Cash flow, profitability and weirdly undervalued Russell 2000

The market's focus has shifted from growth to profitability and cash flow in 2023. In the previous year, many unprofitable tech companies, even the tech giants like Meta, Google, Amazon, Apple, saw their stocks collapse due to excessive hiring and a focus on growth in a zero-interest-rate environment. However, with the market beginning to assign more value to profitability, companies with positive cash flow trends are expected to see their stock prices reflect that positively. Austin Hankowitz, the host of Rich Habits podcast and a writer for Seeking Alpha, believes that predicting a company's cash flow can help predict its stock price. He cites Meta, Salesforce, DraftKings, and SentinelOne as examples of companies that are likely to benefit from this trend. The market's uncertainty over how to value newly IPO'd or SPAC companies in 2020 and 2021 resulted in erratic stock prices for many unprofitable tech names, and some never recovered. Looking forward to 2024, Austin suggests focusing on companies with strong cash flow trends as potential investments.

Companies that have proven their profitability and operational cash flow can make significant acquisitions and investments, as seen with DraftKings' acquisition of Jackpocket for $750 million, despite unexpectedly high profits. This extra capital allows these companies to expand and innovate, leading to potential growth and outperformance in the market. Another intriguing observation is the historical trend of the Russell 2000 underperforming the S&P 500 during bear markets, only to outperform in the following year. For instance, in 1985, the Russell 2000 underperformed by 13% while the S&P 500 gained 17%, but the Russell 2000 made up for this in the following year, outperforming by 18%. This pattern was also seen in 1986, 1991, and 1999. As the Russell 2000 currently underperforms the S&P 500, investors may want to keep an eye on this trend for potential opportunities in 2024.

While the Russell 2000 index, which is home to smaller companies, may have underperformed the S&P 500 in recent years due to the presence of unprofitable technology and biotech companies, investors should focus on the potential for profitability and cash flow in these smaller companies. This trend is historical, and while it's important not to bet the farm on the Russell 2000, a 5 to 7% weighting in a personal portfolio could yield returns as these companies inch toward profitability. It's essential to keep in mind that the S&P 493, which includes the top 493 companies in the S&P 500, did not perform as well as the top 7 during the same period. Therefore, the Russell 2000, with its smaller and often more volatile constituents, can offer opportunities for those with the courage and conviction to invest in companies with potential for long-term growth. The transitory nature of small caps can make investing in this space challenging, but a focus on profitability and cash flow can help mitigate risks. As always, it's crucial to remember that none of this content constitutes investment advice. Listeners should consult their financial advisors before making any investment decisions. Stay tuned for more insights on the world of finance and investing.