You’ve probably heard the phrase, “The stock market is not the economy,” but the differences have never been so great. Think about the craziness in 2020.
Despite a pandemic in which full-year GDP growth was negative and more than 10 million jobs lost in a few months, the stock market came into full swing.
- Apple gained 82%.
- Amazon grew 76%
- Tesla exploded 695%.
Growth stocks drove boring value stocks behind them in a year of widespread economic unease, turning Reddit chat room investors like Roaring Kitty (not his NSFW Reddit handle, by the way) into investment geniuses (and millionaires) while famed value investors like Warren Buffett were whispered was that the market passed him by after Berkshire’s market value fell well short of the markets for the second year in a row.
The tide has turned for America! After being blamed for the worst Covid-19 response, the country went around the corner and is among the best to get vaccines. It is widely expected that by July we will be back to normal and ready for the reopening boom.
Economists expect 2021 to be among the strongest economies most have seen in their lifetime, with projections of over 8% GDP growth being the order of the day.
(That’s the kind of growth you see in China, not the United States!)
Of course, you’d expect growth stocks to continue their dizzying path higher … and you’d be largely mistaken. In fact, high-growth stocks will be beaten this year.
Although both the Dow and S&P 500 have posted positive returns year-to-date, growth stocks have struggled. Amazon has given back the least at 5%, but Apple and Tesla are each down 10% since the start of the year.
Those are amazing numbers when you look at market capitalization and find that Apple and Tesla are down about $ 400 billion and $ 190 billion from their all-time highs earlier this year.
(For comparison: Apple lost a Walmart in market capitalization and Tesla lost a McDonald’s in a few months!)
Here’s the thing … Apple and Tesla are doing fine with growth stocks this year. High-growth favorites like Snowflake, Unity Software, and Fastly are down more than 25% in three months.
Something big happens and the thing is that the growth sells and the value is back to a large extent.
There are a few reasons why growth is slowing … and value is increasing.
As with most market rotations, there is more than one reason that growth is struggling. As mentioned earlier, growth stocks skyrocketed during the pandemic as many were linked to stay-at-home trading. In addition, many of these names have been adopted by retail investors who enjoyed their full potential during the pandemic.
The result was a huge gap between growth and performance of stocks in 2020. According to Morningstar, the relative underperformance between growth and value of large-cap stocks was the largest gap since its inception (32.15%), even larger than in 1999 Peak the dot-com bubble.
Reviews don’t always seem important, but when they do, it really matters. The strong returns on growth stocks have boosted valuations and made value stocks cheap.
The second reason the value outperforms growth is because we expect strong GDP performance.
It may not sound like intuitive, but it makes sense if you think of growth as you think of any other economic good that has a scarcity value. In a slow-growing economy, investors are willing to pay more for stocks that they believe are growing faster than average.
However, when investors expect strong growth from the larger economy, they place less value on above-average growth. Clearly last year investors were thinking about a slow-growing economy, and this year they are overall more optimistic about a full return.
Last is fiscal and monetary policy. You’ve probably heard that the 10-year Treasury Department’s returns rose significantly in 2021 (it’s true, a 75% increase!) As investors sold “safe haven” assets.
There are several reasons why investors are skeptical about bond yields.
- Bond yields include inflation expectations and indicate a contingent believing Jerome Powell cannot control inflation, which could ultimately hurt stock returns.
- Bonds compete with stocks for investor money. So as yields rise, some investors may switch from stocks to bonds.
- For growth stocks that are valued highly based on future growth projections, an increase in interest rates will result in future earnings being worth less due to higher discount rates.
Ultimately, we love growing here at Millennial Money, but we understand that the key to investing well is buying great companies and keeping them for the long term.
We do know, however, that many investors are following the advice of the great ice hockey player Wayne Gretzky to “want to go where the puck goes” and try to build their portfolios with names of value that still have long-term growth potential.
3 names of value with growth potential
Berkshire Hathaway: Essentially a value ETF managed by the largest investor
- Berkshire Hathaway (BRK-A; BRK-B)
- Market Cap: $ 573 billion
- Forward P / E: 23 times
You’d be surprised to see Berkshire Hathaway on this list (maybe not if you came here from the newsletter – thanks for the click) after just discovering that Buffett’s Berkshire was respectfully behind the larger S&P 500 for the past year lagged behind 2 years by 21.5 and 16 percentage points. However, this is what makes Berkshire such a compelling stock at this point in time. Remember that value investing has an opposite component.
Buffett’s portfolio is full of value investments that will benefit from increased economic activity. Berkshire owns approximately 12% of Bank of America, 7.5% of Bank of New York Mellon, and 10% of US Bancorp, which have done well due to the steep yield curve that makes lending more profitable while continuing to pay peanuts for deposits .
Buffett’s railroad investments and oil reserves, $ 4 billion stake in Chevron, and 4 percent stake in General Motors will result from the surge in travel and economic activity.
With 23x forward earnings, Berkshire Hathaway stocks trade roughly the level of the S&P 500 market multiplier, which is undervalued if you put in the world’s largest capital allocator.
Applied materials: short and long term drivers
- Applied Materials (AMAT)
- Market Cap: $ 109 billion
- Forward P / E: 20 times
It’s early, but 2021 hasn’t been kind to tech stocks. As mentioned earlier, software and IT infrastructure assets are being brought to their knees. However, there is a sleepy corner of the IT industry that is on fire – semiconductor equipment and materials. Applied Materials is up 40% this year.
If you haven’t lived under a rock, you’ve probably heard that there is a critical shortage of chips right now. In fact, due to the lack of the component, automotive companies are facing production delays and stoppages as General Motors and Ford raise alarms about the silicon shortage.
There are a few reasons for the shortage of chips, ranging from canceled orders during the pandemic to factory fires to tariffs and trade wars. But the answer is to make more chips. Now. And that’s exactly what Applied Materials does.
The company supplies the critical devices, machines, and even processes that chip manufacturers need to manufacture their products. While demand from the auto industry will fuel earnings in the short term, artificial intelligence and self-driving technology will drive demand for chips in the years to come.
Unfortunately, Applied Materials isn’t as cheap as it used to be, as stocks have skyrocketed nearly 180% in the past year or two. Despite the strong returns, the company is still valued at 20x futures earnings, which is below the S&P 500’s forecast of 22.5 times future earnings, and has a shareholder-friendly approach that consists of dividends and a share buyback program of USD 7.5 billion.
Facebook: Growth and Value
- Facebook (FB)
- Market Cap: $ 795 billion
- Forward P / E: 26 times
Shocked to see a member of the revered “FAANG” cohort on a list of values? Don’t think about investing in inherently contrary products when looking for unloved stocks. When it comes to corporate responsibility, Facebook is for you: because of a close relationship with journalists, governments, and even other FAANG CEOs.
The company had strong returns in 2020 but lagged behind all other FAANG cohorts alongside Google, despite sales and profit margins increasing in a difficult marketing environment. At first glance, however, the company might not appear on value investors’ radar due to its large market cap and naive belief that value stocks cannot grow rapidly.
With 26-fold forward earnings, Facebook trades at a premium for the larger market, but the differences are smaller than since the company’s IPO. However, once you factor in the growth, Facebook’s argument about being a value stock becomes compelling.
For example, Facebook saw revenue grow 22% year over year last year. Mind you, this happened during the pandemic that devastated most industries, particularly marketing, and saw the larger S&P 500 see a year-over-year decline in sales. Facebook has a PEG (PE / Expected Growth) ratio of 1.1, which is firmly considered value stock territory.
Facebook is well positioned to take advantage of the marketing explosion that lies ahead once the world returns to normal.
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