3 Value Stocks Poised For Growth
You’ve likely heard the phrase “the stock market isn’t the economy,” but the differences have never been as stark. Think about the craziness in 2020.
Despite being amid a pandemic that saw negative full-year GDP growth and more than 10 million jobs evaporate in a few months, the stock market kicked into overdrive.
Growth stocks trounced boring value stocks in a year of widespread economic malaise, turning Reddit chatroom investors like Roaring Kitty (not his NSFW Reddit handle, by the way) into investing geniuses (and millionaires) while famous value investors like Warren Buffett were subject to whispers that the market has passed him by after seeing Berkshire’s market value underperform the markets significantly for the second year in a row.
The tide has turned for America! Once faulted for the worst covid-19 response, the country has turned the corner and been among one of the best in getting vaccines into arms. It’s widely expected we can be increasingly back to normal by July and ready for the reopening boom.
Economists are expecting 2021 to be among the likes of the strongest economies most have seen in their lifetimes with predictions of GDP growth more than 8% have become commonplace.
(That’s the kind of growth you see in China, not the United States!)
So naturally you’d expect growth stocks to continue their dizzying path higher…and you’d be mostly wrong. In fact, high-growth stocks are getting pummeled this year.
Despite the Dow and S&P 500 both posting positive returns year-to-date, growth stocks have struggled. Amazon has given back the least at 5% but Apple and Tesla are down 10% year-to-date each.
These are staggering numbers when you look at market cap and realize Apple and Tesla are down approximately $400 billion and $190 billion from all-time highs established earlier this year.
(As a mere point of comparison, Apple’s lost a Walmart in market capitalization and Tesla’s lost a McDonald’s in a few months!)
Here’s the thing…Apple and Tesla are faring well this year for growth stocks. High-growth favorites like Snowflake, Unity Software, and Fastly are all down more than 25% in three months.
Something big is happening and it’s that growth is selling off and value is back in a major way.
There are a few reasons growth is fading… and value is rising.
Like most market rotations, there’s more than one reason why growth is struggling. As we noted earlier, growth stocks exploded during the pandemic on account many were associated with the “stay-at-home trade.” Additionally, many of these names were embraced by retail investors that came out full force during the pandemic.
The result was a huge disparity between growth and value stock performance in 2020. According to Morningstar, the relative underperformance between growth and value in large cap stocks was the largest gap on record (32.15%), even more than in 1999 at the top of the dotcom bubble.
Valuations might not always seem to matter, but when it does, it really matters. The strong returns from growth stocks put valuations at a premium and made value stocks cheap.
The second reason value is outperforming growth is due to the fact we’re expecting strong GDP performance.
It might sound counterintuitive, but it makes sense when you think about growth like any other economic good that has scarcity value. In a low-growth economy, investors are willing to pay more for stocks they perceive have higher-than-average growth rates.
However, when investors expect strong growth from the greater economy they assign less value to above-average growth. Last year investors were clearly thinking about a low-growth economy and this year they’re overall more bullish about a full return.
Last is fiscal and monetary policy. You’ve likely heard that yields on the 10-year U.S. treasury have significantly jumped in 2021 (it’s true, up 75%!) as investors have sold off “safe-haven” assets.
There are a few reasons why investors are skittish about bond yields.
- Bond yields include inflation expectations and point to a contingent that feels Jerome Powell will not be able to control inflation and this could eventually hurt stock returns.
- Bonds compete with stocks for investor money so if yields go up you could see some investors move out of stocks into bonds.
- For growth stocks that are heavily valued on future growth projections, increases in rates makes future earnings worth less due to higher discount rates.
Ultimately, we love growth here at Millennial Money but understand the key to successful investing is to buy great companies and hold them long term.
However, we understand that many investors are taking the advice of hockey great Wayne Gretzky and want to “stake where the puck is going” and look to build out their portfolio with value names that still have long-term growth potential.
3 Value Names With Growth Potential
Berkshire Hathaway: Essentially a value ETF managed by the greatest investor
- Berkshire Hathaway (BRK-A; BRK-B)
- Market Cap: $573 billion
- Forward P/E: 23 times
You might be surprised to see Berkshire Hathaway on this list (maybe not if you came here from the newsletter – thanks for the clickthrough) after I just noted Buffett’s Berkshire underperformed the greater S&P 500 by 21.5 and 16 percentage points, respectfully, in the last two years. However, that’s what makes Berkshire such a compelling stock at this time. Remember, there’s a contrarian component to value investing.
Buffett’s portfolio is chock-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 U.S. Bancorp, which have been significantly performing due to the steeping yield curve, which makes lending more profitable while continuing to pay peanuts on deposits.
Buffett’s railroad investments and oil stocks, the $4 billion stake in Chevron, and the 4% ownership in General Motors will reap the rewards of increased travel and economic activity.
At 23 times forward earnings, shares of Berkshire Hathaway trade at roughly par with the S&P 500 market multiple, which is undervalued when you throw in the greatest capital allocator in the world.
Applied Materials: Short-term and long-term drivers
- Applied Materials (AMAT)
- Market Cap: $109 billion
- Forward P/E: 20 times
It’s early, but 2021 has not been kind to technology stocks. As stated earlier, software and IT infrastructure stocks are getting hammered. However, there’s a sleepy corner of the IT industry that’s been on fire – semiconductor equipment and materials. As a leader in the space, Applied Materials is up 40% this year.
Unless you’ve been living under a rock, you’ve likely heard there’s a critical shortage of chips right now. In fact, automotive companies are facing production delays and halts due to the lack of the component with General Motors and Ford raising alarms about the silicon shortages.
There are a few reasons for the lack of chips, ranging from cancelled orders during the pandemic, factory fires, and even tariffs and trade wars. But the answer is to make more chips. Now. And that’s what Applied Materials does.
The company provides the critical equipment, machinery, and even processes chipmakers need to produce their products. While demand from the auto industry will provide a short-term boost to earnings, artificial intelligence, and self-driving technology will boost demand for chips for years to come.
Unfortunately, Applied Materials isn’t as cheap as it once was as shares have exploded nearly 180% in the last one-year period. Despite the strong returns, the company is still valued at 20 times forward earnings which is below the greater S&P 500’s projected valuation of 22.5 times forward earnings and has a shareholder-friendly approach consisting of dividends and a $7.5 billion stock buyback program.
Facebook: Growth and Value
- Facebook (FB)
- Market Cap: $795 billion
- Forward P/E: 26 times
Shocked to see a member of the venerated “FAANG” cohort on a value list? Don’t be, remember, value investing in inherently contrarian as you’re looking for unloved stocks. When it comes to corporate responsibility, Facebook certainly fits the bill: due to an acrimonious relationship with journalists, governments, and even fellow FAANG CEOs.
The company posted strong returns in 2020 but trailed all other FAANG cohorts aside from Google despite growing top and bottom lines in a tough marketing environment. However, at first glance the company might not pop up on value investors’ radars due to its large market cap and the naïve belief that value stocks cannot post strong growth rates.
At 26 times forward earnings, it’s true that Facebook trades at a premium to the greater market but the differences are narrower than they’ve been since the company went public. However, once you factor in growth Facebook’s case for being a value stock becomes compelling.
For example, Facebook posted 22% year-on-year revenue growth last year. Mind you this was during the pandemic that wreaked havoc on most industries, specifically marketing, and saw the greater S&P 500 post a year-on-year revenue decline. Facebook has a PEG Ratio (PE/expected growth) of 1.1, which is firmly considered value stock territory.
Facebook is well situated to take advantage of the explosion of marketing about to occur once the world returns to normal.
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