December 11, 2024

Three Stocks, One Choice: The Growth Puzzle

<span id="hs_cos_wrapper_name" class="hs_cos_wrapper hs_cos_wrapper_meta_field hs_cos_wrapper_type_text" style="" data-hs-cos-general-type="meta_field" data-hs-cos-type="text" >Three Stocks, One Choice: The Growth Puzzle</span>

Don’t just chase past performance—learn why NVIDIA’s AI potential might outshine Tesla’s cars and Bitcoin’s crypto craze.

What to expect when you are investing. Let’s say, for instance, that you are a regular reader and that you have picked up on one of my many mantras, namely the one in which I am constantly imploring you to have a long-term focus. I try to drive this point home in many ways through many scenarios because I know… WE know that the numbers—THE NUMBERS—show that it is our best chance to get solid average annual returns. But to be clear, this does not apply to silly investments.

Yesterday, I talked about the basic concept of the Efficient Market Hypothesis and the Random Walk. Now, I know that you have heard about these in one form or another over the years. It may have led many to believe that they could just by an Index ETF and go on vacation. Well, that is kind-of true according to the numbers. The S&P 500 has had an annualized average total return of 11.05% over the last 30 years. That’s right, if you bought the SPY ETF 30 years ago, you would have earned around 11% per year ON AVERAGE, for a total return of 2162%. Not every year was a winning year; there were 8 losing years over that period. Of course, not all of us have the ability to stay invested for 30 years, and hopefully the year you needed access to capital was not one of those 8 down years. Still if you followed yesterday’s mini dissertation, if you read Malkiel’s book, or if you have followed even active investor extraordinaire Warren Buffet, you might have just simply bought the SPY ETF. But I know you are reading this report EVERY day because you would like to do better than the market. And yesterday, I told you that you could beat the market if you do your homework, because sometimes the market gets it wrong and provides opportunities.

There is another way of increasing your chances of beating the market. Remember that the S&P500 has… um, 500 companies in it, and not all of them perform the same way. The index is capitalization weighted, so the index is heavily influenced by the biggest stocks—which become the biggest stocks by going up, so the index itself does a good job at sort of selecting the better stocks and minimizing the losers. But I am sure that you have already realized that you might even do better by picking the best and ignoring the worst. Wouldn’t it be great if it were that easy? 🤣🤣

So, where am I going with this? What if I were to ask you to think ahead 5 years. Where do you think you could get the greatest returns. Think about it, what sector has the greatest potential for the largest earnings growth? I am not going to answer that question, this one is all on you, but I will frame it a bit more for you. Think about three companies. One company sells a high-priced durable good along with services that are attached to it; let’s call this Company 1. This company sells its products into a market that does not grow much year-over-year. Company 1 does well because it is innovative, but there is lots of well-capitalized competition. While first mover advantage was part of its success in the past, its competitors are gaining on it, and one has even surpassed it in unit sales.

Company 2 sells products that are at the core of a rapidly growing marketplace. It is, for the most part, an intellectual property company that relies on outsourced manufacturing to minimize capital outlays and to provide it with lots of production flexibility. Its products are in such high demand that they are already taking orders for 2026. This company not only had a first mover advantage by about 20 years, but it has intellectual property protections which prevent the competition from copying it. This company has a so-called "broad moat” around its business. That means that it would be hard to compete with it.

Company 3 is a mystery. We are unsure what the company actually sells. We do know that investors really like its stock which has grown significantly over the past several years and that its growth trajectory has steepened in recent months. We know that the companies’ products, whatever they are, have some utility, but it isn’t clear if those uses are broad. The products do have substitutes which are broadly in use around the world. This company has some regulatory hurdles which may improve in coming months. There are also a number of competing companies with less market share but with low barriers to entry.

Which company would you pick for your portfolio if you are hoping for growth over the next five years? This can’t be that easy. You look at the performance of each of these companies over the past 6 months for a clue. They have returned 134%, 12%, and 43%, respectively. You know what, I am just going to show you the chart. Have a look and follow me to the finish for the big reveal.

Screenshot 2024-12-11 074319

Wow, it is clear from the chart that Company 1 is doing really well. But remember from above, it has lots of competition with minimal barriers to entry, and it sells into an addressable market that is not really expanding. Wait, perhaps we can look at the companies’ earnings growth. Surely that would give us a clue. Surely, we would want to invest in companies that have grown earnings. Company 1 is actually expected to have negative EPS growth for 2024, while Company 2 is expecting its annual EPS growth to be 143%! Company 3 doesn’t really have earnings, but it still has managed to trade higher by some 130% year to date. I will ask you one final time. Which would you invest in if you are seeking big growth over the next several years? It should be obvious that company 2 has the best potential for growth given not only my description of its business but also its actual earnings growth that far exceeds the S&P500’s expected EPS growth of around 10.5%.

OK, here we go. The three investments are, in order, Tesla, NVIDIA, and Bitcoin. Company 3 isn’t even a company with its only benefit is growth driven by demand. There are no earnings, sales, or cash per share, nothing, just supply and demand for a digital currency which accounts for .03% of the world's global daily transactions. Company 1 sells cars, has lots of competition and had a first mover advantage which has completely evaporated. And Company 2, NVIDIA? Well, if you are not sure about exactly what AI is yet, that is OK, but I do want you to think about what the opportunity for its growth is over the next few years. I will ask you one final time, but in a different way. Do you think that Companies 1 and 3 have any chance of having the future revenue and income growth of Company 2? I thought you would say that.

YESTERDAY’S MARKETS

Stocks declined yesterday as investors were at the edges of their seats awaiting today’s big inflation numbers, fearing that disinflation has stalled and that the Fed may not be kind as a result. Small businesses are optimistic according to the latest data from the National Federation of Independent Business, citing optimism over the incoming administration.