The stock market is notorious for going in cycles. Growth and value shares come in and out of fashion at various times. So working out where we are now is key to figuring out where we might go next. And there are some signs for investors.
Growth and value
A classic example of a stock market cycle is the shift from growth to value and back. The core structure’s pretty straightforward. Investors naturally look for growth stocks. But then something happens that reminds them these things are supposed to have valuations.
Rising interest rates are a good candidate. So investors go looking for companies with stronger current cash flows. These are value shares. But sooner or later, investors realise these businesses don’t grow much and go back to growth stocks. And so on…
The best way to invest is by doing the opposite of what everyone else is up to. And the situation in the US is interesting right now.
Artificial intelligence
The rise of artificial intelligence (AI) has had a big impact on tech. But while software has faltered, other names have done well. One of these is Micron (NASDAQ:MU). Quarterly sales are up 200% and the share price has climbed 555% in the last year.
Analysts are expecting strong earnings per share (EPS) growth for the next few years. But investors do need to be careful.
Source: Nasdaq.com
Those earnings are important. But a discounted cash flow (DCF) analysis shows that they’re not the only thing that matters. A DCF calculation shows the present value of those projected earnings. Using a 9% discount rate, they look like this:
| Year | EPS | Present Value (9% Discount Rate) |
|---|---|---|
| 2026 | $57.71 | $52.46 |
| 2027 | $96.57 | $79.81 |
| 2028 | $96.98 | $72.86 |
| Total Present Value | $205.14 |
Together, they make up less than half of the current share price. So what happens after the next three years matters much more.
Long-term investing
Micron’s clearly benefitting from a cyclical boost. But the question is what happens when that changes?
Sales also surged during the pandemic. When things normalised though, profits turned negative. The stock fell more than 50% as a result. And I think there’s a decent chance something similar happens again.
That wouldn’t matter if the short-term earnings boost was enough to justify the current price by itself. But it isn’t. At today’s prices, there needs to be more than just a big cyclical boost coming. Otherwise the stock looks too expensive.
AI might mean higher long-term demand for memory chips. But, in Micron’s case at least, this is already priced in.
Foolish conclusion
Micron’s average annual EPS over the last 10 years has been around $7. But that isn’t enough to justify a $456 share price. Assuming a 4% terminal growth rate, that’s $81 in present value. Added to $205 for the next three years, that’s well below the current price.
That means investors need AI to be more than a short-term surge in demand. It needs to be a permanent change.
The current share price implies around $22 in normalised future EPS. That’s a big increase. Given this, I think there are more compelling opportunities right now. But I’m expecting a better chance at Micron when things look less positive.
