The year 2022 has taught investors a lot of lessons. Even the most experienced traders on Wall Street are learning from this awfully confusing market.
Perhaps the most important is that boring stocks can sometimes double as breakout stocks.
Over the past two decades, high-growth technology stocks have dominated the leaderboards on Wall Street. Names like Shopify (SHOP), Roku (ROKU), Block (SQ), Netflix (NFLX), and more. Those stocks all soared hundreds of percent in the 2010s.
As such, the perception has developed among investors that only hypergrowth stocks soar on Wall Street.
This year has completely obliterated that thesis.
Seven different stocks have soared more than 225% in 2022. Only one is what you would consider a “hypergrowth stock.” The other six are what you would consider “boring stocks.”
One is an oil refiner. Another is an education services firm. One is a workforce lodging operator. Two more are natural gas exploration firms.
Pretty much all are slow-growth firms. Yet, they’re stocks are acting like high-growth superstars.
What gives? Valuation.
High Inflation and the Return of Value Investing?
In the post-2008 world of ultra-low interest rates and zero inflation, valuation was a secondary thought to growth. A stock’s price-to-sales (P/S) or price-to-earnings (P/E) multiple only mattered if the company stopped growing. So long as the company was growing, investors didn’t care about valuation. They bid up growth stocks to stratospheric valuation levels, and that was that.
But we are no longer in that world.
The world we live in today is one of rising interest rates and 50-year-high inflation. Valuation is no longer a secondary thought. A stock’s P/S and P/E multiples suddenly matter more than anything. Companies smashing earnings estimates with superb growth rates are still seeing their stocks crash because they’re trading at nosebleed multiples.
Take software databasing firm MongoDB (MDB), for example. The company just reported ostensibly excellent quarterly numbers. It was a double-beat-and-raise quarter with 50%-plus revenue growth. Superb, right? Well, the stock dropped as much as 30% the day after the report.
Why? Valuation.
MDB stock trades at 550X EBITDA (earnings before income, taxes, depreciation, and amortization), 2,073X EBIT, 11.5X revenues, and 25.2X book value. According to data from Bloomberg, the stock trades at an enormous premium to similar software stocks on all those valuation multiples.
Valuation matters, folks. Indeed, with inflation above 5% and interest rates on the rise, valuation matters now more than it ever has this century.
When Boring Becomes Breakout
And that bring us back to our boring stocks.
One of 2022’s best-performing stocks so far is Scorpio Tankers (STNG). It’s up more than 230% year-to-date, while many hypergrowth stocks are down 50%-plus.
What gives? Valuation.
As of this writing, Scorpio trades at just 6.2X earnings, 5.8X EBITDA, 8.9X EBIT, 4.2X revenue, and 1.3X book value. And those multiples are after the stock has already rallied 233% this year. That means earlier this year, those multiples were about one-third their current size!
Of course, Scorpio Tankers had some help from 2022’s macroeconomic situation. This is an oil and natural gas exploration company. The Russia-Ukraine war has created a sort of “golden era” for fossil fuel investments.
But that actually speaks to the point I’m trying to make here.
In today’s world of rising interest rates and high inflation, a very potent stock market combination is a discounted valuation plus a little macroeconomic nudge. With that, boom – you have a triple-digit winner like Scorpio Tankers.
The Final Word
Thanks to inflation and the Fed, the calculus determining Wall Street’s biggest winners has completely changed.
In the 2010s – with low inflation and interest rates – growth stocks with massive potential were the market’s biggest winners.
In 2022 – with high inflation and interest rates – value stocks with undervalued potential have been the market’s biggest winners.
This change may last. Or it won’t. No one really knows. I, for one, believe inflation will come down, and the Fed will move less aggressively than what it’s saying. So, a return to the growth-stock-dominated era is very likely in 2023.
But that may not happen. Inflation may stay hot. And the Fed may keep its foot on the gas.
No one really knows.
So, why don’t we remove the guesswork and just buy stocks that will work in either environment? Stocks that will rise if inflation falls – or if it stays high. Buy stocks that will rise no matter what.
Sounds pretty good, right?
Of course, you’re probably thinking, Luke, what stocks could you even be talking about?
My answer: Stage 2 stocks.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.