Occasionally I watch a quality stock being punished so much that I see it almost as my duty to step in and invest! I reached that point last month with Scottish Mortgage Investment Trust (LSE: SMT) shares. I added to my existing holding by accumulating £1,000 worth of shares.
Yet the stock is down 29% in one year — and keeps going lower. So am I trying to catch a falling knife?
Only time will tell, but here’s my thinking.
Identifying outliers
Last week, Erling Haaland broke the English Premier League record for the most goals scored by a professional football player in a single season. He’s obviously a rare and great athlete. An outlier, as it were.
Essentially, Scottish Mortgage’s investment strategy is to find the company versions of young Erling Haalands and hold on to them long enough to profit as they go on to (potentially) reach extraordinary heights.
Academic research has shown that the best-performing 4% of stocks (outliers) drove the net gain for the entire US stock market between 1926 and 2016. I find that astonishing.
One recent example of this phenomenon is chip maker Nvidia (a Scottish Mortgage holding), which was the best-performing US stock of the last decade. As of April, it had gained 8,833% over that time.
It’s a similar story with Apple, which Warren Buffet has described as “probably the best business I know in the world“.
Apple stock is another true outlier that famously made early investors rich. But it has also experienced gigantic share price declines along the way. For example, it dropped 51.8% in a single day in September 2000.
For me, the lesson here is to carry on holding through the painful but inevitable drawdowns. Stock market returns rarely follow a linear pattern.
Investing during times of fear
The best thing to do is to buy when shares are thoroughly depressed and that means when other people are selling.
Sir John Templeton
Scottish Mortgage shares currently trade at a 20% discount to the fair value of the trust’s assets. That discount reflects concerns about the true valuations of its private holdings, which make up 30% of the portfolio.
Those concerns aren’t totally unwarranted and there remains uncertainty here. However, I note that these unlisted valuations have been audited externally on a number of occasions over the past year and marked down accordingly. So I’m not overly worried.
My general investing time frame is five years. And my hunch (and hope) is that all this will be a distant memory by 2028.
Portfolio progression
The managers hold the belief that share price returns follow business fundamentals over time. And on this front, I’m encouraged by the progress being made by the companies in the portfolio.
Top holding Moderna, for instance, is advancing a new class of mRNA-based medicines that could completely transform human health in the coming years.
Meanwhile, Nvidia continues to sell the picks and shovels during the artificial intelligence (AI) gold rush. And SpaceX’s satellite network business Starlink now has over 1m active subscribers. It provides low-cost internet to remote locations and T-Mobile has just become a partner.
I reckon it will be this type of business progress that will determine the long-term success of Scottish Mortgage shares.
