By Jacob Sonenshine
Stock investors looking for buy-the-dip opportunities may be tempted to scoop up shares of high-growth technology stocks, but the shares haven't taken the hardest hit and they are still pretty pricey.
Bargain hunters should pivot to industrials instead.
The tech-heavy Nasdaq Composite is down just over 4% from its record high hit in December, but it is still the best performer of the three major U.S. indexes in the past year and in the past five years.
Valuations for many tech companies have reached historically high levels versus valuations in other areas. The Nasdaq trades at 27.5 times analysts' expected aggregate earnings for the coming 12 months for companies on the index, near the highest level in the past two years, according to FactSet.
Yes, tech companies deserve high valuations because artificial intelligence is spurring high earnings growth, but growth will eventually decelerate and these companies aren't worth an infinite amount of money. The Nasdaq could continue to slide.
Meanwhile, the Industrial Select Sector SPDR Fund has dropped almost 9% from its record high in late November and now trades at just below 19 times earnings, one of the widest discounts versus tech in more than a year and a discount to the S&P 500.
Industrial stocks have been caught up in the broader selling of stocks that are particularly sensitive to changes in the economy. The Federal Reserve has signaled it likely won't cut interest rates as many times as the market wanted, which could hurt demand for airfares, transportation of goods, and industrial equipment.
But the Fed may still cut rates a few times so as not to cause a recession. It wants the economy to maintain its recent low single digit percentage growth. If it does, industrial companies will grow.
In 2024, aggregate sales for the industrial fund dropped mildly, led by drops in sales for manufacturers. That sets up an easy comparison this year, especially if interest rates don't surge and customers of manufacturers continue to invest in their business as they prepare for stronger demand.
"There are signs the industrial economy has bottomed," writes Trivariate Research's Adam Parker.
That is why analysts expect industrial sales, broadly, to grow almost 6% this year, as companies such as Caterpillar see mild growth in volumes of products and increase prices as they participate in inflation.
Longer-term growth should be healthy. Analysts expect almost 9% annual sales growth for the industrials fund for the two years beyond 2025, faster than the average S&P 500 company. Plus manufacturers -- think Honeywell, Parker-Hannifin, and Rockwell Automation among others -- are benefiting from industrial automation, as customers exhibit growing demand for additional parts and machines to support more efficient manufacturing processes.
Other manufacturers such as Eaton are seeing growth as data centers, utility companies, and others require additional power to support the proliferation of artificial intelligence and renewable energy.
The resulting revenue growth for industrials will pump earnings for the industrial fund significantly higher, key for investors in the fund because manufacturers represent over half of its market value.
As sales growth outpaces the cost of materials, wages, and other operating expenses, operating profit margins will rise a bit. Earnings per share for the fund are forecast to rise just over 14% annually over the coming two years, a couple percentage points above the S&P 500's expected EPS growth. This year's expected earnings growth for industrials is the third highest out of the 11 index sectors.
The growth will bring the fund's share price higher if the current earnings multiple doesn't fall much further. Industrials appear a bargain right now.
Growth investing isn't all about sexy tech stocks.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
January 03, 2025 15:02 ET (20:02 GMT)
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