Given that the average stock in the S&P 500 fell 0.70% and the Russell 2000 SmallCap Index skidded 2.07%, the first week of June provided little cheer, even as stories in the financial press might suggest otherwise.
I prefer to consider the market as one made up of many individual companies and counsel others to look beyond the headlines as sometimes they can be very misleading in terms of what is happening to a broadly diversified portfolio of inexpensively priced stocks.
Such was the case on two separate occasions recently. After all, “Blue Chips” did not decline on May 30, given that 22 of the 30 Dow Jones Industrial Average members advanced in price, while “Stocks” did not rise on June 4, seeing as how the average holding in the Russell 3000 index was down 1.14%.
The broad-based indexes are heavily influenced by stocks like high-priced Salesforce in the price-weighted Dow Jones Industrial Average or a titan like Nvidia in the capitalization-weighted S&P 500.
And speaking of Nvidia, the investor darling as of 06.07.24 accounted for more than a third (436 basis points) of the S&P’s return in 2024, given its 4.67% average weight in the index and its 144% total return.
THE PRUDENT SPECULATOR WAY
The investment process at The Prudent Speculator, of which I am Editor, is valuation-driven even though it has been evolving since first turning on the lights in March 1977. It relies on the underlying idea that we should be buying stocks when they are on sale and trading at a significant discount to our determination of fair value.
That is, we want to buy stocks that are (temporarily) out-of-favor or underappreciated, as in our view they offer several ways to benefit. These can include a market reassessment upward towards the historical norm for valuation metrics like sales and earnings and/or growth in those metrics. In simplistic terms, the P/E ratio could ratchet back up or the E part of the equation could increase with the P then also climbing.
A disciplined approach has afforded the opportunity to buy stellar Wall Street performers like Apple, which accounts for 15 basis points of the S&P 500’s 2024 year-to-date return; Microsoft, 93 basis points; Alphabet, 43 basis points; and Meta Platforms, 79 basis points; and even Nvidia at inexpensive entry points over time.
With its market capitalization topping $3 trillion last week, it is not surprising that Nvidia would garner lots of investor attention. While we have owned the A.I. superstar in the past with success, we do not presently hold the stock. Clearly, with the benefit of 20-20 hindsight, we wish we still had a position, but the valuation metrics have long been too rich for our taste.
VALUE IN A.I.
Of course, I wouldn’t completely rule out owning Nvidia again. After all, the company, despite its massive market capitalization (which recently topped $3 trillion), still has plenty of growth potential, as the top- and bottom-line is likely to continue to move markedly higher for the foreseeable future.
However, it should not be a surprise that a Value-oriented strategy would find the current stock price of more than 65 times trailing-12-month earnings and 37 times trailing-12-month sales to be expensive. True, those multiples drop to 42x earnings and 22x sales estimates on a forward basis, but there is little room for imperfection in the current valuation, by my way of thinking, especially considering far less-expensive valuations available in the marketplace.
Instead, investors might consider more reasonably priced alternatives to gain exposure to A.I. enthusiasm that can benefit from the same dynamics that have propelled Nvidia to the stratosphere: Broadcom with its cutting-edge A.I. networking and connectivity solutions; Qualcomm with its Snapdragon mobile processors and Adreno GPUs; Micron and its purpose-built memory and storage solutions that support A.I. applications; Digital Realty and its data center real estate, Intel and its data center chips; Microsoft and its monetization of A.I. technology; et cetera.
This is a condensed version of our weekly Market Commentary on theprudentspeculator.com. The Prudent Speculator’s content is curated each week as a valuable resource for recent stock market news, investing tips and economic trends. To receive regular reports like this one along with free stock picks sign up here: Free Stock Picks – The Prudent Speculator.
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