Stock Rally Led by a Few Large Companies Raises Risk for Growth Investors

Market Imbalance Sets Up Fundamental Investing for Big Comeback

Here’s our list of some of the most attractive opportunities in U.S. equities today

The recent narrowing of market leadership to a few large growth stocks is offering compelling opportunities for investors willing to buck the trend and focus on company fundamentals. We see very attractive opportunities in undervalued areas of the market among relatively smaller names, often in unloved or unpopular sectors such as energy, industrials, and materials. But it’s not all about cheap stocks, though; in the face of higher interest rates, tighter credit, and decelerating economic growth, investors should pay close attention to earnings growth. First, though, a quick look at the lack of breadth in the latest market rally.

The tech-heavy Nasdaq 100 Index has roared back in 2023, with a year-to-date gain of more than 19%, leaving in the dust the broad market, as measured by the Russell 3000, which has gained less than a third of that, rising 6% for the year. Value stocks, which staged a strong comeback over growth stocks last year, have gotten trounced, barely eking out a gain of 0.2%, as measured by the Russell 3000 Value Index. The Russell 3000 Growth Index, which trailed its value sibling by almost 2000 basis points last year, is up 12.7% to date. Bitcoin is up almost 70%. Party on, right? Perhaps, but warning lights are flashing red. Following the rally in large growth stocks, the 10 largest companies in the Nasdaq 100 now account for almost 55% of the index’s weight. They trade at an average of 33.5 times forward earnings, even though all but three of them have seen a decline in their consensus estimate for next fiscal year earnings per share. Put differently, investors are either ignoring the companies’ own guidance, or they expect a multiple expansion in these companies’ share prices, which seems unlikely with short term rates now hovering near 5%. Figure 1 shows the change in market leadership in 2023 from 2022. Figure 2 shows the Nasdaq 100’s top 10 names with their 3-month change in next FY estimates and their current valuation.

Figure 1. Performance of Growth, Value & Nasdaq 100 in 2022 and 2023

All returns are price only. YTD returns are through April 6, 2023. Source: Bloomberg.

Figure 2. Ten Largest Holdings in Nasdaq 100 Index by Weight as of April 6, 2023

Company Weight   Earnings Guidance Forward P/E Earnings Yield
Microsoft Corp. (MSFT) 12.57%   -3.5% 28.6 3.8%
Apple Inc. (AAPL) 12.43%   -3.6% 26.4 4.5%, Inc. (AMZN) 6.18%   -19.4% 69.9
NVIDIA Corp. (NVDA) 5.14%   3.5% 60.1 0.9%
Alphabet Inc. Class A (GOOGL) 3.78%   -1.7% 20.3 5.1%
Alphabet Inc. Class C (GOOG) 3.73%   -1.9% 20.5 5.1%
Meta Platforms Inc. (META) 3.64%   22.0% 20.9 7.1%
Tesla, Inc. (TSLA) 3.50%   -28.6% 47.7 3.0%
Broadcom Inc. (AVGO) 2.03%   2.1% 15.0 5.0%
PepsiCo, Inc. (PEP) 1.96%   -0.4% 25.4 3.6%
Total Weight 54.96% Avg. -3.2% 33.5 4.2%
Sources: FactSet, MarketGrader

While large cap technology seems priced to perfection, large parts of the U.S. equity market look very attractive, offering a compelling entry point for certain names trading at double-digit earnings yields (call it the equity risk premium, or the excess return available to equity investors over risk-free rates). We screened our database for the most attractive names offering the rare combination of earnings momentum, high quality, and compelling valuations. Here’s how we built our list.

Along with the MarketGrader score—which measures 24 fundamental factors across growth, value, profitability, and cash flow—we paid close attention to trends in analysts’ revisions of future earnings, which usually follow the companies’ own guidance, to identify areas of weakness in overall corporate profits. As higher interest rates continue to constrain credit, impacting growth across most sectors, the U.S. economy is likely to weaken, putting additional pressure on corporate profits. So, we started by screening for U.S. stocks with a MarketGrader score greater than 50 (in our 100-point scale) and a market capitalization of at least $1 billion. This yielded 1,089 companies. We then looked at the consensus earnings per share estimate for every company’s next fiscal year, and removed all of those whose current estimate is lower than it was three months ago; in other words, we included in our list only companies’ whose earnings prospects have brightened following the most recent earnings season. This narrowed the list to 494 companies. We then removed all Financials, which are having their own set of challenges navigating the current rising rate environment, removed all ADRs, screened for companies with excessive debt loads, and focused on those with forward P/E ratios below 20; these screens narrowed our list to 183 names. We then selected the top 30 names by MarketGrader score, which appear in Figure 3.

Unsurprisingly, the list leans toward smaller names, with an average market cap of $6.9 billion. The largest company is Valero Energy (VLO), with a market cap of $50 billion, and the smallest is Teekay Tankers (TNK), at $1.36 billion. Notably, the average change in next year’s earnings estimate for the group in the last three months is +15%, a stark contrast with the Nasdaq 100 names listed above. Despite this, the group trades at 9.1 times next year’s earnings estimates and sport an average earnings yield of 16.3%, which offers investors ample margin of safety in the face of persistent market volatility. The average MarketGrader score for the group is 83.2, putting them in the 98th percentile of all U.S. stocks covered by MarketGrader today.

Figure 3. Top 30 Companies in MarketGrader with Positive Earnings Guidance & Attractive Valuations

Ticker Company Name MarketCap Industry MG Score Earnigns Guidance Forward P/E Ratio Earnings Yield
VLO Valero Energy Corporation 50,139 Oil Refining/Marketing 79.8 35.0% 5.92 23.0%
ALB Albemarle Corporation 23,054 Chemicals: Specialty 84.5 4.0% 7.01 10.5%
NVR NVR, Inc. 18,011 Homebuilding 82.9 14.2% 14.9 10.7%
STLD Steel Dynamics, Inc. 17,710 Steel 77.5 26.1% 6.94 21.3%
PHM PulteGroup, Inc. 13,227 Homebuilding 84.2 3.3% 7.81 24.4%
AGCO AGCO Corporation 8,932 Trucks/Construction/Farm Machinery 78.0 1.6% 8.78 8.6%
BLD TopBuild Corp. 6,008 Engineering & Construction 77.1 7.1% 12.04 11.0%
SMCI Super Micro Computer, Inc. 5,794 Computer Communications 91.8 7.9% 12.89 12.8%
CMC Commercial Metals Company 5,468 Steel 77.2 16.3% 7.69 16.7%
AIT Applied Industrial Technologies, Inc. 5,132 Wholesale Distributors 79.4 11.9% 15.77 6.2%
ATKR Atkore Inc 5,023 Electrical Products 81.7 17.5% 7.85 17.8%
SKY Skyline Champion Corp. 3,907 Homebuilding 84.7 8.1% 16.7 14.6%
MLI Mueller Industries, Inc. 3,834 Metal Fabrication 81.2 39.7% 10.41 19.7%
BTU Peabody Energy Corporation 3,734 Coal 84.5 17.3% 3.85 29.9%
LTHM Livent Corporation 3,639 Chemicals: Specialty 82.1 3.2% 10.5 6.8%
IBP Installed Building Products, Inc. 3,049 Engineering & Construction 80.4 8.0% 13.51 9.1%
WIRE Encore Wire Corporation 3,042 Electrical Products 87.5 27.5% 8.12 26.8%
RUSHA Rush Enterprises, Inc. Class A 2,848 Specialty Stores 77.3 5.3% 9.73 13.1%
CALM Cal-Maine Foods, Inc. 2,710 Agricultural Commodities/Milling 89.6 25.5% 8.22 27.3%
TRMD TORM PLC Class A 2,438 Marine Shipping 87.4 0.3% 4.27 23.7%
LBRT Liberty Energy, Inc. Class A 2,386 Oilfield Services/Equipment 85.4 3.3% 3.94 13.2%
ARCH Arch Resources, Inc. Class A 2,381 Coal 86.0 7.4% 3.63 44.9%
NEX NexTier Oilfield Solutions, Inc. 2,040 Oilfield Services/Equipment 86.8 8.7% 3.48 13.6%
TGLS Tecnoglass Inc. 1,917 Building Products 91.2 12.7% 10.31 10.6%
INSW International Seaways, Inc. 1,903 Marine Shipping 80.2 17.9% 4.65 21.1%
PERI Perion Network Ltd 1,884 Internet Software/Services 77.4 12.1% 15.64 8.7%
AMPH Amphastar Pharmaceuticals, Inc. 1,865 Pharmaceuticals: Major 78.2 10.4% 18.9 6.3%
CPRX Catalyst Pharmaceuticals, Inc. 1,789 Pharmaceuticals: Major 86.4 24.8% 11.21 4.0%
RES RPC, Inc. 1,734 Oilfield Services/Equipment 91.5 29.7% 5.21 11.3%
TNK Teekay Tankers Ltd. Class A 1,363 Marine Shipping 83.9 43.6% 3.68 21.6%
  Average 6,899   83.2 15.0% 9.1 16.3%
Sources: FactSet, MarketGrader

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