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Stock Prices & Fundamentals Moving in Opposite Direction
The S&P 500 has declined by more than 14% this year while the more tech-heavy NASDAQ has declined more than 23% and the Dow Jones Industrial has declined roughly 10%. Macroeconomic conditions from “living with COVID†to the war in Ukraine to rising inflation and interest rates have created a bearish market for most industries that many hope is about to reach its peak. At the same time, it is because of these macroeconomic factors that we should be hesitant to equate an individual company’s stock price with its intrinsic value and, by extension, its investment potential.
A company’s intrinsic value is determined by many qualitative and quantitative factors known as fundamentals. These factors include but are not limited to profitability, revenue, assets, liabilities, free cash flow, management experience, and growth potential. In general: the health of the company. The fundamentals value can be compared to the current stock price to determine whether or not the company is undervalued by the market. A company is considered undervalued and therefore a good investment opportunity when its stock prices are low or declining but its fundamentals are high or increasing, as often represented by a low P/E ratio. This inverse pattern is precisely the trend we are seeing today, especially in the AI and Deep Learning sector.
The AI sector is projected to see a compound annual growth rate (CAGR) of 38.1% from 2022 to 2030 (1). As a nascent industry, AI is primed for growth in earnings, customer acquisition, and expansion across diverse industries -- growth potential is one of the most heavily-weighted factors in determining a company’s fundamental value. The healthy companies within AI have strong and increasing fundamentals despite declining stock prices that are currently following the downturning stock market. TrueShares’ AI and Deep Learning ETF, known as LRNZ, has several holdings that appear to follow this pattern of declining stock prices with rising fundamentals and therefore present attractive entry points to the AI market before prices start to rebound and the rest of the market starts to catch on.
One such company in the TrueShares LRNZ ETF is ServiceNow, a digital workflow software company. Mirroring the NASDAQ, ServiceNow’s stock price (2) has declined 27.5% this year. On the flip side, its P/E ratio (2) has declined 30.42%, indicating it as an undervalued and potentially strong investment opportunity. Similarly encouraging, ServiceNow maintained more than 30% FCF growth in Q1. The more free cash flow a company has, the more it can pay down its debts and reinvest in growth opportunities. Furthermore, ServiceNow’s earnings per share (EPS) (2) have grown rapidly and remained net positive over the past year, albeit with a slight dip to start out the year despite subscription revenue and customer acquisition growth that is expected to continue. For all of these reasons, ServiceNow is an attractive entry point opportunity in the growing software sector and exemplifies how investors can buy low now to participate in the growth that will come.
As the ServiceNow case study illustrates, fundamentals matter, especially in a bearish market. While stock price is obviously an important indicator of a company’s value, value investors looking to buy low and capitalize on foreseen growth must also look at fundamentals to anticipate gains once the market recovers. Because the AI sector promises strong growth over the next decade, investing in healthy companies while their prices are low could prove lucrative despite a painful start to 2022.
Learn more about TrueShares AI & Deep Learning ETF (LRNZ) at www.truesharesetfs.com/lrnz.
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