“A really wonderful business is very well protected against the vicissitudes of the economy over time and the competition. We’re talking about businesses that are resistant to effective competition. And three of those will be better than 100 average businesses. And they’ll be safer, incidentally."
-Warren Buffett, May 1996
There is no shortage of companies, small and large, that have suffered greatly from the rapid, coronavirus-induced recession that is hitting the United States and the rest of the world. Some small businesses do not have the resources to stay afloat in a shutdown, and some large businesses have too much debt to service when their revenues drop precipitously, and therefore falter on their debt payments. The list of corporate bankruptcies continues to grow, particularly for brick & mortar retailers. Neiman Marcus, JCPenney, J. Crew, and Pier 1 Imports are some examples. Stories about business failures may be grabbing the headlines, but there is a larger story playing out: the strong are getting stronger.
Mega-cap tech/consumer companies entered this year in incredibly strong shape. The three largest are Apple, Microsoft, and Amazon. Their balance sheets were flush with cash, they had grown in size and scale to dominate their respective industries, their management teams were firmly in place and executing at a high level, and they had the secular tailwinds of the ongoing digital revolution driving continued, long-term growth. When the steep and stunningly fast stock market sell-off occurred in March, the stock prices of these companies were pulled down with most other stocks. But since the bottom occurred in March, these stocks have roared back, reaching all-time highs, despite the numerous uncertainties still pressuring the economy and the broader market. These risks include a potential second wave of the virus, US election outcome uncertainty, US/China trade wars, and a sustained global recession. The chart below illustrates the substantial outperformance of Apple, Microsoft, and Amazon versus the S&P 500 this year.
The market values of these three mega-cap tech/consumer companies have now reached jaw-dropping levels. Apple has a market cap of over $1.56 trillion, Microsoft is over $1.49 trillion, and Amazon is over $1.34 trillion. Despite so many uncertainties and so many other businesses facing immense operating pressure and potential bankruptcy, these three mega-caps are not only substantially outperforming, but are poised to exit the crisis stronger than they were pre-pandemic. How is this possible?
First, their bullet-proof balance sheets that are loaded with cash allowed them to easily withstand any bumps in the road that can impact sales, without getting squeezed by required debt and interest payments. At their most recent quarter ends, Apple reported $192.8 billion in cash (including long-term investments), Microsoft reported $137.6 billion in cash, and Amazon reported $55.0 billion in cash – all three are astounding amounts. Some of the companies even took advantage of the Fed lowering interest rates down close to zero to issue new debt at record low rates to further increase their cash stockpiles. At the beginning of June, Amazon broke the record for the lowest interest rate for any bond issued in US corporate history when they issued a 3-year bond at 0.4% yield. These mega-caps are strong free-cash-flow generators, and unlike most other companies, they had no problem continuing to pursue share repurchase programs and make their regular dividend payments during the crisis (not including Amazon, which does not typically pursue either).
Second, the mega-caps’ industry dominance became even greater. During this time of immense uncertainty, customers deepened their relationships with these trusted, best-in-class companies that offer stability and first-rate client service. This contrasts with smaller, weaker competitors that were difficult for customers to rely on as they did not know if these competitors would even maintain their products and services going forward. Best to stick with the proven experts/leaders during uncertainty, so the mega-caps took market share.
Third, the mega-caps’ management teams continued to show the vision and leadership that brought them success prior to the crisis. Despite the enormous size of their companies, these management teams pivoted their businesses with amazing speed to embrace the “new normal.” The cloud infrastructure providers (Amazon and Microsoft) had little problem handling the massive, unexpected surge in demand on their data centers/overall architecture brought about by the volume of activity and commerce moving online during the pandemic. As another example, Microsoft remotely implemented their Teams collaboration platform at the University of Bologna in Italy in March, moving 90% of the university’s courses online for 80,000 students in just three days. Two of the three mega-cap companies saw margins expand in the most recent quarter, illustrating amazing efficiency under duress and benefiting from their scale advantages.
Finally, and most importantly, the secular trend of the digital revolution that has supported the consistent growth of the mega-caps accelerated during the pandemic. These providers of cloud infrastructure services, mobile devices, cloud enterprise software, and e-commerce services became even more relevant and important in the new world of “remote everything.” Business, medicine, education, entertainment, and social activities all went nearly 100% online simultaneously this spring. This created a dramatic increase in the digital tailwind that already supported these mega-cap companies, further enabling them to achieve long-term levels of growth that most companies only dream of. Microsoft CEO Satya Nadella summed it up in his quarterly earnings call at the end of April: “We’ve seen two years’ worth of digital transformation in two months.”
One of the main lessons of the current pandemic/economic crisis is the strong become stronger. Apple, Microsoft, and Amazon are noteworthy examples. These three mega-cap tech/consumer companies have been safer and better stocks to invest in, during good and bad economies – just as Buffett pointed out 24 years ago.