In his 2017 book, “Narrative and Numbers: The Value of Stories in Business,” the highly respected NYU professor Aswath Damodaran focuses on the importance of intentionality and consistency in valuation.
“I see a world increasingly divided between number crunchers, who have abandoned common sense and intuition in pursuit of data analytics and complex models and storytellers, whose soaring narratives are unbounded by reality… I think of valuation as a bridge between stories and numbers, where every story becomes a number in the valuation, and every number in a valuation has a story behind it.”
In a separate interview with Yahoo Finance, Damodaran shared his thoughts on how stories can warp valuations when not reinforced by the numbers,
“I think you see stories, especially when you listen to founders talk about businesses or analysts talk about businesses, and it’s all about the story all the time. And what you’ll often find in these stories are what I call weapons of mass distraction. There are words you throw in because they dazzle people. Words like ‘disruption,’ ‘strategic,’ ‘synergy.’… These are the words we use because the numbers don’t fly.”
Here’s the point: high valuations aren’t always bad if the growth priced into a stock is attainable. However, valuations can get out of hand when the narrative takes over, and numbers fall out of focus.
Inspired by Damodaran’s statements, we screen the S&P 500 for 5 stocks with the most growth priced into their share prices. It’s important to note this week that we make no distinction about whether the growth priced-in is justified. This is simply 5 stocks with the highest proportion of expected growth baked into the market price.
We back into priced-in growth via the Present Value of Growth Opportunities (PVGO) concept. PVGO assumes the market price is fair value and calculates the company’s value based on current earnings, assuming no future earnings growth. Then, the PVGO is calculated as the difference between the market price and the company’s value without growth. Finally, the PVGO is divided by the stock price to find the proportion of the market price attributable to future growth expectations.
You may expect favored names like NVIDIA, Amazon, and Tesla in the top 5. While all those stocks are in the top 10 of the S&P 500, none made the cut for the top 5. The top 5 companies receive much less attention simply because they have a fraction of the market cap as the “Big 7”, although they are more dependent on future growth. If you were curious, PVGO as a percentage of market price for NVDA, AMZN, and TSLA is 85.7%, 84.8%, and 81.3%, respectively.
The only criteria in this scan are that the stocks are members of the S&P 500, are not REITs, and have positive EPS over the trailing twelve-month period. We solved for PVGO as a proportion of market price and selected the top 5 companies.
Seagate Technology Holdings plc (STX)
Illumina, Inc. (ILMN)
Las Vegas Sands Corp. (LVS)
Royal Caribbean Cruises Ltd. (RCL)
Insulet Corporation (PODD)
Five for Friday
Five for Friday uses stock screens to produce five stocks that we expect will outperform if a particular investment theme plays out in the future. Investment themes may be relevant to the current or expected market, industry and/or economic trends. Investment themes may not always represent our current forecast.
This report is not a recommendation to buy or sell the named securities. We intend to elicit ideas about stocks meeting specific criteria and investment themes. Please read our disclosures carefully and do your own research before investing.
Michael Lebowitz, CFA is an Investment Analyst and Portfolio Manager for RIA Advisors. specializing in macroeconomic research, valuations, asset allocation, and risk management. RIA Contributing Editor and Research Director. CFA is an Investment Analyst and Portfolio Manager; Co-founder of 720 Global Research.