John Dorfman on investing: Why I own only two of the sacred seven

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There are seven stocks that investors seem to worship. In the parlance of the 1970s, they are one-decision stocks: You are supposed to buy them and never sell them. Call them the Sacred Seven.

The blessed septet are Alphabet Inc. (GOOGL, formerly Google), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Meta Platforms Inc. (FB, formerly Facebook), Microsoft Corp. (MSFT), Netflix Inc. (NFLX) and Tesla Inc. (TSLAJ).

I personally own only two of these seven stocks. I’ll list them in order of my preference.

I’m not completely objective about Alphabet, since my oldest daughter works for the company’s Deep Mind division in London. However, I try to be objective, and I still think Alphabet is a good candidate for the most innovative company on earth.

It owns the ubiquitous Google search engines, the promising self-driving car project Waymo, and the popular video sharing platform YouTube. By price/earnings ratio, it is the second-cheapest of the Sacred Seven, with the stock selling for 28 times recent earnings and 26 times estimated earnings.

Apple Inc., lord of the iPhone, has nearly $17 billion in cash and more than $113 billion in marketable securities. It has earned 20% or more on invested capital in 12 of the past 15 fiscal years, and last year’s figure was above 35%, the best since 2009.

Customer loyalty? Most people I know own iPhones, love them, and can’t imagine life without them.

Apple’s stock price is up 1,114% over the past decade, including a 29% gain in the past year. The stock price is 31 times earnings.

Once best known for dominating the personal-computer software field (Microsoft Office, Excel), Microsoft is now a big provider of cloud services to companies. Earnings growth, which averaged about 12% over the past decade, shot up to 44% in the past year.

My hesitancy about the stock relates to valuation. It sells for 37 times recent earnings, a bit pricier than Alphabet and Apple. The price/book ratio (stock price divided by corporate net worth per share) and price/sales ratio (stock price divided by per-share revenue) are quite high at 16 and 14, respectively.

Amazon.com

I first heard of Amazon.com around 1995, when a friend who owned a bookstore complained that the company was eating his lunch. From books, Amazon gradually expanded into selling every type of merchandise.

Computer power has always been the key to its success, and lately it, like Microsoft, provides cloud services to many large companies.

I think Amazon will continue to grow. Home shopping jumped because of the pandemic, but it was growing steadily even before that. However, the stock, at 66 times earnings, discounts a lot of future success.

Netflix deserves immense praise for pioneering the streaming model of home entertainment, in which consumers can watch almost anything they wish, at a time convenient for them. But success always breeds imitation — in other words, increasing competition.

Streaming services now competing with Netflix include Amazon Prime, Disney Plus, HBO Plus and Paramount Plus. Return on invested capital, recently about 15%, had weakened prior to the pandemic, and still is below the levels of 2006-2010.

The price/earnings ratio is steep at 55 times recent earnings and 47 times estimated earnings.

Meta Platforms

Meta Platforms, formerly Facebook, has some major competitive advantages. Because so many people use its sites, they are useful for finding people or staying in touch with friends. And because the company has detailed information about people, it can target ads — something that advertisers relish.

There are clouds, however. Use by younger people is edging downward. Politicians and regulators in Europe and the U.S. are pushing the company to give users more privacy protections. Meta also has problems in policing unacceptable speech on its site, including hate speech and malicious political propaganda.

Because of these issues, Meta sells for the lowest price/earnings ratio in the Sacred Seven, 24 times trailing earnings and 22 times estimated forward earnings.

Elon Musk’s manufacturer of snazzy electric cars broke into the black in 2020 and improved its profits a lot in 2021. Musk has flair, charisma and boldness — and strikingly bad judgment at times, for example when he feuds with the Securities and Exchange Commission.

Tesla’s valuations defy the old saying “Even trees don’t grow to the sky.” The stock sells for 345 times recent earnings, 147 times estimated forward earnings. Anything than perfect corporate performance could trigger an enormous drop.

Disclosure: I own Alphabet and Apple personally and for almost all of my clients. My wife, Katharine Davidge, who is a portfolio manager at Dorfman Value Investments, owns Microsoft and Amazon.com personally and for clients.

John Dorfman is chairman of Dorfman Value Investments LLC in Boston. He can be reached at jdorfman@dorfmanvalue.com.