2023 was another successful year for Lyrical. Our CS composite delivered a return of 27.2%, surpassing the S&P 500 by 90 basis points (bps). This was a notable achievement considering the strong performance of the Magnificent Seven mega-cap growth stocks, which had a significant impact on overall market returns. As value investors, we did not hold any of these stocks, but we had other strong performers in our portfolio that more than compensated for it.
This marks the third consecutive year in which our CS composite has outperformed the S&P 500. In comparison to our style benchmark, the S&P 500 Value, 2023 was an even better year. Our CS composite outperformed it by 500 bps, despite the benchmark also benefiting from the mega-cap growth stocks. In comparison to other value indices that were more focused on value investing, our outperformance margin was even wider. We outperformed the U.S. large-cap value indices from Russell, MSCI, and FT Wilshire by over 1,500 bps in 2023.
After such strong returns, it is natural for investors to be concerned about valuation. The S&P 500 forward P/E ratio was nearly 20x at the end of the year, which raises valuation concerns about the overall market. However, our CS composite had a forward P/E ratio of just 11x, so we have no valuation concerns about our own portfolio. In fact, we still see significant upside potential.
Over the past three years, our CS composite has consistently outperformed the S&P 500. In 2021, we outperformed by 230 bps, in 2022 by 90 bps, and once again in 2023 by 90 bps. We are proud of these results, especially considering the challenging market conditions during this period. Despite factors such as recession fears, inflation, strong sector crosscurrents, a banking crisis, AI mania, and the influence of the Magnificent Seven, we have managed to achieve strong outperformance. We believe that even greater outperformance lies ahead due to the growth characteristics of our portfolio and the wide valuation spread relative to the S&P 500.
The Magnificent Seven refers to the seven mega-cap growth stocks that were responsible for much of the S&P 500’s returns in 2023. These stocks are Microsoft (MSFT), Apple (AAPL), NVIDIA (NVDA), Amazon (AMZN), META, Tesla (TSLA), and Alphabet (GOOG, GOOGL). As disciplined value investors, we did not hold any of these stocks in our portfolio, as they do not fit within the value category. The high P/E ratios of these stocks further highlight their departure from value investing principles.
The impact of the Magnificent Seven on the S&P 500’s returns in 2023 was significant. With a weighted average return of 62.8% and a combined average index weight of 26%, these stocks contributed 16.3 percentage points to the index return of 26.3%. The remaining stocks in the S&P 500, which we refer to as the “S&P 493,” returned 13.5%, significantly lower than the Magnificent Seven. Despite this, our CS composite outperformed the S&P 500 by 90 bps, outperformed the S&P 493 by 1,370 bps, and outperformed the S&P 500 Equal Weight by 1,330 bps.
Interestingly, the S&P 500 Value index was also influenced by mega-cap growth stocks, despite its name implying a focus on value investing. Meta, Microsoft, Amazon, and Salesforce were the four largest contributors to the S&P 500 Value index return, with an average index weight of 13.5% and an average return of 73.5%. Excluding these stocks, the index would have had a return of 14.7%, 750 bps lower. Even with these growth stocks impacting the S&P 500 Value, our CS composite still outperformed it by 500 bps and by 1,250 bps without the influence of these stocks.
Throughout our firm’s history, our portfolios have consistently had lower forward P/E ratios than the S&P 500, while maintaining comparable or superior growth. Our portfolios have demonstrated a growth history of over 9% per annum, compared to less than 6.8% for the S&P 500. Additionally, our portfolio has exhibited less sensitivity to economic factors, as seen during the COVID shutdowns in 2020 and the Global Financial Crisis in 2008-09.
In terms of valuation, our CS composite ended 2023 with a forward P/E ratio of 11.1x, slightly below our 15-year average. This unique combination of deep value and attractive growth is a key characteristic of Lyrical’s investment approach.
The valuation spread between our portfolio and the S&P 500 remains wide, with the S&P 500 having a forward P/E ratio of 19.7x, significantly higher than its 15-year average. In contrast, our portfolio’s valuation is slightly below our 15-year average. We anticipate that at some point, this valuation spread will revert to its historical average of around 30%, which could potentially drive significant outperformance over several years. However, the timing of this reversion is uncertain. Despite the prolonged wait, we remain confident in the potential for substantial outperformance.
In conclusion, 2023 was a successful year for Lyrical. Our CS composite generated strong absolute returns, outperforming both the S&P 500 and the S&P 500 Value. We achieved this outperformance despite not holding any of the Magnificent Seven stocks. While there are valuation concerns about the overall market, we have no such concerns about our own portfolio. We believe that our collection of resilient, growing companies at discounted valuations offers significant upside potential. The wide valuation spread relative to the S&P 500 further supports our expectation of substantial outperformance in the future.
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