Overrated

Overrated.  Stocks had a mixed close yesterday as higher interest rates were on the minds and screens of traders.  Tech and growth stocks bore the brunt of selling in yesterday’s session, while value stocks got a boost.

N O T E W O R T H Y

A tale of two cities.  The debate is as old as Wall Street itself.  Well, not quite that old, but it is a theme, oft debated.  I am talking about value stocks versus growth stocks.  If you look far enough back in history, you wouldn’t even guess that there was such a thing as a growth stock.  Investors bought stocks based on value. Solid earnings growth, strong balance sheets, competent management, and, oh yeah, fair price.  It was also important to have good potential earnings growth and achievable, upbeat future prospects.  “Wait,” you are thinking, “isn’t that always the way we make investments.”  Not really, or rather, not recently at least.  Last week, I highlighted Warren Buffet’s continued impact on the markets and how his investing style has its roots in his mentor and onetime partner Benjamin Graham.  Graham, if you recall is known as the father of value investing, having memorialized the investing methodology in his seminal book Security Analysis, penned in 1934.  That was, indeed, a long time ago, but the style of investing long predated the book.  Graham and his co-author David Dodd are recognized as the first to focus on methodical, fundamental analysis. Ok, that was then, so what has changed?  Well, the first big jolt came in the 1980’s with the birth of the, now grandparents of technology growth stocks:  Microsoft and Apple.  Those were companies with great prospects but very little earnings and winning track records… relative to the old guard, that is.  Those two trailblazers were up against companies like IBM, Xerox, and Motorola.  You know how that story turned out.  The birth of the internet, the inflating and popping of the Dotcom bubble led to a whole new breed of new-guard growth stocks.  Amazon, an internet-based bookseller emerged to compete with long time favorite Barnes & Noble. Same space, different business model, and completely different financials.  You know how that story turned out as well.  In the past few years since the end of the Great Recession, yet another breed of growth stocks has emerged and they cover almost all sectors.  They all have different business models, different customers, and some don’t even use technology, though most of them try to sneak the word into their mission statement.  Today we have social media, electric vehicle manufacturers, meat substitute companies, cyber security consultants, space travel companies, virtual fitness providers, video conference companies, etc.  I don’t have to even mention names because I know that you are well aware of the companies to which I am referencing.  Those companies are all quite different but they have one principal thing in common: they are all valued based on the their future growth potential.  Balance sheets, the home of assets and liabilities, are of little concern.  The Income Statement, home of earnings, is important in a peculiar way. Absolute earnings are less important than earnings growth. If a company demonstrates a steep increase in recent earnings, it qualifies them as a growth stock. Oh, and the steeper the ascension path, the better.  For example, Beyond Meat (BYND), a well-run meat substitute upstart sold $297 million worth of faux, but tasty-I-am-told, burgers and sausages in 2019.  Impressive, for an upstart focusing on a growing market.  Though the company has not announced its 2020 results yet (2/25 announcement, later this week), analysts expect the firm to have sales of +407 million, a growth of +37%… good growth. Oh, and the company has yet to be profitable.  However if that revenue growth continues in the future, the company will be worth a lot… eventually.  That is precisely why investors have flocked to the stock, great potential. Prospectors can invest in Tyson Foods, a very solid meat producer with a long track record of success.  Tyson (TSN), rightly, has a market cap of $24.9 billion, which eclipses Beyond Meat’s $9.5 billion market cap.  Let’s compare stock prices.  Beyond Meat has a Price-Sales ratio of 23.14 times while Tyson Foods trades at 0.58 times sales.  If we apply that multiple to Beyond Meat, its shares should be trading at around $68 / share, though the stock is actually trading around $150.  How can that be?  Future growth potential.  Investors expect the stock to eventually overtake even the likes of food producing giant Tyson.  That is a classic growth versus value stock comparison.  Now, analysts are a smart bunch and they are able to mathematically come up with a stock’s theoretical share price based on its future earnings.  The equation assume that a company will continue to grow revenues at or around its current growth rate, and the earnings/cash flow from those future revenues are adjusted into today’s dollars. Sparing you all the gory math, I will tell you that interest rates are a big factor in that equation.  If they are higher, the stock is theoretically worth less.  So the model is highly dependent on income growth and interest rates. Recently, longer-dated bond yields have been going up… remember the equation? Assuming that investors expect growth to be stable, growth stocks are theoretically worth less today in a higher interest rate environment.  That is one of the reasons that we have witnessed pressure on growth stocks in recent weeks.  Of course there are many other reasons for the pullback, but rising interest rates are a principle driver.  The moral of the story?  While growth stocks can earn investors great returns, value stocks can also add value to a portfolio, as we have seen in recent months.  By the way, Tyson’s stock price has risen by +369% since 2008 while the S&P500 Index returned +186% over the same period.  I may have forgotten to mention that Tyson also pays a 2.6% dividend. 

Finally, I simply used these two stocks to demonstrate the differences between investing styles and I am not endorsing either as an investment… those decisions are yours.

THE MARKETS

Stocks pulled back yesterday, held back by a slide in growth stocks as the prospect of higher interest rates puts pressure on stock values.  The S&P500 sold off by -0.77%, the Dow Jones Industrial Average climbed by +0.09%, the Russell 2000 Index slipped by -0.69%, and the Nasdaq Composite Index dropped by -2.46%.  Bonds pulled back and 10-year treasury yields climbed by +3 basis points to 1.36%.

NXT UP

– FHFA House Price Index (Dec) is expected to show a +1.0% growth even with November’s rise.

– Conference Board Consumer Confidence (Feb) may have risen to 90.0 from 89.3.

– Richmond Fed Manufacturing Index (Feb) is expected to have risen to 15 from 14.

– Fed Chairman Jerome Powell will testify on Capitol Hill today and all eyes will be on his statements.  Investors will listen for clues on how the Fed plans to deal with rising bond yields.

– This morning Home Depot, Leidos, and Macy’s all beat estimates.  After the bell we expect announcements from Upwork, Square, Intuit, CoStar, Pioneer Resources, and Cabot Oil.