The New Nifty Fifty?

Or, why Costco probably won't work from here

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A discussion on this week’s Power Hour was inspired by this thread on the Nifty Fifty:

McDonald’s grew its revenue by 24% and earnings per share (EPS) by 25% from 1972 - 1980. In 1980, the stock was down 35%. 67% if adjusted for inflation.

This is a terrible outcome for investors. I don’t care that the Nifty Fifty basket actually outperformed if you held on until sometime in the 1990s. Why? Because:

1. You would not have held. No, trust me, you would have sold.

2. The outperformance is mainly due to Phillip Morris and a few other stocks.

Anytime a stock is down 35% over eight years, I think it was a mistake to own it. I get that there will be periods of underperformance when holding long-term winners, but any reasonably sharp investor should be able to see if a stock is wildly overvalued and stay sober enough to sell/trim the position at extremes.

Which brings us to the New Nifty Fifty. As we sit here in early 2024, the same mentality that drove the market in the late 60’s and early 70’s seems to have returned. I am being told there are some stocks where it is never a mistake to buy shares, no matter how high the price goes.

Our example on this week’s podcast was Costco. Cue the YouTube comments section:

Like clockwork. Or, from my seat, like lambs to the slaughter.

According to this blog post on Intrinsic Investing, the average Nifty Fifty stock had a price-to-earnings ratio (P/E) of 42 at the peak.

So, what stocks belong in the New Nifty Fifty?

I ran a screener from our friends at Finchat.io (use our link to get a discount on any paid plan!) to identify large-cap stocks in the United States that trade at Nifty Fifty multiples.

The two criteria were:

• Market cap above $100 billion

• Trailing P/E above 35

Some stocks are on the list with misleading high earnings ratios due to suppressed trailing margins. I know. Amazon is a clear example. I tried to exclude these stocks to make it as fair as possible. Stop yelling at me.

Some (keyword: some) of these stocks will do well over the next 10 years. I can see a world where Netflix, Mastercard, and Microsoft all outperform if things fall their way.

Here is the list in descending market cap and the corresponding P/E for the stock:

• Microsoft - 37

• Nvidia - 79

• Eli Lily - 52

• Broadcom - 53

• Tesla - 45

• Mastercard - 36

• Costco - 52

• Merck - 146

• Abbvie - 49

• Salesforce - 68

• Netflix - 42

• Thermo Fisher - 38

• Adobe - 46

• Danaher - 49

• Intuit - 67

• Amgen - 44.9

• Intuitive Surgical - 72

I could go on. And this doesn’t even make it down to below a $100 billion market capitalization. Chipotle trades at a P/E of 67. WingStop trades at a P/E of 138. A restaurant!

What are we doing? This will not work. A few of these stocks will probably work. But on average, the likelihood that this basket of stocks performs well for investors over the next 10 years is close to zero. You cannot delude yourself into buying these names just because the last 10 years (or 20) have looked great.

Price matters, especially if you are a never-sell investor. Because if you plan to never sell a position and end up actually never selling it, the only returns you can get are cash distributed back to you as a shareholder.

You can’t eat multiple expansion unless you sell. Remember that when holding WingStop at over 100x earnings.

Costco’s P/E is shocking. The company grew revenue by 9% year-over-year last quarter. Let’s say they can keep this up for the next 10 years. That would mean 137% cumulative revenue growth 10 years from now. I think that is optimistic but not entirely unreasonable if you are bullish on the business and think inflation remains above 3% in the United States.

Let’s be nice and say they can expand margins by raising membership pricing faster than revenue and achieve 200% cumulative earnings growth.

Assuming a stable share count, Costco would have a P/E of 17 in 10 years based on today’s share price. There is a good chance shares are flat or lower in this ~optimistc~ scenario.

This is a crazy bet to make. You are betting:

• Business quality does not deteriorate over 10 years

• A mature business with $250 billion in revenue more than doubles its top line in 10 years

• A future even more mature business with $500 billion+ in sales and minimal optionality will trade at an elevated P/E because “reasons”

This feels like a terrible risk/reward to me. Should long-term shareholders in Costco sell? Maybe. Perhaps a trim is the most prudent option. It’s a good problem to have, sitting on all those gains.

But no sane person is buying Costco in 2024 at a P/E above 50. It will likely be a mistake unless Costco is still trading at a P/E of 50 in 2030.

Anyone want to make that bet?

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