Give the magnificent middle some love

The S&P 500’s magnificent seven have made us all richer this year but investors ignore the less illustrious, cheaper shares at their peril

The S&P 500’s recovery over the past year has obscured some relatively cheap value stocks across the world. Or as Dan Brocklebank, portfolio manager at Orbis Asset Management, puts it: the magnificent seven stocks have drawn investors away from the magnificent middle those midcap stocks easily overlooked in a bid to make a quick return.

The magnificent seven are Amazon, Apple, Google parent Alphabet, Meta, Microsoft, Nvidia and

Tesla. Combined, they constituted 29% of the

S&P 500 at the end of last month. Thanks to their surging share prices, the index now trades at a hefty p:e of

21.7 and a price-tobook ratio of four.

“We looked at [the magnificent seven’s] multiples, [and] to justify their current valuations, they probably need to grow [earnings] by at least 15% as a group,” Brocklebank tells the FM. Put another way: “They need to find $15bn of profit somewhere between them.”

So tight is the valuation of these seven companies, that Brocklebank fears anything going wrong can send a single stock’s share price down sharply. “Some of that profit growth, for the successful companies, is going to come from the other members of [the seven]. Their numbers are just too big otherwise. And if that happens, some of them are going to lose a lot.”

For example, Microsoft and Google are both targeting the same businesses — such as cloud computing.

Then there’s the extraordinary performance from companies exposed to AI — such as Nvidia, which manufactures powerful graphic cards that support the memory-heavy processing required.

Nvidia’s shares are up 198% year to date, putting the company on a p:e of 117.

“I think there’s a lot of hype,” says Brocklebank. For one, he’s uncertain whether AI will “result in profit growth”.

Instead, “we’re looking for cheap stocks that are trading at a discount to their intrinsic value. Where we’re not finding value is in the mega-caps … particularly in the US.” Where Orbis does find value is in the “magnificent middle”.

“Many of them are not household names. They’re big companies, they’ve got smart management and are well governed. They’re big enough that we can take decent positions in them.”

As of end-October, the largest holding in the Orbis Global Equity Fund, which manages $18.9bn, was a payment platform and fleet services company called Fleetcor, which is listed on the New

York Stock Exchange.

At a p:e of 17.9 and a one-year return of 18%, it is dwarfed by the likes of Microsoft (p:e of 35.5 and price return of 51%) and Apple (p:e of 30 and return of 25%).

“We looked at the 10 largest companies in the world and asked what percentage of our peer asset managers owned each of [them]. The least-owned company is ExxonMobil with 15% of our peers owning [the company]; we also don’t own it.”

About 60% of Orbis’s peers owned Alphabet, 42% owned “flavour of the month” Nvidia, 71% owned Microsoft and 43% owned Amazon, Brocklebank says, showing the investment market’s concentration on a handful of shares.

“It is an incredible herding that is going on across asset managers,” he says. “There are commercial reasons for asset managers to do that. Most commercial asset managers try to avoid alpha performance.” (“Alpha” describes an investment strategy’s ability to beat the market.)

But even as Orbis sticks to its convictions, and the belief that its picks will outperform their benchmarks, it isn’t an easy ride. The Orbis Equity Fund, for example, has underperformed its MSCI world index benchmark over five and 10 years, while beating its peer group in both instances.

“Half of our portfolios are very different to the benchmark,” says Brocklebank. “Only 6% of our peers own Fleetcor. The company in our top 10 that is most popular is the Japanese bank Sumitomo Mitsui Financial Group, which is held by only 13% of our peers.”

Still, he sees upside to Orbis’s picks, especially in an environment in which inflation seems likely to be a long-term fixture.

“The energy transition, end of globalisation, labour market issues — all of those factors, if you put them together … there could be a bias upwards to inflation. We wouldn’t be surprised if inflation averaged between 3.5% and 4.5% [globally].”

If the bias is to higher inflation and interest rates in the near future, it changes the price of money and makes near-term cash flows much better value relative to promises of cash flow a long way out, Brocklebank says.

“Companies that generate lots of cash flow now could become significantly repriced [upwards] if the forces of inflation start to play out.”