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Algorithmic trading accounts for 60-75% of all trading volume in the current stock market. The largest companies have the most liquidity and most activity. Over the last 15 years, very few companies provide for the vast majority of outperformance versus an index. It is why terms like the magnificent seven are so applicable. It makes for an extremely concentrated market for investors who own investments which bring higher returns. A few important questions to consider are: Will this environment continue and if so, for how long? How intelligent is it to invest in a trend which has existed for so long? What if sentiment changes? How might that affect capital flows? These are not simple or easy questions to answer. If you are managing your own capital, let me suggest a different approach.
A philosophy which I have always found appealing is owning companies which provide mandatory assets. Mandatory assets are the infrastructure which delivers necessary services in some form. Let’s delve into this concept a little deeper. A prime example is the exchange providers for listed companies. In order for a company to go public, they must be on a public exchange like the New York Stock Exchange, Nasdaq, London Stock Exchange, Toronto Stock Exchange, etc. You can own a piece of the NYSE by owning stock in Intercontinental Exchange (ICE). The same holds true for the Nasdaq (NASDAQ).
I grew up and live in Las Vegas. It has long been the case that the best way to make money in a casino is by owning stock in the companies which own the casinos. Each casino company has a target market and strategy for growing their business. You are probably familiar with their names: Las Vegas Sands (LVS), Wynn Resorts (WYNN), MGM (MGM), and Caesars Entertainment (CZR). WYNN and LVS target the Asia market with the vast majority of their revenues coming from that region, specifically Macau. The latter two are the dominant providers on the Strip, but they lease nearly all of their properties from VICI Properties (VICI). VICI is a real estate investment trust. For locals, the two dominant companies are Red Rock Resorts (RRR), and Boyd Gaming (BYD). Both have casinos outside of Las Vegas but cater to many Las Vegas residents. Casinos are interesting because in many ways they are a recession proof business. Yes, there is some dependance on the strength of the economy for volumes, but gambling is an activity which people show little sign of not participating in.
Another area for mandatory assets is the providers of systems of record keeping. Some interesting components are advertising, accounting, tax, human resources, marketing, retirement and benefits, and supply chains. The wonderful part of many of these businesses is the profitability aspect relative to the rest of the market. Examples of companies are Intuit (INTU), ADT (ADT), Salesforce (CRM), Paychex (PAYX), Oracle (ORCL), Microsoft (MSFT), Adobe (ADBE), Alphabet (GOOG), Amazon (AMZN), and Facebook (FB).
Related to the different components is the cloud space. These providers concentrate on the storage and capacity for businesses to host their web sites and related content. The cloud providers are the names the whole world is familiar with, including Amazon with their web services platform, Microsoft, Google, and Facebook. Digging a little deeper into this important area, the cloud providers all need capacity for the enormous storage needs. They buy and lease their server equipment through data centers. The real estate investment trust companies like Digital Bridge Group (DBRG) , Equinix (EQIX), and Digital Realty (DLR) are the biggest suppliers for the cloud providers.
Let’s turn to energy, maybe the most hated, but probably the most critical of the mandatory assets for the globe. The biggest sources of energy are carbon related industries and renewables. Carbon related inputs include oil, different types of gas, and coal. Renewable pieces are solar, wind, geothermal, nuclear, and biofuels. Electrification of the energy complex to move away from carbon based assets is the transition the world is trying to navigate. It involves the massive challenge of providing the infrastructure for the different kinds of electric transportation systems (cars, trucks, planes, trains, ships, scooters, bikes, carts, mopeds). As part of this complex is the electrical system and how it gets upgraded to handle the challenge of meeting demand with intermittent energy sources. The choices for investment in these areas are abundant. I recommend starting with the large integrated oil and gas companies like Exxon (XOM), Chevron (CVX), Shell (SHELL), and BP (BP). They all own every piece of the oil and gas value chain, meaning upstream (exploration and production), midstream (pipelines and storage terminals), and downstream (marketing through stations. Each is also involved with the various segments of renewables. Shell and BP are far more invested in renewables than the other oil majors. Investors can delve into concentrated areas like on or off shore exploration and production, servicing and equipment, and marketing with smaller companies. The same holds true for the renewable segments. Your specific risk tolerance and interest will guide you to determine what you find appealing and appropriate for your circumstances.
Finally, it is important to research any company extensively before you invest in it. I would start with the background and history of the management team and company. You should look at the prior ten years of the business to see why it is in the current position. Just as important are the plan for growing the company over the next three, five, and ten years. You should investigate the management ownership of the company to see what percentage each member owns. Next, analyze the financial statements to see what kind of performance has taken place over the last decade. Are things getting better or worse? The current market environment is a challenge, but it is usually this way. There are very few companies which do better than the market, and this article is meant to help investors find them. Thank you for reading it and if you have any comments or questions, please feel free to post them or contact me at information@y-hc.com
(Y H & C Investments has positions in companies mentioned in this newsletter. It is the responsibility of each investor to research the investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives. Past performance is not an indication of future results, and you may lose your principal by investing in stocks.)
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