The strong start last week went for naught as the end of the week resulted in a disconcerting sell-off across all equity markets. Once again, the major damage was to the growth and technology sectors.
Growth Stocks are Bargains
All of a sudden, growth stocks have become value plays. Let me explain. There are several ways to look at stock valuation from a price perspective. One such valuation, and a primary one, is that of Price to Earnings multiple of PE. This tells us how much the market is willing to pay for every dollar of earnings for a stock. Some stocks have low PE ratios because they tend to slow growers and pay high dividends. Other stocks have high PE ratios because they tend to be growing faster and pay little or no dividends.
Yet, PE ratio does not factor in earnings growth for a company. Hence we use a second price based stock valuation which takes into consideration both the PE ratio and earnings growth. This is referred to as the Price Earnings to Growth ratio or PEG. By using this we can: 1) normalize all companies based on earnings and growth and 2) determine which stocks are too pricey and which are cheap.
In general, a stock with a PEG ratio at or less than 1.0 is a bargain. Those with a PEG of 2.0 or greater are risky. Typically, you can expect a PEG somewhere in between with 1.5 being a reasonable PEG ratio. Using this tool, we can separate the highflying momentum stocks (most with PEG over two or in some cases negative earnings) from true growth stocks.
With the recent market disdain for stocks, many growth stocks have been pushed into sub 1.0 PEG levels, especially in NASDAQ. Take Google (GOOGL) for example. The company’s stock sells for PE 20; has a two year earnings growth rate of 21% per annum; which equates to a PEG below 1.0 (0.95 to be exact). For a growth stock, and GOOGL is one, this is a gift.
So while these sell-offs may sometimes be irrational and about as fun as standing naked in a hail storm, they will pass. I have seen plenty of such behavior in the markets in my thirty years in the business. Over long periods of time, growth stocks will lead your portfolio higher. Unless we are going into a recession, or the winter continues into August, there are great opportunities all around, many of which we own and others which we will pick up. However, you cannot put a price on patience and that is exactly what you need in these markets.
Disney’s Captain America Sets Box Office Record
After Grub Hub (GRUB) went public, we picked up some stock for our Restaurant & Food Chain Portfolio. Disney’s (DIS) Captain America: The Winter Soldier set an April box office record for an opening weekend with $96.2 million in sales. That does not even count the popcorn, M&Ms and soda that were also sold. I expect that Disney shares will benefit from that flick.
In another sign that spring is here, my son and I went to Home Depot (HD) yesterday. It was like Macy’s (M) on Black Friday.
Friday had all the feeling of a panic sell-off. As for today, the opening should see some follow-through selling as retail investors got worried over the weekend and entered sell orders at the open. Taken together, we are setting up for a rebound which should get the market back on track for a run higher.
Kentucky over Connecticut
It will be Kentucky versus Connecticut in tonight’s NCAA Men’s Basketball Championship game. This is a hard game to pick. Both teams have beaten much stronger and higher ranked opponents to get to tonight’s final game. The Wildcats of Kentucky have five freshman starters whereas The Connecticut Huskies are more experienced and have one of the top if not the top guard in the nation, Shabazz Napier. The Vegas Odds are Kentucky minus 2 1/5 points. Gun to my head, Kentucky wins but does not cover the spread.
Please continue to email me your queries related to the markets or economy at email@example.com and I will compile the questions and answers for publication later this week.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was long DIS, GOOGL & GRUB — although positions can change at any time.
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Scott Rothbort is also the publisher of the LakeView Restaurant & Food Chain Report, a newsletter focusing in on food, restaurant and agricultural stocks. A subscription is included with a paid Platinum Membership to Wall Street All-Stars or an individual subscription to the newsletter which can be ordered at www.restaurantstox.com
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