- A new millennial index has been created, the “Next 50.”
- Valuations are extremely high, but the trends are all in favor of millennial companies.
- We’ll provide a few investing strategies, so you can choose the best for you.
Barron’s recently created an index of 50 stocks loved by young American consumers, the Next 50 index. Not surprisingly, there’s also an ETF that tracks millennial stocks, the Global X Millennial Thematic ETF, and we’ll likely soon see a new ETF that tracks the Next 50 index.
Today we’ll discuss how much of the hype around millennial stocks is significant for long term positive investment returns, and why you should jump on the bandwagon.
The Next 50 Index
At Barron’s, they believe tracking the Next 50 index is the best measure of how companies are “reshaping American life through innovation in social media, financial transactions, shopping, entertainment, and dating.” They also believe that the index has a good shot at “beating the market over the coming years” because it “tilts toward fast-growing companies.”
Such statements are ones that investors who have been around for a while have heard a few too many times. However, the Next 50 index has beaten the S&P 500 index by 7 times in the past 10 years. But as the index is created by including only the millennial winners of the past decade and excluding the ones that lost their coolness, the extreme over-performance is rational.
The index includes 26 consumer stocks, 9 financials, 1 industrial, 11 information technology and 3 telecom stocks.
It’s very important to note that the index is equally weighted, meaning it doesn’t skew its performance by giving more influence to stocks with a larger market capitalization. Barron’s also says that it will include companies like Snapchat if it becomes public, and will drop less-relevant or flagging businesses over time.
Now, if you’re a millennial, you probably use most of the products and services from the above company list, and therefore probably think the index or individual stocks are a great buy, but hold your horses. Let’s first take a look at fundamentals.
A Look At Fundamentals
I know fundamentals aren’t as exciting as a billion monthly active users or paying for a coffee via a selfie. Nevertheless, fundamentals are the essence of investing and therefore have to be analyzed as without profits, millennial companies won’t be able to last long.
Amazon.com Inc. (NASDAQ: AMZN) has a current PE ratio of 203.4, which isn’t that bad compared to the PE ratios above 1,000 it has had in the past. Investors are expecting huge earnings growth and a future dividend as evidenced by their willingness to pay more than 200 times what AMZN currently earns. If AMZN had the S&P 500’s average PE ratio of 24.84, the stock would be worth $99.52, not $817.33, and in order for the stock to have an average PE ratio, AMZN’s earnings would have to grow to $32.92 per share. For this to be achieved, AMZN would have to grow its revenue by 8 times, which is exactly what it has done in the last 9 years.
With improved margins, AMZN could reach that target in less than 8 years, but such profits would attract even more competition. We know that Wal-Mart Stores Inc. (NYSE: WMT) is making a strong entrance into the ecommerce field, and there will always be new players trying to get a piece of the pie. Therefore, if the fundamentals of a millennial company are overstretched before investing, we have to look at new possible entrants that might increase competition.
One of the new players is also a member of the index, Etsy Inc. (NASDAQ: ETSY), which had its IPO last year and is currently worth $1.63 billion. ETSY is an online marketplace where people can sell their handmade goods. It’s not yet profitable and who knows if it ever will be, but it shows how hype can be created on a business model that is attractive to millennials. The funny thing with ETSY is that it was worth double its current worth at its IPO.
Another example of stock market hype is Expedia (NASDAQ: EXPE), which has a pretty stable online traveling business model, but has a PE ratio of 85.9 for revenue growth of around 16% per year.
Many other companies have extremely high PE ratios while others have very low PE ratios. By equally weighting the earnings of each company, we arrive at a collective PE ratio of 37.97 for the Next 50 index.
38 is a high PE ratio for the uncertain, highly competitive environment these companies are operating in, but an investment in the Next 50 index isn’t about earnings, it’s about potential 10 baggers (stocks whose price goes up 10 times).
There is certainly the possibility that 10 out of the 50 companies above become 10 baggers in the next 10 years. For that to become a reality, you need revenue and earnings to grow at around 25% per year with valuations equal to the above. If 10 of the above 50 companies manage to do that and the other 40 go bankrupt, you still double your investment in the next 10 years. We’re exaggerating a bit with this example, but it pretty much covers the topic.
Should You Invest In The Next 50 Now?
In answer to that question, it depends on your risk appetite.
Most of the companies above didn’t even exist back during the Great Recession, and we don’t know how their customers will behave if a recession hits the U.S. Many of the companies above are consumer discretionary, and such businesses are severely hit during tough times, especially those with high valuations based on high expected future growth rates.
A good example of what can happen is Expedia’s fall back in 2009 when it went from a high of $65.20 in November 2007, to a low of $15.94 in February 2009.
Figure 3: EXPE. Source: Yahoo Finance.
Therefore, the risks are very high right now as it seems that the economy has reached its low interest rates limit and a recession is around the corner. Perhaps it’s best to wait for better entry opportunities and when such an opportunity arises, exchange some of the defensive stocks in your portfolio for the more aggressive millennial ones.
The structural trends in the market are all for increased millennial consumption. Millennials are the largest U.S. generation.
Figure 4: U.S. generations. Source: Global X Funds.
Millennials are expected to be the generation that spends the most in the next 10 years.
Figure 5: Millennial spending. Source: Global X Funds.
Their spending habits are in line with the products and services the Next 50 index companies offer.
Figure 6: Millennial behavior. Source: Global X Funds.
The trends are clear, but valuations are high. As there is plenty of time until 2025 when millennials will take over the lead in consuming, there will also be plenty of opportunities to take advantage of the trend at a much lower cost. Investing in trendy companies after a 7-year bull market with high valuations is a very risky thing to do, although it can also be rewarding if macroeconomic factors stay the same.
We’ll finish with an indication of the risks for investing in millennial companies on which you can base your strategy:
- Current situation: High risk with potential market outperforming reward.
- Wait for a recession situation: Much lower risk with potential explosive reward.
- Recession never happens and you wait for one: Rewards are missed but there will be plenty of other opportunities.