The stock market can be a battleground between winners and losers, with outcomes heavily influenced by various factors such as company performance, economic conditions, and more. If you’re wondering how to identify the winners in this landscape, it’s no simple task. However, timing plays a crucial role.
In the recent past, the stock market experienced a substantial surge, with the S&P 500 boasting a remarkable 25% increase. While Big Tech took the spotlight, other stocks also made significant gains. For instance, the Invesco S&P 500 Equal Weight Exchange-Traded Fund (RSP), which eliminates the impact of Big Tech and treats each stock in the index equally, recorded a solid 20% growth.
The primary driver behind this market rally was the anticipation of the Federal Reserve halting interest rate hikes as inflation showed signs of cooling down. The absence of further rate increases suggests a stable economy and, more importantly, reliable corporate profits.
Let’s delve into how this played out last October: Optimism regarding the economy lifted all stocks in a phenomenon known as positive correlation. According to the Cboe Options Exchange, this correlation stood at 50% by the end of the year.
However, the market has now priced in this optimism, causing fewer stocks to witness upward momentum. In just three months, correlation has dropped to below 20%, nearing its lowest point in over a decade.
So, who are the winners in this scenario? They are the companies effectively executing their strategies.
Julian Emanuel, a strategist at Evercore, aptly described the current market as a “market of stocks” rather than a “stock market.”
Now, the pivotal question remains: which stocks represent worthwhile investments?
Some stocks have been unjustly affected by external factors. For instance, regional bank stocks took a hit due to bank failures earlier this year. The SPDR S&P Regional Banking Exchange-Traded Fund (KRE) plummeted by 25%.
Nonetheless, not all banks experienced deteriorating fundamentals. Take Bread Financial (BFH) as an example. With a market capitalization of $1.7 billion, it has faced an 8% decline this year and a double-digit drop at one point. Currently, it trades at a forward earnings-per-share forecast of 3.2 times, compared to an average of nearly 6 times over the past five years, as recorded by FactSet. Furthermore, the company has maintained stable deposits throughout the year, leading analysts to revise higher their EPS estimates.
In conclusion, navigating the stock market to identify winners can be complex. While timing remains crucial, focusing on companies that effectively implement their strategies is vital. Examples such as Bread Financial highlight the potential for undervalued stocks that may present an opportunity for investors.
Consumer Staples Sector: A Changing Landscape
Investors who sought the safety of consumer staple companies last year were handsomely rewarded as stocks soared. However, things are changing rapidly in the market. The Vanguard Consumer Staples Index Fund Exchange-Traded Fund (VDC) has outperformed the S&P 500 significantly, prompting investors to seek new opportunities. As a result, the staples ETF is now down 3% from its peak in December.
While most consumer staple companies are experiencing a downturn like banks, there are exceptions. Coca-Cola (KO) is one such exception. Although it is down 7% from its December high, it currently trades at 22 times earnings, which is a 16% premium compared to the S&P 500’s 19 times. Historically, Coca-Cola has traded at a premium of above 40% when consumer staples are more in favor. With this valuation level, analysts anticipate a solid total return as earnings growth and dividend payments are expected. Analysts predict a 7% annualized EPS growth for the next three years, and the company plans to increase its dividend payment by about 5.5% annually.
Another company executing a high-growth strategy is Starbucks (SBUX). The coffee chain is expanding its presence in China and attracting new rewards members at home, thereby driving sales growth. As a result, profit margins are poised to expand.
Despite this positive outlook, Starbucks stock has declined by 11% since April. Currently trading at 25 times earnings, which is about 33% higher than the S&P 500’s multiple, Starbucks has the potential to trade at an even higher premium, sometimes exceeding 60%. This is due to the company’s expected earnings growth, which is predicted to be twice as fast as the S&P 500 over the next three years. Furthermore, Starbucks has consistently beaten EPS expectations in three out of the last four quarters.
To identify winning investments, the key lies in finding robust businesses at reasonable prices. One effective strategy is to observe what investors are selling and determine the reasons behind their actions. By uncovering hidden gems amidst the rubble, astute investors can take advantage of opportunities that others might overlook.
