The Next Wave of Growth Stocks Has Arrived

Ever since the Federal Reserve allowed interest rates to begin rising nearly three years ago, technology stocks have vastly outperformed the overall market. From its February 2016 low through its July 2018 high, the tech-heavy NASDAQ Composite Index gained 85%  in just 18 months while the S&P 500 Index returned 54%.

That degree of outperformance would be even more remarkable if the contribution from the tech sector was removed from the S&P 500. That’s because the index is cap-weighted, meaning companies contribute to its performance according to their relative size. Five of the 10 biggest companies in the S&P 500 are tech stocks.

Included in that list is Facebook (NSDQ: FB), which lost $120 billion of value in a single day after releasing second-quarter results on July 25 that exposed the extent to which the company’s recent woes may impact future performance. That plunge wiped out the past 12 months’ worth of gains in Facebook stock and put it into the red for 2018.

In the days following Facebook’s debacle, the other three members of the original FANG quartet of “can’t-miss” momentum stocks felt some of its pain. Amazon (NSDQ: AMZN) dropped 4%, Netflix (NSDQ: NFLX) fell 8%, and Alphabet (NSDQ: GOOGL) got off easy with only a 1% hit to its share price.

Admittedly, those short-term losses pale in comparison to Facebook’s 22% loss, but the greater impact may be a long-term shift in attitude towards risk. If the most popular momentum stocks are no longer immune to market sentiment, where will investors turn to for growth?

The Next Wave of Market Leaders

I don’t claim to know the answer to that question, but I do know what “reversion to the mean” looks like and it isn’t going to be pretty for most overvalued stocks. The good news is there are plenty of other companies trading at reasonable valuations that should be the beneficiaries of money coming out of the FANG stocks.

The trillion-dollar question is, which ones will they be?

I also do not know the answer to that question. I do, however, have a pretty good idea of what they will look like:

  • They will have strong operating cash flow that allows them to invest in the growth of their business without taking on too much debt;
  • They will return profits to their shareholders in the form of dividends and stock buybacks rather than hoard for some as yet unknown future purpose; and
  • They are currently priced at relatively low earnings multiples, with clear earnings visibility over the next 12 – 24 months.

Renewed Interest in Value

Don’t believe me? Take a quick look at some of the names that have been surging while the FANG stocks hit the skids.

Over the past 30 days, retail pharmacy Walgreens Boots Alliance (NYSE: WBA) rallied 30% after dropping on news that Amazon made a minor acquisition in the healthcare space. Even still, WBA is priced at just 10 times forward earnings and only 0.54 times sales. Along with its 2.8% forward dividend yield — roughly equal to what the 5-year Treasury note is paying — Walgreens has become a cash flow machine.

Energy consortium Chevron (NYSE: CVX) has gained 4% over the past week after reporting $3.4 billion of net income during the second quarter. The company announced it will spend about $3 billion per year on stock repurchases, in addition to its 3.6% annual dividend yield. With the price of oil near $70 a barrel and Iran in the hot seat, Chevron could be looking at record profitability next year.

Banking giant Citigroup (NYSE: C) has risen 10% over the past 30 days after it aced the annual “stress test” conducted by the Federal Reserve. Financial stocks are coming back into vogue after going on hiatus for the past year, especially those that can post double-digit growth in earnings like Citi is expected to do.

The next wave of growth stocks won’t make cool gadgets that entertain you. Instead, they will make a lot of money and share it with you. After all, isn’t that what stock ownership was supposed to be about all along?

Speaking of technology…

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Stock Talk

Lyubov Litvin

Lyubov Litvin

Hi Jim,
What do you think about Rite Aid (RAD) now when they do not merge with Albertson because shareholders did not approve the merger?

Jim Pearce

Jim Pearce

I don’t see much long-term upside potential in Rite Aid. Its best bet was getting acquired by Walgreens, which the regulators did not allow. Now that its deal with Albertsons is kaput, my guess is it is only a matter of time until the company’s remaining stores are sold off to the highest bidders or the company goes private so it can restructure itself for a subsequent IPO down the road.

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