Is the AI trade over?
No one knows for sure, but economist and market strategist Jim Paulsen thinks it could be.
He points out that the relative performance of AI stocks has been leading the increase in the ratio of New Era spending to real GDP since early 2023. It follows that the current underperformance of AI stocks could be warning of a significant decline in New Era spending compared to overall real GDP going forward. After all, stocks typically anticipate economic and sector trends – as was the case during the AI boom time of the past three years.
If he’s right, it makes sense to tilt your portfolio more towards “old era” non-AI stocks. They’ve been vastly outperforming AI stocks in the past month. During that time, his S&P 500 Old Era Stock Price Index (comprising a market cap weighting of the nine S&P 500 sectors excluding the New Era technology & communications sectors) has risen by 4.2%, compared to a 27% decline in the Bank of America AI Beneficiaries Index. This could be the start of a trend that has old-era stocks outperforming AI stocks going forward.
Old-era stocks have a lot of ground to make up. They made up 80% of the S&P 500 ten years ago, compared to just 50% in early October, Paulsen points out in his Paulsen Perspectives on Substack.
A Defensive Dividend Stock to Buy if AI Stocks Keep Falling
PepsiCo (PEP)
If you want to diversify away from AI stocks in favor of old-era and more defensive names, consider owning PepsiCo. Snack foods and fizzy drinks are about as far away from AI as an investor could get.
Shares of the brand powerhouse were recently down around 20% from their early February highs.
In the weakness, a director who knows the snack and soft drink space quite well because of a lifetime of experience in the business and at PepsiCo stepped up to buy $23.7 million worth of stock.
The purchase makes sense because there are good reasons to think that PepsiCo results may improve from here.
Investors doubt a mini turnaround in the works will pan out. Buying shares here is a bet they will be wrong. I think it is a good bet, given the director’s enthusiasm for the stock.
PepsiCo is doing some renovation work in its kitchens, and improvements to the business look like they will boost sales performance from here. That’s clearly what this director is counting on, with his huge purchase.
Third-quarter sales overall grew 5.6%, which doesn’t sound terrible. But organic growth was only 3.1%. The rest came from one-offs like acquisitions and divestitures and foreign exchange benefits.
Drilling down, international sales were up 8% and North American beverage and food sales were roughly flat. This tells you what you need to know about the growth opportunities from here. Expect further strength abroad as the company continues to invest in growth in Latin America, Asia, and Africa. The renovation work at home in North America should continue to boost results there.
North America
Let’s focus on what’s going on in North America, since this is where the biggest opportunity for improvement lies. Growth has slowed down over the past two years, mainly due to sluggish performance as the GLP-1 effect continues to hit sales, and consumers generally turn more health conscious and buy less due to rising costs overall.
The company is taking steps to stem the tide.
It is making products more affordable. In snacks, it is innovating by adding more natural ingredients to make products appear healthier. In beverages, the company is developing in-house brands and looking to brand licensing to expand its presences in non-sparkling categories. It is also investing more in digital marketing.
The tweaks seem to be working. Volumes improved in the third quarter. In food, volume was flat compared to down 2% in the second quarter. Drink sales volume contracted by 2% compared to 4%. Management guides for further improvement. Though like all turnarounds, this one will take time.
[text_ad]
Natural Strengths
PepsiCo has some natural strengths that support both the turnaround effort and the investment thesis.
* Besides the powerful brands, its sheer size ($94 billion in revenue) gives it huge distribution and procurement clout.
PepsiCo ranks number one in the $247 billion global savory snacks market, according to Euromonitor, thanks to well-known brands such as Lay’s, Cheetos, and Doritos. It controls 22% of this space. In drinks, PepsiCo is the world’s second-largest beverage provider behind Coca-Cola (KO), offering popular brands like Gatorade, Pepsi-Cola, and Mountain Dew.
Not surprisingly, the company has close relationships with retailers. Its brands drive foot traffic, making PepsiCo a must-have partner to most retailers. In return, it gets favorable shelf placement.
All of these advantages give PepsiCo a wide moat.
* PepsiCo has defensive characteristics which suggest the stock will hold up if the tech pullback continues, or if we do go into a phase of economic weakness.
* PepsiCo is in excellent financial health. It has a solid balance sheet and strong free cash flow backing a 4.2% dividend yield. It is a net debt/EBITDA ratio of 2.7, which is fairly conservative.
The bottom line: PepsiCo is undervalued, as investors doubt its ability to restore consistent profit growth. Its current price-to-sales ratio of 2 is 21% below the trailing five-year average. The forward price-to-earnings ratio of 16.9 is a 19% discount to the five-year average of 20.9. I suggest betting against the negative investor sentiment, alongside the director who just made a massive stock purchase.
Director Robert Pohlad, with his $23.7 million purchase, is betting these valuation gaps will close as international growth continues and the mini-turnaround continues to bear fruit. He’s worth listening to because he knows the space so well. Pohlad served as chairman and CEO of PepsiAmericas from 2002 until PepsiCo acquired it in 2010. He worked at various PepsiCo distributors for years before 2002. Pohlad, who, along with his family, owns the Minnesota Twins, has been a PepsiCo director since 2015.
For more “old era” names to consider owning for outperformance because insiders love them, subscribe to Cabot Insider Edge.
[author_ad]
