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Nifty Fifty – Part I

by Altais on June 16th, 2013

Nifty Fifty was an informal term used to refer to 50 high flying growth stocks in the late 1960s and early 1970s that were widely regarded as solid buy and hold growth stocks. ‘Nifty Fifty’ phenomenon is often cited as an example of speculation resulting from unrealistic investor expectations for growth stocks – where these are touted as ‘one-decision’ stocks, just to be bought irrespective of price, held onto irrespective of valuations, and never to be sold.

Though there was no official list of Nifty Fifty stocks, it composed of blue chips like Coca-Cola, IBM, Xerox, Polaroid, Walmart, Philip Morris, Pfizer, Gillette etc. The common characteristics were solid earning growth, stable businesses with long term visibility, and high valuations (Average P/E of 41.9 times vz. 18.9 for S&P 500, and dividend yield at 1.1% was less than half that of other large stocks). Because their prospects were so bright, many analysts claimed that the only direction they could go was up. The delusion was that these companies were so good it didn’t matter what you paid for them; their inexorable growth would bail you out.

When the stock market crashed in 1973, the Nifty Fifty defied gravity for a while, held up by institutional enthusiasm that created a two-tiered market of the richly priced Nifty Fifty and the depressed rest (sounds familiar?). Then, in the memorable words of a Forbes columnist, the Nifty Fifty were taken out and shot one by one.

As Buffett notes in his 1996 letter “You can, of course, pay too much for even the best of businesses. The overpayment risk surfaces periodically and, in our opinion, may now be quite high for the purchasers of virtually all stocks, The Inevitables included. Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.”

Further, he adds “A far more serious problem occurs when the management of a great company gets sidetracked and neglects its wonderful base business while purchasing other businesses that are so-so or worse. When that happens, the suffering of investors is often prolonged. Unfortunately, that is precisely what transpired years ago at both Coke and Gillette. (Would you believe that a few decades back they were growing shrimp at Coke and exploring for oil at Gillette?) Loss of focus is what most worries Charlie and me when we contemplate investing in businesses that in general look outstanding. All too often, we’ve seen value stagnate in the presence of hubris or of boredom that caused the attention of managers to wander. That’s not going to happen again at Coke and Gillette, however – not given their current and prospective managements.”

Now that would be what Munger calls Lollapalooza effect – you pay an inflated price and management does something stupid!!

Since we do not know about the management mistakes for these companies, let’s focus on the valuation part only.

I came across an article by Perma-Bull Jerermy Siegel (Author of ‘Stocks for the Long run’ and whom Charlie Munger famously described as ‘demented’!). (Do read it first)

http://www.aaii.com/journal/article/valuing-growth-stocks-revisiting-the-nifty-fifty

and contrary view

http://economics-files.pomona.edu/GarySmith/Nifty50/Nifty50.html

My conclusions looking at his data/ analysis are a bit different:

  1. Nifty Fifty stocks just matched returns of S&P 500 over the long term (1972-1998), inspite of investing in best of companies (which logically should outperform general markets), and after buying/ holding stocks at lofty multiples (poor risk reward ratio).
  2. This set of stocks dramatically got sold off in a bear market and underperformed the broad markets in stress times. (Newton’s Law?). So don’t chase valuations, Mr. Market will redeem you in times to come, so be patient and prepared.
  3. Jeremy however does note one aspect “If you examine the actual price-earnings ratios of the Nifty Fifty stocks, the 25 stocks with the highest ratios (averaging 54) yielded only about half the subsequent return as the 25 stocks with the lowest price-earnings ratios (averaging 30).”

Stocks with strong moat, long term growth visibility, high profitability and cash flows, and capable managements can be purchased at higher valuations but only to an extent. Don’t stretch the logic. GARP investing is fine (Growth at reasonable price), not GAAP investing (Growth at any price).

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