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Two apparently unrelated announcements this week illustrate how difficult it is to make the big calls that move the dial in investment.
The first was Terry Smith’s justification to investors for why he had chosen not to invest in Nvidia. The second was a report on Saudi Aramco’s €740m (£623) bet that the internal combustion engine will be around for a lot longer than we think.
Both underline the challenge of allocating capital without the benefit of a crystal ball. They show the importance as well as the risks of being a contrarian. Both calls require other investors to be wrong – about the transformative impact of AI on the one hand and the rapid demise of petrol and diesel vehicles on the other.
More broadly, they set me thinking about the tendency of investors to prefer novelty to durability and what the opposite approach might look like.
Smith told investors in his half-year update on the Fundsmith Equity fund that he had avoided Nvidia because its outlook was not predictable enough. Obviously in the short term this has been a costly mistake, as Nvidia and four other big US tech stocks have accounted for more than half the S&P 500’s nearly 15pc gain so far in 2024. Smith is swimming against the tide. Nvidia briefly became the world’s biggest company recently, having grown tenfold in two years.
We don’t yet know if Saudi Aramco’s equally contrarian investment in a company manufacturing fuel-based car engines will pay off. It has bought a 10pc stake in Horse Powertrain, a company spun out of Renault and Chinese carmaker Geely.
It is betting that as the main carmakers focus on electric vehicles, they will need to outsource production of traditional engines for the 50pc or so of cars that may still run on conventional fuel in 2050.
Shunning the shiny and new
Unlike Smith and Saudi Aramco, most investors prefer to look for the shiny and new.
Familiarity breeds contempt when it comes to constructing our investment portfolios, making us vulnerable to investment manias and bubbles. A compelling growth narrative trumps all other rational considerations, which is why Nvidia’s share price chart looks so similar to that of RCA in the 1920s and Cisco’s a generation ago.
One investor who has done pretty well out of avoiding this novelty bias is Warren Buffett. Some of his most successful investments have been in dull businesses that had been ploughing the same predictable furrow for many years before he jumped aboard.
He started investing in Coca Cola in 1988, 102 years after it was first drunk at an Atlanta soda fountain. When Buffett bought See’s Candies in 1972 for $25m (£19), it had been selling sweets for 51 years. His $600m investment in Gillette in 1989 came nearly 90 years after King C. Gillette invented the safety razor in 1901.
All of these businesses had proved themselves over decades. Buffett’s insight was to realise that they would continue to do so because of recurring demand for their products and the competitive advantage or “moat” that their brands afforded them.
There are two key differences between these investments and one in Nvidia or any other AI-related stock. First, their businesses were and still are predictable (this is Terry Smith’s point). Second, they were so boring that Buffett could pick them up at a price that included little or no hope value. Nothing needed to go right to make them a good investment. Unlike AI, sugary drinks and daily grooming do not require a revolution to deliver attractive returns to shareholders.
Buffett’s success came from favouring the durable over the new and untested. This was why he invested in the unfashionable Burlington Northern Santa Fe railroad. He identified that railways were an old and cheap solution to a new problem, with cost and environmental advantages over trucks amid growing demand for freight.
Betting on durability
So, as AI stocks continue to part company with the rest of the market – the equal weighted S&P 500 index is down over the past three months – how might investors take a leaf out of the Buffett, Smith, Aramco playbook and bet not on novelty but durability? What products and services do we know for sure we will be using and consuming in 30 years’ time?
I think they come in five main categories. They are the things that make us human.
First is food. There aren’t many companies that have appeared in the FTSE 100 since its launch in 1984 but among them are Tesco, Sainsbury’s and AB Foods.
Next is shelter. One of the sectors being highlighted as a beneficiary of the new Labour government is housebuilding. We have not built enough homes for years.
Third is love and connection. There is a reason why fashion and cosmetics are two of the world’s largest industries. A related aspect of humanity is community. The myth that we would all want to work in isolation at home outlasted Covid but not by long. There is a future for offices and shops, albeit they are likely to look different and need to be more environmentally sustainable than in the past.
Fourth, I would continue to bet on human weakness and the need to escape. There is a reason why Imperial Brands and British American Tobacco (BAT) live on in the UK’s blue-chip index and why Kweichow Moutai, a popular Chinese drinks company, has compounded its earnings at 17pc a year for the past five years.
Category number five is, sadly, conflict. The last three years have shown that the need to defend ourselves remains a constant. In the past 10 years, an investment in Bae Systems has performed nearly three times as well as the FTSE 100.
The great thing about investing in the durable rather than the new is that you will be buying shares in unexciting companies in unfashionable sectors. And that means that, unlike the shiny investments that hog the headlines, they will be cheap.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
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