The Scottish Mortgage Investment Trust (LSE: SMT) has become a superstar of the UK fund sector in recent years. The trust’s positions in growth stocks such as Tesla, Amazon and NIO have paid off with big gains.
The Scottish Mortgage share price has risen by 120% over the last year, compared to a gain of just 35% for the FTSE All-Share Index. Over 10 years, the results are even better. SMT is up by 670%, versus a gain of just 23% for the FTSE All-Share.
However, there may be trouble in paradise. Although SMT’s managers have taken profits on big winners such as Tesla in recent months, the firm remains heavily exposed to such names.
The recent correction we’ve seen in US tech stocks has hit SMT’s share price, which has fallen 20% since peaking on 15 February. I’m wondering whether this could be an opportunity for me to buy Scottish Mortgage shares for my portfolio — or whether it’s the start of a larger slump.
How I’m approaching this
Scottish Mortgage is an investment trust. In simple terms, it’s a company that invests its own money in other companies. Investors can buy shares in Scottish Mortgage to benefit from growth in the trust’s portfolio.
This means that to understand the valuation of the trust, I need to look at its shareholdings. The largest holdings will have the biggest impact on SMT’s share price, so I started with these.
At the end of January (the latest data available), Scottish Mortgage’s five largest holdings were Chinese e-commerce group Tencent, genetic sequencing firm Illumina, online mega-giant Amazon, and electric car firms Tesla and NIO.
Are these top stocks heading for a crash?
All of the five stocks I’ve listed are growing fast. They all have strong valuations, but I have to admit Tencent, Illumina, and Amazon don’t look as expensive as I expected.
In a market sell-off, I’d expect these firms, and many of SMT’s other holdings, to suffer short-term losses. But from the top five holdings I’ve listed, the only two that concern me are Tesla and NIO.
NIO has yet to turn a profit. I don’t know when it will. This makes valuation difficult, in my view.
The situation with Tesla is a little more complicated. This business is larger and more developed — and it is profitable. However, even the best business in the world is a bad investment if it’s too expensive. And this is what I think about Tesla.
With a market-cap of £465bn, Tesla is valued at twice the combined value of Ford, BMW, Volkswagen, and General Motors. That just doesn’t make sense to me. I think Tesla’s valuation has got too far ahead. Many years of growth are already priced into this business, in my view.
Scottish Mortgage: my verdict
Most of Scottish Mortgage’s investments look expensive by conventional measures. But the trust’s growth record suggests to me its managers are skilled at looking ahead and spotting businesses that can change the world.
Even so, SMT’s exposure to Tesla and other electric vehicle companies is too risky for me to accept. If big US tech stocks enter a period of correction, I think Scottish Mortgage’s share price could have a lot further to fall. I’m not comfortable buying at the moment.