Investors Should Focus on Stocks to Take Their Portfolios to the Next Level

Index (Symbol)

S&P 500 (.SPX)

Price

3041

Data is as of
June 15, 2020
Sharek’s Take
David SharekSo far in 2020 the stock market (S&P 500) has gone from being up 5% at the highs in February, to -32% for the year during March, then back to even (0%) as of the end of last week. Don’t be surprised if the market is this price a year-from now.

This quarter, small investors tried their Luck the Stock Market — and Won! Lots of new investors have done well this qtr, many of these investors made nice returns investing in low-quality stocks like airlines and cruse lines.

But its always easy at the beginning of a Bull Market. The best stocks in the early stages of a new Bull Market include penny stocks and stocks in companies that had a risk of going out of business. If there is optimism about the economy, these stocks should bounce back in a big way.

So the easy money has been made, and now we get to the serious part. How to take your portfolio to the next level? First, let’s look at where the market stands today.

One Year Chart
Here’s a one-year chart of the S&P 500. In this chart, quarterly profit growth is along the bottom, with Estimates for the next two qtrs bottom/right.

The past 4 qtrs shown here are 2019 Q1 to 2019 Q4.

2020 Q1 is the first Estimate, with +2% profit growth expected. Yes, we are in June, yet Q1 numbers aren’t yet in the books. Most companies have their 1st qtr end March 31st, but some end April 30 or May 31. Thus, I don’t have Q1 numbers yet. Note: many non-essential stores were closed around mid-March.

2020 Q2 is the -42% qtr, and this is when we see the affect of the Coronavirus.

The market’s P/E is 23. That’s high. The P/E was 13 last qtr, when the S&P was $2237. Now it’s $3041.

In the Annual Profits column, note profits have been up every year since 2011. 2020 will break that streak.

Earnings Table
Here in the Earnings Table we take a deeper look into the fundamentals. When you read this table, figures taken that qtr go from left-to-right.

Notice qtrly profit growth was strong towards the end of 2019. Now profit growth is expected to be fair for the 1st qtr of 2020, then decline the next 2 qtrs, and thinks don’t look so bad for 2020 Q4. 

Annual Profit Estimates see a big decline this qtr. Note 2021’s estimate ($161.60) is similar to what analysts felt the S&P would make in 2020 as of last qtr ($169.61).

Fair Value
The S&P sells for a number of years worth of profits, or a multiple of profits. This “multiple” is referred to as the P/E ratio. The P/E for the S&P 500 is usually between 15 and 20, as you can see here. Notice the S&P has had a P/E of around 18 the past three years.

Since interest rates are low, there’s not much competition for your money from bank CDs (or bonds in general), thus we should assume the market should have a higher P/E than normal. Stocks are more attractive than bonds right now, My Fair Value on the market is a P/E of 19. This calculates to 18% downside for the market this year, but investors already know 2020 will be a bad year. We are looking past this. And the market was already down to this level earlier in the year.

2021 is what money managers are looking at. And a 19 P/E on current 2021 profit estimates of gets us a price on the market similar to what we have today. Thus, this next year could be a lost year for investors. But, I do believe companies will start to come out and beat expectations, and this could raise the profit figure for the S&P.

Bottom Line
When we see a ten-year chart of the S&P 500, profits have grown 5% the past decade with the index climbing 11%. These two numbers are often close together but since we were coming out of a recession and Bear Market ten-years ago and had another this year, the figures are erratic. Last qtr, this ten-year chart showed both profits and the index rose 7% per year.

Over the long-term I expect the S&P 500 to grow profits 5-7% per year, with the S&P 500 Index growing at a similar rate.

The current stock market rally is actually investors looking ahead to next year’s recovery. But now we are at a point where it seems the upside is already reflected in stock prices.

Now is the time for investors to switch gears and look for stocks that will likely outperform the stock market. This is a stock pickers market. Here are the sectors I think investors need to look in to find tomorrow’s stock market winners today:

  • Software stocks that make it easy for businesses to operate with people working from home.
  • Cyber security stocks that protect organizations from hackers trying to get into home computers and into the company’s network.
  • Online retailers that deliver consumer goods to homes.
  • Financial Technology (FinTech) stocks that allow people an easy way to send money or buy things online.
  • Discount Retailers with physical locations outside the mall. Mall based stores have been hit hard, and many will go out of business. Discount clothing stores will likely pick up additional market share.