Category 2 Large Caps and Current Opportunities

I write a lot about what I call Category 2 stocks: high quality, mature large companies when the sentiment turns negative. I still see lots of commentary online about how there is no edge in large caps, but the 52 week high is over 50% higher than the 52 week low for even the largest stocks in the market in most years. The largest stock in the world a decade ago (AAPL) is up 12x since then (roughly 30% CAGR). The largest and most widely followed bank in the world (JPM), is up 3x since it traded at 8 P/E in 2022 (a 34% CAGR with dividends). And the largest health insurer (UNH) is up 60% from its 52 week low last summer.

These are obviously cherry picked examples and there are plenty of Category 2 stocks that have had terminal declines, but I do think it’s possible to recognize value in real time in some of these large caps when sentiment turns against them. Not every idea works out, but the batting average here has been higher than other investment categories in Saber’s portfolio over the last decade, and I’ve found it to be one of the most reliable ways to find good investments.

Ben Graham used to call these stocks “unpopular large caps” and considered the group a recurring opportunity set. Graham is much more known for his net net strategy (which also still works today), but I believe this lesser talked about approach to buying great companies when the sentiment turns against them is perhaps more sustainable, more scalable, and just as effective today as when Graham wrote about it in the Intelligent Investor decades ago. The reason is that the edge to this approach comes from human behavior, which doesn’t change with technology and informational advantages. We have far better technology, higher standards of living, better medicine, better athletes, better food (debatable?), worse music (not debatable), but we have the exact same emotions that we had 50 years ago. In fact, I think technology has only enhanced this “Category 2” advantage, as our attention spans, our time horizons and our capacity to suffer (patience) all continue to hit all-time lows.

As I’ve talked about in the chat and in these posts, I think there are lots of undervalued stocks currently, despite the index near all time highs. Lots of capital has been concentrated into the top AI names and related stocks with high momentum are quite expensive. Simultaneously, many stocks outside the highest momentum pockets are getting sold off and are at multi-year lows and in some cases have the cheapest valuations they’ve had in a decade or more. This is a similar dynamic to what happened in the late 90’s, and I think it is a stock picker’s dream conditions: lots of value that perhaps might end up being uncorrelated to the S&P 500.

I have a few Category 2’s on the watchlist to write about. Let’s talk about one today.