Key Points
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Short-term options that are far-out-of-the-money are the “casino corner” of the stock market, but long-term investing is different.
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I like to focus on companies with high revenue and net income growth rates that have compelling multi-year catalysts.
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Companies with low market caps can deliver outsize returns if they have good fundamentals.
The stock market is a complex institution. Although there is a “casino corner” in the markets consisting of options traders with far-out-of-the-money contracts that expire at the end of the week, the real money is made with long-term investments that remove casino mechanics from investing.
However, that doesn’t mean every stock investment is guaranteed to make money. It’s possible to lose money, even if you have a long-term mindset and avoid the casino corner. I like to say that the stock market is a game of probabilities, and filtering out winners from losers can lead you much closer to your financial goals than staying on the sidelines.
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The long-term nature of stock investing removes the casino mirage
Some real estate investors refer to the stock market as a casino while touting rental properties, flipping homes, and other real estate investing strategies. However, a long-term approach to stock investing turns it into a process similar to buying and holding property.
When I buy a stock, I always intend to hold it for at least five years, unless the fundamentals change drastically. A single negative earnings report that features a slight revenue dip often isn’t enough to change the long-term thesis. However, if it came out that a company’s impressive results were driven entirely by fraud, that would change the entire thesis.
For instance, I initiated a long position in Silicon MotionTechnology(NASDAQ: SIMO) this year because I see it as a key memory player. I like it when a company delivers high revenue growth rates and rising profit margins, two things Silicon Motion Technology has been doing.
I bought this stock with for the long haul, not to do some trade because of a random technical indicator a few months later. If you buy any stock with a time horizon of less than one year, it is a gamble. Macroeconomic forces, a bad earnings report, or a negative reaction to a good earnings report can instantly create a loss without enough time to recover. Stretching the time horizon turns it into an investment.
I narrow my focus to tech stocks
I focus on companies with high revenue growth and rising margins, and those types of results are more easily found in the tech sector. It’s where I do the majority of my research, instead of diversifying into industries that tend to have lower returns.
The S&P 500 is a good starting point for investors, and although it’s touted as a diverse engine of growth, that isn’t really the case anymore. Tech stocks make up about 40% of the index’s total value. Nvidia(NASDAQ: NVDA) and Apple(NASDAQ: AAPL) alone make up more than 15% of the benchmark.
The top 10 stocks in the State Street SPDR S&P 500 ETF Trust are tech companies, representing almost 40% of the entire S&P 500. The 13th top holding in the exchange-traded fund (ETF), Advanced Micro Devices(NASDAQ: AMD), also is a tech stock. This fund, which reflect the broader market, has gained 11% gain year to date.
Only about a third of the companies in the benchmark have outperformed that return, with almost half of the S&P 500’s holdings producing negative returns year to date. Most of the S&P 500 holdings that have doubled this year are in tech or connected to artificial intelligence (AI).
A low market cap is the icing on the cake
Financial growth rates and a company’s long-term catalysts are the most important parts of my fundamental analysis, but I also look at a stock’s market cap. If a company has a low valuation, it doesn’t require as much capital for that stock to double. For instance, Nvidia has a $5.6 trillion market cap, which means the stock must reach an $11 trillion market cap for it to double.
Meanwhile, Silicon Motion Technology only has a $9.5 billion market cap and must reach a $19 billion market cap to double. Silicon Motion Technology has to do something that many companies have done before for it to produce a 100% return. Nvidia needs to add $5.6 trillion to its market cap to achieve the same feat, and it has never been done before.
Looked at another way, Nvidia must add the equivalent of Silicon Motion’s $9.5 billion market cap 579 times to double in value.
Both companies reported more than 100% year-over-year revenue growth in their recent quarters. While Nvidia has a much larger market share, I’m more concerned with how much market share any company can gain, relative to its current percentage of market share.
A company turning a 1% market share into a 2% market share tends to produce higher returns for new investors than a company that turns an 80% market share into an 81% market share.
That’s why I value a low market cap on top of high financial growth rates. The highest returns tend to come from tech stocks, which is why I focus my efforts on that sector.
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Marc Guberti has positions in Apple and Silicon Motion Technology. The Motley Fool has positions in and recommends Advanced Micro Devices, Apple, and Nvidia. The Motley Fool has a disclosure policy.
