The S&P 500 is made up of roughly 500 US companies with the largest market caps. This understandably includes some of the largest companies in the world, such as Apple, Amazon and Microsoft. Further, the S&P 500 has been continually hitting new highs. But I’m avoiding these S&P 500 stocks in favour of a lesser-known US growth stock. Here’s why.
Why am I avoiding S&P 500 stocks?
Due to the excellent performance of the large majority of S&P 500 stocks, valuations now look pricy. In addition, it seems that the market expects the economy to make a full recovery from coronavirus. This means that the S&P 500 currently has an average price-to-earnings ratio of 35, far higher than in previous years. Of course, this is partly due to the number of exciting growth stocks in the index, and it does not necessarily mean that these stocks are going to fall. Nonetheless, it is still an indication that the stocks may be overvalued. Consequently, any weakness in earnings is likely to be met with a very negative response.
This viewpoint is also shared by others, and the Chief Investment Officer at Morgan Stanley, Mike Wilson, recently stated that he expects the S&P 500 to fall by over 10% in the coming months. This is due to investors currently having over-optimistic expectations. I also feel that this correction may be coming, and this is the reason why I’m not tempted by S&P 500 stocks right now.
The US growth stock I prefer
The fact that I’m avoiding such stocks, does not mean that I’m avoiding US shares altogether. In fact, I believe that there are still a number of opportunities in the US markets, with slightly less established companies. One example is SoFi Technologies (NASDAQ: SOFI), a fintech providing a number of different services, including loan refinancing, mortgages, investing and banking. So, why do I like this growth stock?
After its recent second-quarter trading update, I think that the SoFi share price was unfairly punished. In fact, on the day, it fell 14%, due to the company posting a higher-than-expected loss of $165.3m. But there are a couple of reasons why I think this dip offers the perfect time to buy.
Firstly, revenue managed to rise to $231.3m from $115m last year, and this was higher than analysts were expecting. The company’s member base also grew to 2.6m, up from 1.2m the previous year. These numbers clearly demonstrate growth and give me hope that the company has huge potential for the future.
Secondly, the largest contributors to the loss included stock-based compensation expenses and fair value changes in warrants. Both of these expenses are short term and non-recurring, and this gives me hope that SoFi can reach profitability in the near future. Of course, this is not guaranteed, and the current unprofitability is a risk that requires consideration.
Even so, I am willing to overlook this due to the potential of this business. With a price-to-sales ratio of 12, SoFi also seems more reasonably priced than other fintech companies. Indeed, Robinhood trades with a price-to-sales ratio of over 40. This is why SoFi makes up part of my portfolio, and I’m tempted to buy more at these prices.
