At The Graduate, a young Dustin Hoffman, after graduating from college, is taken aside by a family friend for career advice. Buddy offers Dustin one word; “Plastic”. It encourages Hoffman’s character to pursue a career in the up and coming plastics industry. We might want to think of similar advice for our kids and their prom friends on us.
It is also our duty to heed the same advice in relation to our investment portfolios. If we have a long-term window and can ignore short-term volatility, should we invest in volatile growth stocks like Nvidia or a stable, low-growth company like Clorox?
Many investment experts might rephrase the question as a choice between a value stock and a growth stock. The terms “value” and “growth” have become blurred in recent years. What appears to be a valuable stock may only be in its reputation.
Reviews are important
Most readers with long-term investment prospects will answer our previous question by choosing the semiconductor giant Nvidia.
I confidently state that the semiconductor industry will grow multiples of the bleaching industry.
However, the question of value investing for value growth is not about stock that is growth or value, but rather that it is priced cheaper due to distinctly different growth rates. At the right price, Clorox might be a much better investment than Nvidia, despite Nvidia’s great growth potential.
Unfortunately, many passive investors assume that companies with a long, successful history and mature products in low-growth industries are valuable stocks. On the contrary, a semiconductor or other high-growth technology company should be a developing company in the eyes of many investors. Such assumptions put investors in trouble.
Nvidia or Clorox: where’s the value?
To help answer our question, we start with a quick look at their stock prices since 2020.
As the chart below shows, CLX was performing well during the peak of the pandemic as bleaching was in high demand. After a 60% increase, the gains gradually faded away and returned to similar levels two years ago.
NVDA initially fell 35% in March 2020 but made a comeback, rising from $50 to $333. Since hitting a record high in November 2021, it has fallen nearly 50%, although it is still trading at a reasonable premium to pre-pandemic levels.
While most investors stare at stock prices all day, the fundamentals are what count. Simply put, what do you get for the price? This is where the Nvidia and Clorox reviews and recent performance get interesting. Moreover, it is where the line between value and growth becomes blurry.
Since 2020, NVDA revenue has increased by 146%, while CLX revenue has increased by 15%. Sales are an important consideration in inventory analysis, but how important it is to translate sales revenue into net profit growth is even more important. NVDA increased its EBITDA 242%, while CLX saw a 23% decrease in EBITDA over the same period. Profits are a function of sales and margins. NVDA’s operating margins are up nearly 11 points since 2020, while CLX’s are down 7.5.
The price-to-earnings (P/E) ratio in NVDA has decreased by 14 since 2020. Meanwhile, the CLX is up by 13.5.
The above data certainly indicates that NVDA is the highest growing company with stronger fundamentals. However, we want to stress the importance of price and basics, but only in the context of ratings.
The company can have poor growth rates and poor margins, but it could be an excellent investment with a low enough valuation. On the contrary, a company like Tesla is experiencing explosive growth, but its market value is equal to the entire auto industry.
With that background, let’s compare NVDA and CLX ratings.
If you only look at the table above and don’t know which companies these companies were, you’ll likely have a hard time choosing a stock value. NVDA has a higher P/E but lower forward P/E. Also, NVDA’s price is much lower compared to book value, but the price-to-sales ratio is much higher.
To help break the tie, let’s compare linkage ratios. The P/E ratio or P/E ratio is the price-to-earnings ratio divided by earnings growth. This ratio helps in understanding P/E in the context of expected growth. An AP/E of 100 may be cheap, for example, if profits increase by 200%. On the contrary, the PE of five may be costly if profits shrink.
One’s PEG usually sets the boundary between overvaluation and undervaluation. On this scale, both companies are overvalued, with ratios well above one. However, NVDA’s PEG is much lower than CLX’s.
We believe NVDA is trading undervalued than Clorox based on the above data.
To add to the analysis, we share our internal model. The model helps assess whether stocks are rich or cheap relative to their normal long-term valuations. The model assigns a fair value price based on a normal P/E ratio. It then tracks how the stock price is trading around this ratio.
In the Clorox chart below, the stock price (black line) tends to gravitate around the gray fair value line from 2012 to 2019. When it is above the gray line, we can say that the Clorox stock price is overvalued and vice versa when it is lower. Currently, Clorox exceeds two standard deviations or 60% above the model’s fair value.
The following chart shows a similar analysis for NVDA. From 2012 to 2019, it also bounced around the fair value level. However, once the epidemic broke out, it was trading well above fair value. As of November 2021, Nvidia’s stock, like Clorox, was more than two standard deviations above its fair value. Since then, it has slipped closer to fair value, and is currently trading at a premium of 19%.
Neither stock is cheap with this model, but the model confirms that Nvidia, not Clorox, is the most reasonable of the two companies. I dare say if I should pick a valuable stock out of the two options, it would be Nvidia, not Clorox.
NVDA increases revenue and revenue much faster than Clorox. This in itself is no surprise. The real discovery is that these two companies trade at similar valuations despite vastly different growth trajectories.
Given that NVDA is multiplying and CLX growth appears to be limited, our analysis questions why a “value” stock in CLX is held versus a “growing” stock in NVDA. This article is not a solicitation to buy Nvidia stock or sell Clorox stock, but it does highlight that some stocks are seen as valuable despite valuations on par with growth stocks that offer significantly greater growth potential.
Investors tend to group some stocks into broad ratings. Clorox, for example, is widely described as a valuable stock. NVDA is known as a high-growth stockpile. The problem with these classifications is that it is not the underlying work that matters; It’s the price you pay for their potential earnings.
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The author or his company may have positions in the securities mentioned at the time of publication. Any opinions expressed here are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
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