The One Large-Cap Stock We’re Buying Today, and the Two We Find Too Toxic to Touch

Texas Pacific Land exudes a certain quiet confidence. There won’t be any ostentatious product launches or quarterly earnings calls where executives avoid discussing declining margins. Situated above one of the world’s most productive oil-producing formations, just 868,000 acres of West Texas land are collecting royalties in the same manner as a landlord collects rent. It’s not a glamorous tale. However, glamour has a peculiar way of getting people into trouble when it comes to investing.

Texas Pacific Land isn’t pursuing expansion in the conventional sense. It makes money from what is already there, such as the water piped across its property, the oil extracted from the Permian Basin, and the leases that energy companies sign in order to use its surface rights. The flywheel effect, in which current assets continue to produce returns without necessitating a significant investment of new capital, is becoming less common among large-cap companies. It’s difficult to ignore why institutional investors keep returning to that model as you watch it subtly compound over time.

Nike’s story is different and hasn’t been very promising lately. The brand, which was once unbeatable due to decades of athlete endorsements and a genuinely strong identity, seems to be losing the momentum that made it legendary. For the past two years, steady currency revenue growth has been modest. It’s not a blip. It’s a signal. The kind of valuation math that makes seasoned investors uneasy is trading at 27 times forward earnings for a company that can’t seem to rekindle demand. The sneakers continue to sell. Simply put, the numbers don’t tell the story that the price tag believes they will.

Nike’s leadership may be able to solve this problem by cutting expenses, focusing on direct-to-consumer sales, and finding a spark in its innovation pipeline. However, diminishing returns on capital from a weak beginning point indicate that neither the new strategy nor the old one are working as well as they could. A stock that is priced for recovery without providing the evidence still has too much uncertainty in it.

Another type of issue that Illinois Tool Works raises is the gradual, nearly imperceptible kind. ITW is the kind of business that seems unbreakable until you look at organic revenue trends. It was founded on more than a hundred patents and developed over decades of industrial manufacturing. For the past two years, core business has failed. The 3.2% sales growth forecast for the upcoming year is, at best, modest and uncertain if things worsen. Over the previous two years, EPS grew by just 3.8% annually, falling short of peers facing similar challenges. The market appears to be paying for a consistency that the fundamentals aren’t quite providing at almost 24 times forward earnings.

There is a certain psychological comfort associated with large-cap stocks. They feel secure. They have a sense of security. And occasionally they are; Texas Pacific Land is a good illustration of a business whose structural advantages truly warrant trust. However, a portfolio is not protected by size alone. Selling Japanese sneakers under a different brand in a different era helped Nike establish its empire. It’s an impressive history. It simply doesn’t mean that everything will go as planned over the next five years. The history of Illinois Tool Works is equally legendary. However, a compelling present is not the same as that past.

Whether Nike or ITW will succeed in the upcoming 12 to 18 months is still up in the air. Both have real infrastructure, real brands, and real assets. However, there is increasing conflict between what these companies charge investors to own them and the actual output of the underlying business. That silent but enduring gap is precisely the kind of thing that eventually, and occasionally all at once, tends to matter.