New Year 2021 — is there a stock market bubble?
At heart I am a value investor. I do invest in high multiple stocks, but only when I think their long term earnings will grow into that valuation. I sometimes let stocks run beyond their fair valuation because they are popular and have momentum, but feel uneasy doing so. In the end I believe that given sufficient time stock prices revert to a reasonable multiple of their future earnings, and I am always looking for opportunities to buy below that number and sell above it.
Given these predilections, the current market is a puzzler. Many of the stocks I have liked and followed in the past (e.g. AVAV) have gone well beyond what I think they could reasonably earn in the foreseeable future. At the same time, some stocks that I think have good long term prospects are dead in the water and it is hard to hold them while the market climbs continually higher. Pervading it all is the ongoing debate about whether there is a stock market bubble.
Considering this uncertainty I decided to run a COVID Delta analysis on some of the stocks I am following; check out COVID Delta Part #1 if the idea of COVID Delta is new to you. My goal is to figure out:
- Is the market as a whole overvalued?
- Are the growth stocks I like just a little expensive, or completely outrageous?
- Do the lagging value stocks represent a big enough opportunity to be worth the wait?
What I found — the market (S&P 500) as a whole is not particularly overvalued compared to where it was in February of 2020, though I felt it was getting a bit toppy then. There are however a number of stocks I follow that are trading much higher than I might have expected and others significantly lower. I will look to trim the former and add to the latter. Here are the specific stocks I looked at, and corresponding COVID Deltas as of 16 January 2021.
| Analysis | % Anticipated | % Actual | COVIDDelta | |
| AAPL | Apple has been able to pivot quickly away from needing its retail stores during COVID and its products have benefitted from work-from-home. It has introduced a number of new products over the past months, including a new line of 5G phones. Its services business has continued to grow, and it is rumored to be re-emphasising its electric car efforts. Overall it has benefitted moderately from COVID and continued to execute well on its strategy. | +20% | +59% | -39% |
| AMAT | AMAT has weathered COVID with relatively minor impact to revenue and the thesis that semiconductors will play an even bigger role in the future economy has strengthened. A biden presidency should provide some short term benefit. Solar will benefit from federal subsidies and displays will benefit from continued stimulus spending. A more conciliatory relationship with China will reduce the pressure on them to develop their own semiconductor equipment capacity. AMAT was fairly inexpensive at the beginning of COVID. On the down side the semiconductor capital equipment industry can build a lot of innovation and capacity without growing, which makes it easy to overestimate the impact of trends in demand for chips on equipment suppliers. | +30% | +58% | -28% |
| AON | COVID has had a significant negative impact on Aon in areas such as travel and entertainment, where its customers have had far less to insure. As the pandemic abates, these should come back quickly. More broadly the amount of change and disruption in the global economy has increased the scope and complexity of risk that individuals and companies have to deal with. Increased complexity is good for Aon as underwriters and insurance customers need more help understanding their risks. Scope of risk opens opportunities for new products (cyber, IP, …). On the down side, these are also opportunities for smaller and more nimble competitors to gain market share and first mover advantage. Apart from COVID, the WTW acquisition is a net positive in that it moves the market from oligopoly towards duopoly. | +20% | -12% | 32% |
| AVAV | Aerovironment has continued to grow its defense footprint with contract wins and numerous new product introductions, including aggressive acquisitions. They continue to make progress on HAPS. So far Starlink seems mostly complementary (wide area low capacity vs. HAPS which is potentially a way to put a lot of density in a particular area quickly). Longer term Mars helicopters could make AVAV part of the space economy as well. Ag business doesn’t seem to be getting any traction. I expect that there will be more military conflict over the next couple of years as China, Iran, North Korea, and the Taliban test the Biden administration. | +35% | +86% | -56% |
| EXAS | At the beginning, COVID was a setback to Exact Sciences because their sales people couldn’t meet with doctors in person and because procedures requiring their tests were being deferred. They quickly replaced that lost revenue by repurposing some of their labs to conduct COVID testing. They also saw a rapid acceleration of their roadmap for online prescribing, due to relaxation of restrictions on telemedicine. Recent acquisitions show that they aim to be an acquirer of advanced cancer detection products. | +40% | +46% | -6% |
| GOLD | After some minor operational impact from the pandemic, Barrick has adapted and is producing at near pre-pandemic levels. They continue executing on their strategy of operational excellence and good relationships with people/governments in the places where they have mines. That said, their long term results will be most strongly correlated to the price of gold. Anything over $1,200 per ounce adds significantly to their margin (though not pure margin because they have royalty agreements tied to the price of gold). Gold is up ~20% since the start of the pandemic, but has been heading down as risks around the US presidential election are resolved. The largest segment of gold demand is still jewelry and there is presumably significant pent up demand from COVID deferred weddings in India and China. I also believe that there will be ongoing risk/uncertainty in the coming years. | 25% | +12% | +12% |
| HON | Mix of businesses that benefit (PPE and warehouse automation) and are hurt (aerospace) by COVID. Sales are off ~15% due to COVID, but likely to bounce back quickly as travel comes back. HON has also become a player in quantum computing. Given the growing availability of vaccines, aerospace should bounce back quickly and other businesses continue to thrive. | 25% | +14% | +10% |
| IBM | In the near term IBM has been hurt by a concentration of customers who have been hurt by COVID (banks, airlines, …). These should recover as the pandemic subsides, but technology investments might be hampered by the increased debt they took on to survive the pandemic. IBM’s cloud centric strategy has made some progress, but not enough to change valuation. The spin off of its services division seems like a good idea, but also not enough to significantly change valuation. Also of concern–why wasn’t IBM able to take more advantage of the accelerated digitization that boosted a lot of its competitors. | -10% | -15% | +5% |
| KMI | In 2020 Kinder Morgan saw a reduction in revenue due to lower demand for natural gas from the global economic slowdown. This should go back to historical levels as COVID recedes and the world moves away from coal. CNG will likely be a wash as US transport capacity increases, but other low cost producers like Saudi Arabia also come on line. There may be opportunites to acquire assets at good prices from pipeline operators who don’t survide the pandemic, but probably not a big impact because there is so much money competing for investments. Low interest rates are good in the near term, but could be a problem longer term if there is significant inflation. Biden administration will likely increase regulation, which is good for incumbents like KMI. They a have started talking about hydrogen transport, which is immaterial in the near term but could be important in the future. | 10% | -30% | +39% |
| SPY | Many stocks in the S&P have suffered a significant loss of business since the pandemic started and have had to incur significant debt to survive (e.g. hotels and airlines). Others have benefitted (e.g. Amazon). In aggregate the effect is negative given reduced economic activity. Also, the S&P was a bit expensive before COVID. On the positive side, the government has injected a lot of money into the economy, and bankruptcies in smaller private companies could mean less competition in the future. There is also significant pent up demand that will be satisfied in 2021 and 2022 as the pandemic subsides. | 10% | +12% | -2% |
| T | The pandemic has hurt AT&T’s b2b business, but helped its home and mobile business. Lockdowns have probably helped it’s content business, but likely not in a material way. We are one year closer to 5G, which makes it a bit better. | 0% | -24% | +24% |