Everything has gone right for the market—and now it’s time to start planning for when things go wrong. Buying stocks with “earnings momentum” is one way to do that.
The
S&P 500
has gained about 22% from its early October bear market. Much of the recent gain is from Big Tech, which is benefiting from artificial intelligence, but the rally has recently broadened as investors bet that the Federal Reserve is almost ready to pause on hiking interest rates as inflation steadily eases. A pause would mean the economy and earnings could stabilize soon.
The problem now is finding stocks that still have room to run. The average stock in the S&P 500 has gained 5.8% so far in June, while the index trades for 18.8 times 12-month forward earnings, particularly high when compared with the current level of interest rates. “With the S&P 500 now at a 19x forward multiple, the equity risk premium has fallen to a new cycle low and the lowest level in nearly two decades,” writes Roth MKM market strategist Michael Darda.
What’s the best way to pick stocks in that environment? Buy the ones “the last buyers have yet to buy,” writes Evercore ISI strategist Julian Emanuel. He screened for stocks that have seen their 2023 earnings estimates revised higher this year and are expected to grow earnings per share year over year. Emanuel also wanted stocks that have high short interest, which means that investors who have bet against the stock will have to buy if shares start to rally. The screen includes
United Airlines Holdings
(ticker: UAL), cruise operator
Royal Caribbean Cruises
(RCL), and cybersecurity companies
Fortinet
(FTNT), and
Zscaler
(ZS). .
It also includes
Alphabet
(GOOGL), despite the fact that the stock has gained 39% so far this year. The stock has benefited from a big earnings beat during its most recent quarter, and the launch of its ChatGPT competitor, Bard. It also said it would layer artificial intelligence into its advertising and cloud offerings, making them more compelling to customers. As a result, profits should keep growing, with analysts expecting 18% annualized growth over the next two years.
Meanwhile, funds could keep buying more Alphabet stock, with short interest in its 66th percentile in the past year. Consistent with that, the stock trades at about 21 times 12-month forward earnings, a reasonable price for high-teens EPS growth.
Eli Lilly
(LLY) also made the list. Analysts have raised their 2023 earnings forecasts by 13% this year, while its Alzheimer’s drug donanemab, which could get approved for use in Medicare, should keep those earnings growing. Its Type 2 diabetes drug, Mounjaro, should see sales of just over $3 billion this year, and then over $20 billion several years from now.
Overall, analysts now expect earnings to grow at about 30% annually for the three years starting in 2024. More buyers could come in, with short interest also in its 66th percentile in the past year. Even at 43 times earnings, Lilly might just be worth the price.
Write to Jacob Sonenshine at [email protected]
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