR Inc (NYSE:NVR) achieved a 12% growth in revenue during the second quarter. EPS grew by 4% and new orders increased by 3%.
Alphabet Inc (NASDAQ:GOOGL) (Google) achieved a 14% growth in revenue. Adjusted EPS increased 31%. Following these strong results, we have increased our estimates for the year and now expect EPS growth of 25%.
Medpace Holdings Inc (NASDAQ:MEDP) had an excellent quarter, with revenues rising 15% and EPS climbing 42%. However, new contracts declined by 4%. Despite this, the company maintains its EPS growth targets of around 30% for 2024.
Lululemon Athletica Inc (NASDAQ:LULU) performed well during the last quarter. Its revenues grew by 10% and its EPS by 11%. The company expects revenue to increase by about 11% in 2024 and EPS by approximately 12%.
The Typical Time Horizon For Investors
In recent decades, the time horizon of US investors has changed drastically. Five decades ago, the average holding period for a share on the stock market in the US was five years. While it was still on average 18 months when I started in 1993, today it is 10 months.
At Giverny Capital, the average holding period of our securities is about seven to eight years (or if you prefer 84 to 96 months), which is about nine times the average investor.
Many studies show that for all investors, the higher the turnover rate of a portfolio (and therefore the shorter the holding period), the lower the annual return. As Warren Buffett would say: “The stock market is a device that transfers money from the impatient investor to the patient investor”.
François Rochon
and the Giverny Capital team