As a perpetual student of the stock market, I’m always keeping tabs on what’s moving and shaking in the world of finance. Lately it’s been a group of stocks I call the “COVID-proof” stocks — Facebook, Amazon, Apple, Netflix, Tesla, Zoom, Microsoft, and Google, that are doing most of the moving and shaking. (Meanwhile, the S&P 500 is almost flat for the year — down a mere 1.4%)
All of these stocks have seen incredible price gains since the market lows of mid-March. A few are up nearly 100%. In the case of Tesla, the shares have more than tripled in the span of four months! That’s wild.
What kind of crazy is this?
Something fishy is going on here. For anyone with a decent nose for business, it’s starting to stink.
The share price gains likely have very little to do with greater profitability or improving business prospects. While all of these are growth stocks (with rising sales and improving profitability), this kind of stock price increase borders on insanity.
Clearly, there is a great number of people staying home and speculating on stocks. Maybe it’s the new national pastime. They’re gambling, plain and simple. And doing surprisingly well…
Why Does The COVID-Proof Trade Work?
The buying and selling of these supposed “COVID proof” stocks, has been an extremely successful trade in 2020. Largely it works (I believe), because speculators view these businesses as isolated from the effects of COVID-19. Most of these are tech-stocks that operate online, without storefronts, and they’ve been largely unaffected by pandemic restrictions.
And speculators have been buying them with little regard for valuation.
People want to pick winners, and these are the obvious winners right now. So obvious, it’s almost painful. Winning stocks like Zoom (Symbol: ZM) are helping people work remotely. As a result, business is thriving at Zoom. Zoom’s share price has doubled in the last four months.
These are EASY picks for unsophisticated investors — They have momentum. Speculators can put zero thought into the valuation or profitability of a business, and simply “ride the wave” of momentum upward. It’s been the easy way to win in 2020.
The only hitch in this “COVID-proof” strategy is that investors aren’t looking to share in the improving profitability of the business; they’re looking to sell to a greater fool. The “COVID-proof” stocks are simply trading vehicles for speculators. Most are short term traders, not long term investors looking to compound dollars over time.
But if they’re doing so well, why not join them?
Avoiding Momentum Stocks
Normally I agree with the sentiment “do whatever works” in investing. The biggest problem in my opinion, is that this isn’t investing. It’s gambling, and I try to not gamble whenever possible. It’s one of my main missions with this blog — I advocate for investing not speculation.
I typically look for investments with a history of steady earnings, a reasonable earnings yield, sales growth that exceeds inflation, and the ability to compound cash back into the business at good rates of return.
This isn’t the case with these so-called “COVID-proof” stocks. Speculators are completely ignoring fundamental valuation methods. They’ll buy shares at any price. Most in this group absolutely fail the earnings-yield test.
Check out the earnings yields of the group:
If these stocks were bonds and paid out 100% of earnings, most would yield under 1%.
Now we all know stocks aren’t bonds, because there’s growth prospects to consider…
But how much growth can we expect from these titans of the business world? Will sales triple at Apple in 2020? Will Tesla sell 10 times as many cars next year? Can Netflix sign up 10 times as many subscribers?
It doesn’t take a genius to realize these stocks are priced for levels of growth that are completely unrealistic. Simple logic tells me this is extremely speculative territory, fraught with danger.
How long can it continue?
Nobody knows! It could end tomorrow, or a decade from now! But one day, the music will finally stop. Sooner or later, most of these momentum stocks will come back down to earth after visiting the clouds. I have no wish to be on the losing end of that trade.
As Aesop and Warren Buffett once said, “It’s better to have one in the hand than two in the bush.” These “COVID-proof” speculators have nothing in the hand and everything in the bush.
Alternative Stocks To Study
So where do I recommend investors look outside of this “COVID-proof” stock group?
There’s a number of very good companies out there, relatively unaffected by the pandemic, and selling for far more reasonable prices than the “COVID-proof” group. These stocks are being largely ignored by speculators.
Here’s a few categories of stocks that I think might ride-out the pandemic with ease, and are set to prosper in the near future:
Home Improvement — I’ve already mentioned my investment in Home Depot (Symbol: HD) on this blog, but its competitor Lowes (Symbol: LOW) is likely to also do very well. Sales are expected to grow over the next year. As a group, I believe most of the sales at home improvement stores will be sticky over the long term. I could write a whole blog post about why this is likely, and I might just do that!
Banks — Believe it or not, banks might be a very good place to invest right now. Yes, interest rates are down, and earnings will be down next quarter, but savings rates are up — way up! This means very cheap deposits for banks that will one day recover. If you’re worried about inflation caused by all the stimulus, look no further than banks. They’re one of the few industries that’s relatively inflation-proof. Banks like Bank of America (Symbol: BAC), J.P. Morgan Chase (Symbol: JPM), and Discover Financial Services (Symbol: DFS) will one day be winners again.
Road-Trip Travel Stocks — In a recent post, I detailed how I believe 2020 is going to be the year of the road trip. Travel stocks like Wyndhamm Hotels (Symbol: WH) and Cedar Fair (Symbol: FUN) will likely see losses this year (like all travel stocks), but I believe these two will be quick to recover because they’ll capture a good amount of the growing “road trip revenue”.
Biotech — While many of the smaller biotechs look sketchy to me, I’ve long envied the businesses of the larger biotech giants. Who’s going to stop taking cancer meds just because of a pandemic? Almost nobody. Stocks like Amgen (Symbol: AMGN), Gilead (Symbol: GILD), and AbbVie (Symbol: ABBV) look set to prosper over the next 12 months. Given the earnings and sales increases they’re expected to see, this group looks downright cheap.
Earnings Gotcha’s To Look Out For
Historically investors have use fundamental valuation metrics like the P/E ratio to gauge the relative sanity of an investment. The problem is, earnings will be absolutely ridiculous for the rest of 2020. Because earnings are going to be ridiculous, P/E‘s are going to look like absolute crazy town.
As a standard metric of valuation, the Price-to-Earnings ratio is going to be useless in 2020. Instead, I recommend looking at alternative valuation metrics that have little to do with earnings — price to sales, book value, price to cash flow, and lots of industry specific metrics.
Over the next few weeks, earnings are going to look grim. Really grim. I’m almost certain the shares of many stocks will dive after they’ve announcing Q2 earnings.
So be it. To astute investors, willing to look beyond the obvious bad earnings, this could represent a very good opportunity to pick up assets at good prices. Don’t despair!
Always remember when buying stocks — you’re buying more than just a piece of paper. You’re buying a business, a system, along with its assets. A business can be measured with more than just GAAP earnings.
For those willing to study and look beyond the obvious, 2020 may represent the single biggest investing opportunity of your life!
[Image Credit: Flickr]