Don’t put all your eggs in one basket.
You might have heard this saying many times before. Many investors argue in favor of diversification to minimize the risk of losing capital, making it a fundamental rule in one’s investment objectives.
Yet when we look at the top 10 richest people on the planet we clearly realize that focusing on a single venture has fueled the wealth of many.
9 out of the 10 richest people are founders of successful businesses, with Warren Buffett being the sole investor in the top ten with Berkshire Hathaway (BRK.B). Examples like Elon Musk with Tesla (TSLA), Bernard Arnault with LVMH (OTCPK:LVMHF) and Mark Zuckerberg with Meta (META) demonstrate how concentrated bets can lead to immense wealth.
However, replicating their entrepreneurial success and deep business acumen isn’t easy for everyone.
This is where Warren Buffett’s advice of “not putting all your eggs in one basket” becomes relevant. Recognizing the limitations of knowledge and resources in average investors, he advocates for diversification through index investing or passive funds.
These in theory should offer low fees, better performance than most actively managed funds, and wider exposure to the market, reducing risk for those lacking expertise.
But is your portfolio truly diversified when you follow Buffett’s advice and buy, for instance, the S&P 500 (SPY)?
Despite aiming for diversification, the S&P 500’s market-cap weighting leads to significant concentration, with the top 5 companies holding 24.85% of the index.
- Microsoft (MSFT), weight 7.26%
- Apple (AAPL), 6.62%
- Alphabet (GOOGL), 3.77% (combined A & B shares)
- Nvidia (NVDA), 3.73%
- Amazon (AMZN), 3.47%
The index not only lacks company diversification but also exhibits sector imbalances.
Information Technology’s massive 29.5% weight raises concerns, followed by 2nd largest sector Financials with 13.14% and Healthcare with 12.77%.
The S&P 500’s market-cap weighting undeniably concentrates influence in the hands of a few giants.
Their dominance is no fluke – superior products used by billions, great management, and consistent cash flow generation have earned their place.
However, this raises a crucial question.
Are we comfortable with such significant exposure to few businesses, especially with a potential GDP growth slowdown in 2024?
To mitigate this risk and diversify your portfolio, consider putting these 3 quality companies on your watchlist for the next market pullback.
1. MSCI Inc. (MSCI) – Target Buy Price $550
MSCI, also known as Morgan Stanley Capital International, is a major player in the financial industry that you perhaps haven’t heard about.
With a market cap of $47.8 billion, the company is the smallest of the three high-quality financial companies focused on investment tools, financial data, indices, and credit ratings, alongside S&P Global (SPGI) and Moody’s Corporation (MCO).
MSCI is a global provider of tools that aid investment decisions, delivering in-depth financial data, analytics, and indices.
These resources are invaluable for investors, empowering them to make wise and well-informed choices.
Even here on Seeking Alpha, one of the most common questions in the comment sections is, “Where is the data coming from?”
In today’s financial markets, having accurate data and analytics is key to making accurate and rewarding decisions.
MSCI’s core business revolves around providing insights and solutions tailored to help investors manage risks, optimize performance, and navigate the complexities of the global market.
MSCI serves over 6,600 customers in 95 countries. They leverage four key business segments to empower investors and drive diversification:
- Indices (56% of revenue): These globally recognized benchmarks, spanning equities, fixed income, and multi-asset classes, help clients evaluate performance, allocate assets strategically, and even create diverse investment products like ETFs.
- Analytics (24% of revenue): MSCI provides in-depth data and analytical tools to aid informed investment decisions.
- ESG & Climate (11% of revenue): Recognizing the growing importance of sustainability, MSCI offers solutions that incorporate environmental, social, and governance factors into investment strategies.
- Private Assets & Other (9% of revenue): This segment caters to specialized investment needs with solutions like real estate portfolio services and private capital insights.
MSCI’s primary clientele comprises asset managers, banks, and trading companies with 96% of their revenue is recurring, indicating strong customer loyalty and a predictable income stream.
This week, their impressive Q4 2023 earnings fueled a 10% stock price surge, driven by:
- Adjusted EPS growth of nearly 30% to $3.68
- Organic revenue growth of 15%
- Free cash flow growth of 24%
- EBITDA margin increase of 130 basis points to 60.1%
Moreover, AUM in equity ETF products linked to MSCI Indices reached a record $1.47 trillion at year-end, highlighting their growing influence in the investment world.
For reference, this is still significantly trailing BlackRock’s (BLK) $5.29 trillion AUM in equities.
MSCI demonstrates a strong commitment to shareholder value through a combination of strategic share repurchases and a growing dividend.
Over the past 11 years, the company has repurchased over 40% of its outstanding shares at an average price of $117 per share, creating significant value for shareholders.
Though the current dividend of $1.60 yields just 1.06%, remember it has grown a substantial 789% in the past decade.
MSCI, characterized by its superior quality and an impressive annual growth of 21.3% in EPS since 2016, is currently not trading at a discounted valuation.
Presently, the stock is valued at 44.3x its blended PE, exceeding the historical average of 38.5x since 2016.
Despite the 18% growth in 2023, I hold the view that the stock is currently richly valued. The recent 10% surge post the earnings report might indicate a potential consolidation phase around the corner.
Looking ahead, growth is expected to persist at around 14%, a bit below historical levels. However, it’s noteworthy that MSCI has a tendency to consistently surpass expectations.
I believe a growth expectation of 16% to 18% between 2024 and 2026 is plausible.
While I already hold a substantial stake in MSCI and am not considering additional purchases at the current price, I recommend new buyers to exercise patience and wait for a more favorable entry point, ideally around $500, preferably below $480.
This would bring the valuation below the historical average of 38.5x its earnings and open the possibility for 15%+ annual returns, instead of today’s forecasted 9% returns.
For growth stocks like MSCI, I also advise a phased approach, suggesting buyers to layer into the stock with 25% increments at different price levels, rather than making a single large investment.
2. PayPal Holdings, Inc. (PYPL) – Target Buy Price $55
PayPal’s stock has not been given much love in the last 2 years.
Soaring online transactions during the COVID-19 pandemic fueled PayPal’s growth, boosting revenue from $17.8 billion in 2019 to over $25 billion in 2021.
Its stock price skyrocketed to a record high of $289.
However, with the pandemic gone, the boom went bust. Disappointing growth sent the stock on a downward spiral, erasing all pandemic gains and currently sitting at a mere $62.
PayPal’s stock has faced recent selling pressure due to concerns about slower growth, competition, and elevated costs. However, the company continues to hold a strong position in the market with a history of success.
With its ongoing efforts to address challenges, the current dip might represent an attractive entry point for long-term investors.
While PayPal boasts an impressive network of 430 million active accounts across 200+ markets, facilitating $1.5 trillion in payment volume and 24 billion transactions annually, its once-stellar growth has cooled down.
This slowdown can be attributed, in part, to the increasingly competitive landscape in the digital payment sphere, with players like Block (SQ) and Adyen N.V. (OTCPK:ADYEY) vying for market share.
PayPal is projected to report Q4 earnings on February 6th. The consensus for earnings is $1.36, representing a 13% YoY increase, and $7.9 billion in revenue.
Strong e-commerce volume during the holiday season, confirmed also by Amazon, should support checkout growth volume for PayPal’s Q4 numbers. This, alongside increased cost controls and recent measures to temper labor costs, should help PYPL achieve on-target growth.
Naturally, this growth is slower than what we have been accustomed to with PayPal in prior years.
Since 2015, the company has averaged EPS growth of around 16%. If we were to exclude the pandemic and post-pandemic years from the picture, the EPS growth used to be 24.6%, significantly higher than what PayPal is projected to report for Q4 earnings.
While I believe the years of 20%+ growth are over due to elevated competition, as long as PayPal does not reinvent the wheel, the stock is trading at only 12.3x its blended PE.
From a historical standpoint, this is unprecedented for a company whose historical valuation has been around 34x its earnings, even when growth slows.
PayPal still has strong brands under its umbrella, including Venmo, Xoom, and Braintree.
In Q3, this propelled total payment volume or “TPV” to $388 billion, marking a 15% increase from the previous year and the swiftest growth in the past six quarters.
I expect this accelerating trend to continue, especially with the strong holiday season, leading to TPV growth. This should mark the bottom of peak pessimism for PayPal.
Here is the EPS growth projection for PayPal in the following years
- 2024: EPS of $5.50E, 10% YoY Growth
- 2025: EPS of $6.20E, 13% YoY Growth
- 2026: EPS of $6.50E, 5% YoY Growth
If we consider today’s valuation of 12.3x and anticipate a 10% YoY growth for 2024, the forward PEG ratio is 1.23x, which, in today’s pricey market, is quite favorable.
However, while PayPal presents good long-term value at today’s price, in the event of a pullback, I would recommend aggressive accumulation of shares at $55 and $50.
It’s essential to note that the reversal to the mean will not be immediate and may take a couple of quarters or even years to play out.
This investment is suitable for patient investors, with a target price of $190 by the end of 2026, representing a potential for 46%+ annual returns.
3. Booking.com (BKNG) – Target Buy Price $3,250
The COVID-19 pandemic dealt a severe blow to the travel industry, causing a halt in international travel and imposing restrictions on domestic travel.
This had a significant impact on hotels, travel agencies, airlines, and related services. However, in 2023, following the end of the pandemic, the industry experienced a year of recovery.
Booking’s expected EPS are anticipated to reach $149.8, indicating a remarkable 50% YoY increase.
The stock reflects optimism in the industry, trading at an all-time high, nearing $3,600.
Looking ahead to 2024, the expected normalization of growth shouldn’t be viewed as a sign of weakness but rather as a positive return to normalcy.
The economic landscape seems favorable for continued consumer spending. Despite potential concerns about a slowdown in GDP growth, shifts in consumer behavior, with a preference for travel over other expenditures, are evident. This shift is anticipated to provide support for growth, even in the presence of certain weak points.
In recent years, the travel industry has experienced significant benefits, evolving into a social status symbol, particularly influenced by the widespread use of social media. This trend places a higher priority on travel experiences over the acquisition of material luxuries.
Although many perceive Booking as a platform for hotel reservations, its business model is more diverse, encompassing ownership of other brands, such as:
- Priceline.com
- Agoda.com
- Kayak.com
- CheapFlights
- Rentalcars.com
- Momondo
- OpenTable
The company’s diversified approach, spanning hotels, short-term rental properties, cars, flights, and experiences, operating in 200 countries, enables it to capitalize on every facet of travel, catering to both leisure and business needs, hence, I prefer it over its rival Airbnb (ABNB), which, in my view, is more holiday oriented.
This diversification was evident in the Q3 earnings, where Booking’s traveler customers booked an impressive 276 million room nights, representing over a quarter of a billion, a 15% YoY increase.
The gross bookings reached $40 billion, marking a 24% YoY growth. Despite inflation, room night growth compared to 2019 was a resilient 24% in Q3. Both room nights and gross bookings achieved record quarterly figures, surpassing previous expectations.
In the third quarter, the company recorded revenue of $7.3 billion, a 21% increase, and an adjusted EBITDA of $3.3 billion, a 24% increase compared to the same period last year.
The company’s management remains optimistic, highlighting the resilience in global leisure travel demand.
Looking ahead to 2024, early indications suggest robust growth in bookings for the Q1 of the year, although a significant portion of these bookings is subject to cancellation.
In line with current trends, Booking’s management expects that customers will continue prioritizing travel over other discretionary spending in 2024, similar to my expectations.
While accommodations are crucial, flights play a pivotal role in the travel experience. The company is actively enhancing its flight offering on Booking.com, evident in the remarkable 57% YoY increase in air tickets booked in the Q3.
This growth is propelled by the expansion of Booking’s flight services. To put this into perspective, the 9 million tickets booked during the third quarter surpass the number of air tickets booked through the platform in Q3 2019 by more than five times.
An essential growth driver for Booking is AI. The company has introduced a new AI Trip Planner to elevate users’ experiences. Travelers can now ask the AI Trip Planner general and specific travel-related questions, supporting various stages of trip planning.
This includes exploring destinations, finding accommodation options, and receiving personalized travel recommendations. This AI-driven feature is expected to boost demand and engagement with Booking’s owned brands.
As one might anticipate, travel falls under discretionary spending, and Booking’s historical growth has been shaped by these fluctuations. However, the company has managed to achieve a 16.6% annual growth in its EPS since 2011.
Contrary to slowing growth, the growth trajectory suggests the opposite:
- 2024: EPS of $170E, 16% YoY Growth
- 2025: EPS of $209E, 20% YoY Growth
- 2026: EPS of $236E, 13% YoY Growth
The growth outlook is undeniably optimistic, but there’s little room for error with the current trading multiple at 23.4x its blended PE.
Although this figure is still slightly below the historical average of 24.8x, indicating a modest discount, I’d be more inclined to increase my holdings if the stock pullback a bit.
While buying the stock now could potentially yield a compelling annual return of 18.7% until the end of 2026 if the projected growth materializes, I’d personally prefer a slight pullback to around $3,250.
This would not only allow me to build a more substantial position but also create the potential for even greater returns, while providing a better margin of safety.
Takeaway
For the average investor, opting for an index like the S&P 500 and consistently investing a fixed amount each month for dollar-cost averaging is often the most advisable strategy.
However, in the current market landscape where market cap-weighted indices are heavily influenced by a handful of mega-cap companies, relying solely on indices may not offer sufficient diversification, leading to elevated risks due to concentration in a few businesses.
During such times, it’s worthwhile to explore opportunities for diversification beyond indices, focusing on a select few high-quality companies.
In this article, I’ve introduced three companies with reasonable valuations.
Nonetheless, my recommendation is to exercise patience and wait for the next market pullback before initiating positions. This approach could potentially lead to superior returns from these companies and better margin of safety.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.