Alternative Stocks Poised To Succeed In A COVID-19 World
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!
Good luck!
[Image Credit: Flickr]
Up and up and up for the FAANG group. Where will it stop? Probably somewhere reasonable! When? Who knows! That ol’ Keynes saying “the market can remain irrational longer than you can remain solvent” is ringing in my ears.
“They’re looking to sell to a greater fool”
*Lays back, sips coffee, remembers 08-09 Great Recession mistakes, verifies monthly VTSAX order*
Uh, yeah, think I’m going to sit this one out. A good reminder of a post though 🙂
Do I need to remind you as a buyer of VTSAX this month you’re also one of the people buying those stocks. Check the top holdings. A good 20ish percent is going into those very stocks.
as you may or may not know, mr. tako, we own a lot of growth stocks. i bought our largest holdings back in ’16 and ’17 and just hold them. our largest holdings by % are SHOP,MTCH,NVDA,MA,NFLX,OKTA, and AMZN. we bought AMZN back in ’16 for $500/share and they’re about $3200 today but probably would not have fit your model for a good buy back then. all but one of those top 7 (MA) made new all time highs this past month. i think the growth thesis was correct and the pandemic accelerated the want to own these future winners. with all that being said it does seem a little crazy the pace of the share price gains this year. i’ve been selling small pieces (1-3% of positions) as they make new highs weekly just to keep the target asset allocation near where i want it. i consider it like “making your own dividends” as they’re long term capital gains.
i suppose it’s just contrasting styles between the two of us. i put out a scorecard every month for accountability and have only been tracking since jan. 1, 2019. we’ll see where it all ends up and maybe my family will end up in a van down by the river. i’m sure your strategy will do just fine. good luck and happy investing.
Yep, you’re what I call a momentum investor. Congrats on your incredible trading performance!
Just remember one teeny tiny little thing — That’s luck, not skill. 😉
Do you look into other valuation metrics besides PE as some may find PE not useful ?
Thank you
Clearly you didn’t read the post. Most of the time I recommend NOT using PE. In 2020 especially.
If my strategy was actually analyzing fundamentals and handpicking my stock portfolio, I’m not really sure what I would do. I would be really tempted to ride the momentum but I’m really not sure.
Because of this I’m an indexer. I don’t trust myself not to make stupid decisions. So I just own the whole lot and forget about it.
Nothing wrong with admitting what you don’t know! Cheers Backpack Finance!
I am worried about banks because:
1) they are just a black box if the economy goes down the toilet for a long time. Who know if their reserves taken are sufficient or wildly underestimated? Seems to be anyone’s guess.
2) The interest rate has been low for over a decade, and no sign banks have been unable to get sufficient low rate savings to lend out when they needed it. Problem has been the lending rate has been so low there hasn’t been much of an interest spread. Likely will be a low rate environment for a long time.
What are your thought Mr. Tako? Thank you.
My thoughts? It depends on the bank.
That’s the simple answer, but reality is far more complicated. In general, I think most of the larger banks are very well capitalized. Stress Capital Buffer requirements and CET1 risk-based capital ratio for large banks regulate exactly what you’re talking about. Given the government’s stress tests (which assume something like the 2009 Great Recession all over again), banks are well capitalized.
But the Fed is being cautious and restricting share buybacks anyway. If things get far far worse, the Fed might need to restrict dividends and increase capital requirements, but I find that very unlikely.
From my point of view, the interest spread looks fine. There was a time in the 1990’s when it was better, but I’m not expecting that in the future.
Whenever I bring up that Tesla is speculative I get told about how Elon Musk is the answer to everything blah blah, autonomous vehicles, rockets etc, fundamentals dont matter with Tesla etc… Its same junk I heard about Dotcom, same junk I heard about Bitcoin. The speculators have just found a new vehicle, and I can participate as a speculator if I’d like. It amazes me every time that humans love buying something when the prices are rapidly increasing…
Pretty crazy isn’t it? Tesla is now valued more than Toyota, and nobody can explain to me how that makes any logical sense. JD Power initial car quality survey ranked Tesla dead last. Check it out: https://www.jdpower.com/sites/default/files/styles/small/public/image/2020-06/2020070a.JPG?itok=qKK29b-t
As long as investors are willing to keep giving Tesla cash, the company will continue burning through it. Make hay while the sun shines I guess.
I’m also fascinated by the fact that Elon has leveraged his position and pulled out a lot of the value via margin loans (54% according to Bloomberg). If the share price goes down, it unravels super quickly…
I thought I’d put out something maybe you you might consider (or probably already have). We’re in an era of free to almost free money. If money is free, any company that does not grow dynamically or as close to exponentially as possible, should be valued at $0. Any company that grows / has possibility to grow should start heading towards infinity. As such, I would suggest these FAANGT stocks are perfectly priced for the current low interest environment. Also, several (not all) of the average Joe speculators I talk to are not play with their money in their mind. They’re play with government stimulus checks, or their enhanced unemployment money derived from the CARES act. Again, back the free money mantra. I’ll get down off of my soap box.
I wouldn’t agree that money is free. Sure, a bunch of people got stimulus checks in 2020, but they’ll probably see higher taxes in future years to pay for it.
As for banks, deposits are very low cost right now. That’s not the same as free. If you look at interest rates paid by corporations during the last couple of months, they’re actually paying around 3-4%.
Don’t believe me? Try borrowing money to pay this “infinity” for stocks. You won’t get far if you think you’ll be paying nothing and borrowing as much as you want.
The same goes for a home loan. Try to borrow 10 million at 0% interest to buy yourself a mansion. They’ll laugh you right out of the bank.
You nailed it! To me this feels exactly like 1999 and watching Bitcoin in 2017. We are in bubble territory. The top five tech companies account for 25% of the S&P valuation.
This will end badly for many investors buying now. While these COVID proof companies are good companies high valuations imply big drawdowns ahead.
Good luck out there!
-Mike
Thanks Mike!
Home improvement stocks are looking good right now. Even if the recession continues, people will fix up their homes. We are spending so much time at home.
I went to IKEA on Saturday and there were over 100 people waiting in line to get in. Maybe 200. I gave up and went home. I can’t believe people are willing to stand in line for so long to go to IKEA. If they were public, I’d buy some stocks. I’ll try again on Monday.
Home improvement stocks will probably do well over the next little while as people stay home and spend more time fixing up their homes. Costco will probably continue to do well for the foreseeable future too.
a lot of gamblers using etoro and robinhood…am just watching in the sidelines drinking my coffee confident in my biotech investment (2006 Nobel Prize Winning RNA-interference)