On January 30, 2000, 88 million Super Bowl viewers were peppered with ads… from a sock puppet. The puppet was a mascot for Pets.com, an online pet supply delivery company.

Just a week later, the stock debuted in public markets and hit its all-time high at $11. But it was all downhill from there.

The young dot-com’s commercials received plenty of attention, but they also blew the marketing budget for the company. For fiscal year 1999, Pets.com earned $619,000 in revenue but spent $11.8 million on advertising.

Many of us remember how that story ended. Eleven months later, Pets.com filed for bankruptcy. On the day of the bankruptcy announcement, the stock traded at just $0.22.

Meanwhile, Amazon.com skipped the fanfare of Super Bowl ads. Its stock suffered a 94% decline during the dot-com crash. But Amazon lived on. And since 2000, its shares have returned 3,224%.

The difference between these two companies shows how difficult – and important – it is to separate hype from reality during the early days of a new trend like the dot-com bubble.

That’s why I’m turning my full attention to the current trend in AI. We’re still in the early stages of this revolutionary trend. And I think Wall Street and the talking heads on TV are too focused on the wrong companies.

Yesterday, I shared why I’m so excited about the opportunity in AI.

But just finding the trend isn’t enough. Now you’ve got to find the right stocks to profit from.

After all, during the dot-com boom in the ‘90s, there was no shortage of trendy names. So what separated the now-defunct Pets.com from Amazon.com?

Today, I’m going to share my battle-tested strategy for identifying stocks with the biggest return potential.

For paid subscribers of Brownstone, this is the same approach I’ll use to bring you the best opportunities every month.

But even if you aren’t a paid subscriber, you can use my methods to make you a better investor.

No Escape

I start by identifying an undeniable trend.

The stock market sees plenty of fads. Things like NFTs, internet-of-things, metaverse, and wearables come and go with the news cycle.

I’m looking for something bigger. A trend that is too powerful to ignore.

Examples include the dot-com, social media, and smartphone disruptions.

Right now, AI is my latest undeniable trend. The cost savings and boost in productivity will give early adopters a huge advantage over stalwarts that are slow to adopt it.

Competitive Edge

Next, I look for the one company in its space that has an edge over the competition.

I liken it to the Olympics. No one remembers who won silver. You won’t find a silver medal winner on a Kellogg’s cereal box.

It’s all about the gold.

Second place in the stock market doesn’t make investors rich.

Just look at examples like Apple vs. Samsung in the battle over smartphones.

Since June 2007, when Apple released the first iPhone, Apple’s shares have returned 4,570%. Samsung has only returned 395%. That’s more than a 10x difference over the past 16 years.

There’s a similar story in athletic wear. Under Armour was an up-and-coming name in the mid-2000s. But mismanagement saw it take second place to Nike. Since 2005, Nike has returned 1,140% while Under Armour returned just 141% to investors.

Intel has long been one of the largest chipmakers. But its lack of innovation allowed others to catch up. Since 2015, Intel has only returned 16% to shareholders. Meanwhile, AMD is up 4,740%.

The companies that had a real edge over the competition went on to return life-changing windfalls to early investors. Their second-place rivals traded sideways or worse… went out of business.

Businesses with a competitive edge can be difficult to pinpoint. But generally, I look for things like a robust intellectual property moat… an innovative, unique, or iconic product design… or infrastructure that makes competition nearly impossible.

Leadership Counts

Businesses with an edge need a leader that will keep it sharp.

These are people that see where the market is heading. And they understand the right investments to make today to stay ahead of the competition.

Consider the chipmakers for a moment. Intel dominated the market in the ‘90s-2000s. It sold 80% of all the chips used in PCs. But its leadership got lazy. It stopped innovating and relied on its massive contracts to hold onto market share.

Intel also let the smartphone market slip through its fingers. Steve Jobs discreetly approached Intel to fabricate a chip for the iPhone.

But Intel’s CEO at the time, Paul Otellini, declined.

Meanwhile, Lisa Su (CEO of AMD) saw an opportunity to steal market share from Intel. AMD was a tiny chipmaker at the time. But it developed an edge over Intel by focusing on gamers, forging partnerships, and offering better prices.

As of late 2022, Intel controlled only 62% of the CPU market share. The rest went to AMD. And if the trend holds, AMD will overtake Intel in the years ahead. 2022 was also the year that AMD surpassed Intel in market cap for the first time.

By the Books

Great leaders don’t just develop a competitive edge. They also generate profits.

That’s why I look at the financials to confirm that the right leadership is in place. Every industry is different. But a company with a strong cash flow and higher operating profits than its peers is usually because of strong leadership.

Pets.com, again, was a perfect example. No sane leadership team would have agreed to spend multiples of their yearly revenue on advertising.

That’s a dramatic example. But – in most instances – whenever we see executives that are not focused on profitability and cash flow, that’s a good sign to run in the opposite direction.

Time to Strike

The final question I ask myself is, “Why now?”

A great company can be a bad buy if it’s trading for too much… or stuck in a downtrend.

That’s why I use technicals and valuation to make sure the timing is right.

For technicals, I use support and resistance levels to confirm a good price to enter… and when to take profits. 

That means I’m only buying a stock when it’s in an uptrend with plenty of room to keep running higher.

Let’s take a look at Nvidia for a moment. Its shares are trading around $430.

That puts it at the upper range of its six-year trading range. I’d rather be taking profits at this level than opening a new position.

And for valuation, I like to compare a stock against its own historical valuations.

For example, some stocks like Nvidia, Tesla, and Amazon have always been considered expensive by mainstream investors.

But what really matters is the historical valuation shareholders are willing to pay.

Nvidia has had a price-to-sales (P/S) ratio of 17.4x over the past five years. Its current P/S ratio is 39.3x. That’s also significantly higher than its peers with an average of roughly 8x.

That tells me Wall Street is overly optimistic about this stock.

I like the AI trend the company is tapping into.

I like its edge in GPUs.

I like Jensen Huang as CEO.

I like its forecasted increasing revenue growth.

But I don’t like its valuation or technical setup. It’s overvalued and trading near its resistance level.

That means it’s not a buy right now.

For me to recommend a stock, it has to ace every point. No exceptions.

In the coming weeks, I’ll share companies that pass my five-point checklist with readers of my Near Future Report…

Regards,

Colin Tedards
Editor, The Bleeding Edge