Before you buy SpaceX stock

I don’t normally disagree with Warren Buffett, but I definitely do when it comes to his advice on index funds. And I disagree even more now that SpaceX is going public next week.

Buffett has long argued that most investors shouldn’t pick individual stocks since it’s too dangerous. Too easy to mess up.

It’s better to just go buy an S&P 500 index fund instead, he’s said repeatedly throughout the years:

I get what he’s saying. But when I look at the full list of S&P 500 companies, there are plenty I just don’t want to own.

Some are speculatively valued, meaning they have no margin of safety to offer. Others don’t produce the predictable sales, earnings, and/or cash flow growth I want to see from a long-term investment.

And most importantly to me, many aren’t very generous with shareholder returns via dividends and buybacks. So why would I want to buy an index that forces me to own the good with the bad?

Add to that the S&P 500’s initial agreement to immediately include SpaceX, and I’m even less inclined to buy into it as a whole. Its last-minute change of heart matters – but only by so much.

Here’s one thing the S&P 500 has always had going for it: It’s specified that its holdings must be profitable.

In order to get on its index, companies have to have at least four consecutive quarters of positive GAAP (generally accepted accounting practices) earnings. And they have to continue proving profitable to stay there.

Yet it came very close to tossing that rule aside in order to capitalize on the string of big-name tech IPOs coming down the pike this year. SpaceX… OpenAI… Anthropic… The S&P 500 was going to welcome all three of these speculative and so-far unprofitable companies onto its index with open arms.

Fortunately for everyone involved, news broke just last night that it would be sticking to its rules after all.

That was a massive win for passive investors, those who pursue reliable profits, and those who don’t want to speculate. So let’s give kudos where kudos is due to the people running the show over there.

Even so, it’s disconcerting that they came so close to caving to pressure. And, for the record, they’re still including SpaceX on some of their smaller index products.

The same goes for competing assets such as the Nasdaq 100 ETF, one of the Russell US Equity indexes, and a well-known FTSE Global Equity index.

Some argue that these changes are necessary: that these indices are supposed to represent the largest companies operating in America. And they do have a point.

I just don’t think it’s good enough.

The prior rules served as great guardrails for investors, protecting them from unknown speculation… which will now be running rampant. People who think they’re playing it safe by investing in a bundled asset could very easily be blindsided after next week…

Especially for any index investment that’s market-cap weighted.

In short, if you’re someone who holds passive investments like exchange-traded funds (ETFs), you’re going to want to look closely at whether yours have bent a knee to the mega-cap tech stocks on the IPO docket.

In Warren Buffett’s defense, none of this drama was going on when he made those pro-index-fund comments I began with. Yet I also have to point out that he hardly made his fortune by following his own advice.

Instead, he very carefully and repeatedly selected the highest-quality individual companies he could find when they were trading at fair value or better. That’s how real money is made.

That’s why, in this case at least, Wide Moat Research believes in doing as Buffett does, not as he says.

We’ve never once recommended a low-cost index fund in our Wide Moat Letter portfolios. We aim to do better by doing our research and avoiding investments that aren’t worth our time.

And, at the risk of being blunt, SpaceX is not worth our time. Not yet anyway.

Yes, it’s a very exciting company; and the fact that its IPO could raise $75 billion in capital is a very big deal. Yet, as Brad mentioned last week, it’s also completely unprofitable.

After looking at its prospectus, I would add that it’s outright impossible to evaluate as well.

First off, SpaceX is losing money. Secondly, there’s no clear path toward profits. Yet, according to its S-1 filing, its total addressable market (TAM) is nearly 6x larger than Nvidia’s (NVDA) market capitalization, the world’s current largest company.

I know SpaceX founder and CEO Elon Musk is a brilliant, big-ideas guy. But he doesn’t know what the future holds any more than you or I do.

So while he might very well want to believe his company will one day generate trillions of dollars in profits… While he might even actually believe that possibility will become reality sometime soon…

There are absolutely no guarantees it will.

I’m the first person to admit that SpaceX’s mission statement, as shown below, sounds good.

But as an investor, I don’t care much about grandiose statements. I care about cash flows – which SpaceX currently lacks.

Its S-1 filing shows that it generated $4.69 billion in sales from January through March – but an operating loss of $1.94 billion.

This is why I have to conclude that SpaceX is highly speculative. At current valuation levels, it’s quite simply stated an IPO I’m content to avoid.

If SpaceX captures that $1.75 trillion IPO valuation it’s going for, it will become one of the world’s largest companies. And if everything works out as planned, it will be worth every one of those dollars.

However, those are multi-trillion-dollar “ifs” with enormous room for error.

SpaceX could just as easily fail to ever print meaningful cash flows. In which case, people buying shares next week will end up being fleeced by this IPO.

Or, more likely, the company will take years – decades even – to reach its full financial potential, with plenty of speculation-driven dips, dives, and crashes along the way.

Stocks like SpaceX being so quickly included in well-known index funds have the potential to create significant volatility in the markets. And therefore, even those investors who are holding supposedly safe, well-diversified single-basket assets could see their stress levels rise.

That’s why, with all due respect to Warren Buffett, I’m so thankful to be an individual stock picker. Maybe one day I’ll choose to buy SpaceX, Anthropic, or OpenAI shares, but I’m not going to do so speculatively.

I’m more than happy to sit back and wait until these profitless companies can prove what they’re really worth.

Kind regards,

Nick Ward
Analyst, Wide Moat Research

Here’s an abbreviation that might be new for you: HALO.

In the investing world, it now stands for businesses with “Heavy Assets” and “Low Obsolescence.”

Attributed to Ritholtz Wealth Management CEO Josh Brown, HALO investments are assets that AI just can’t disrupt, from major oil companies to major food companies to major retailers.

Ritholtz has his list, of course. And Wide Moat Research has ours… including some with compelling valuations I cover in this week’s Wide Moat Show.

Catch the full episode right here.