The Fed has pumped $3.1 trillion into financial markets over the past year, driving many on Wall Street to worry that stock prices have swelled to unjustified and unsupportable levels.
It’s true that easy money, coupled with a fragile post-quarantine economy, makes the S&P 500, in particular, look precarious at 22X earnings. After all, profit expectations have collapsed.
But as I told TD Ameritrade’s reporters a few days ago (and Trading Desk readers were ahead of the curve), this market is more than the Fed’s froth making stale companies look vibrant. (Click here for the video.)
Sure, Amazon.com Inc. (NASDAQ:AMZN) and Apple Corp. (NASDAQ:AAPL) are months from restarting their earnings growth engines. Hot money favorites like Netflix Inc. (NASDAQ:NFLX) and Tesla Inc. (NASDAQ:TSLA) are even farther from tangible progress.
However, some stocks are rallying because the numbers actually look good. They would even look good if we weren’t comparing them to areas of the economy that were more directly exposed to the recession that the pandemic left in its wake.
Cut through the hype and these stocks are where the real leadership is. Whatever happens to the S&P 500 as a whole, I’d rather my subscribers invest in these names and skip the obvious soft sectors where hype is the only thing that is keeping the buyers coming.
Statistics Hide Reality
The availability of real growth stocks at reasonable prices flies in the face of arguments that everything on Wall Street is rotten right now. As you know, that’s the bright side we focus on every week on my Millionaire Maker radio show. (Click here for recorded episodes and local stations.)
Even though consensus on the market as a whole has swung from healthy 10% earnings growth this year to a 20% earnings contraction, those numbers are simply a statistical aggregate. A lot of companies are doing much, much worse.
The energy sector, for example, is on track to report a complete loss this year, while most retail, industrial and financial stocks aren’t in much better shape.
Taken as a group, these pain points account for 33% of the S&P 500 and are a serious drag on the overall economy. But only a rank beginner would insist that all stocks are feeling the same drag.
A lot of companies were in a position to benefit from the economic disruption that the pandemic brought. They’re thriving.
And for people like me who aren’t content with index funds and their “random walk,” all you need to do is create a smaller version of the S&P 500 that focuses on strength and avoids obvious weakness.
There’s no hype or Fed fluff involved. Everything else being equal, these are the companies that have positive year-over-year growth trends on their side.
A few months from now, they’ll be making more money than they did in 2019. That’s usually what it takes to justify a higher stock price in the future. This is what we all want, right?
Of course, higher growth rates point to faster investor gratification and normally rate higher multiples. Again, this is back to basics stuff that doesn’t require any mental stretching.
The challenge is paying a reasonable price for growth. A stock like AMZN, for example, trades at a nosebleeding 166X earnings because investors expect massive long-term growth ahead.
I think they’re going to be disappointed. All of that growth is already factored into the stock. We aren’t likely to see earnings soar 900% to bring its valuation back down to a normal 15X multiple.
And even if you’re contemplating AMZN at $6,000 or higher in the immediate future, that multiple is only going to get steeper with every step to the upside. Sooner or later, the bubble will burst.
Humble Stocks, Realistic Valuations
Whenever I see a company priced at a multiple below its anticipated annual growth rate, I get excited. That’s true no matter what the Fed is doing.
Right now, Dollar General Corp. (NYSE:DG), eBay Inc. (NASDAQ:EBAY), NortonLifeLock Inc. (NASDAQ:NLOK) and Newmont Corp. (NYSE:NEM) fit that bill. They’re as far from the Silicon Valley giants as it gets.
DG and EBAY are all about recession-resistant retail. NLOK’s credit protection services have become more essential than ever as the economy has soured and fraud activity has increased. And NEM digs up gold, the most defensive of all assets.
All four have done well on Wall Street, despite the pandemic. A year from now, they’ll be bigger companies and generating more than enough cash to justify their current valuations.
Start a portfolio with just these four names. Let’s come back in a year and see how well they did.