For the last 129 years, the iconic Dow Jones Industrial Average (DJINDICES: ^DJI) has served as Wall Street’s most front-and-center health barometer.
When the Dow was incepted in the late 19th century, it was composed of one dozen (mostly) industrial companies. Over time, it’s evolved into the ageless index we see today, which is made up of 30 highly diverse, time-tested, multinational businesses.
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Although the Dow Jones Industrial Average has historically risen over long periods, it doesn’t mean every component is necessarily worth buying. As we power ahead into the heart of earnings season in May, two colossal Dow stocks have checked all the right boxes for investors, while another is throwing up no shortage of red flags.
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Sensational Dow stock No. 1 to buy hand over fist in May: Visa
The Dow component I’d argue has the highest-conviction upside over the next five years is payment-processing titan Visa (NYSE: V).
Visa is a cyclical business, and there have been concerns about the growing possibility of the U.S. economy weakening or dipping into a recession. The initial first-quarter gross domestic product (GDP) report showed the U.S. economy contracted by 0.3%. When the U.S. economy is shrinking, the expectation is that consumers and businesses will spend less. A weaker spending environment isn’t good news for a company like Visa that generates fees from payment-based transactions.
But cyclicality works in both directions. Even though recessions are an inevitable aspect of economic cycles, they’re historically quick to resolve. Since the end of World War II, a dozen U.S. recessions have occurred. Whereas the average recession has resolved in roughly 10 months, the typical economic expansion has lasted for around five years. Visa disproportionately benefits from lengthy periods of economic growth.
It’s also a company that has a lengthy growth runway ahead of it. In Visa’s fiscal second quarter (ended March 31), it announced cross-border payment volume growth of 13%. Visa has been consistently delivering double-digit growth in cross-border payment volume, which speaks to its largely untapped opportunity in emerging markets.
Something else smart investors are going to note about Visa is that its management team has avoided dipping the company’s proverbial toes into lending. By acting only as a payment facilitator, Visa avoids the need to set aside capital to cover potential loan losses and credit delinquencies. In short, it can bounce back from periods of economic turbulence much faster than other financial institutions.
Though Visa stock hasn’t pulled back significantly during the current correction for the Dow Jones Industrial Average, it’s still a bargain. Its forward price-to-earnings (P/E) ratio of roughly 27 sits 6% below its average forward-year earnings multiple over the last half-decade.
Image source: Getty Images.
Colossal Dow stock No. 2 to buy hand over fist in May: UnitedHealth Group
A second colossal Dow stock that long-term investors can add to their portfolios with confidence in May is health insurance and services giant UnitedHealth Group (NYSE: UNH).
On April 17, UnitedHealth stock produced its worst single-session performance of the century, with a loss of 22%. The company reduced its full-year profit guidance and pointed to unanticipated increases in Medicare Advantage costs, including outpatient services, for its surprising and disappointing forecast. While it may take a few quarters before UnitedHealth’s operating performance fully stabilizes, there are a few core catalysts here that remain undisturbed, despite its poor recent operating results.
Health insurance may be a boring business, but it’s one that tends to generate consistent profits and leads to modest growth. Every so often, one or more insurers will contend with a catastrophe event or unexpected cost issues that weigh on results. However, the wider-lens view shows that insurers possess significant premium pricing power. They’re able to use these events as justification to increase premiums to cover their higher outlays. Higher medical costs are rarely, if ever, a prolonged issue for health insurers.
It’s also a predictable operating model. Regardless of how well or poorly the U.S. economy and stock market are performing, demand for medical services remains fairly constant. More often than not, UnitedHealth’s management team is going to be able to accurately forecast its expenses.
However, UnitedHealth Group’s crown jewel is its Optum subsidiary, which provides everything from pharmacy benefit services to software and data analytics that medical businesses use to make their operations more efficient. The operating margin associated with Optum has pretty consistently outpaced the margins for the insurance segment — and Optum has been growing sales at a faster pace, too!
UnitedHealth Group’s hiccup has lowered its forward-year earnings multiple down to just 13, which is the lowest it’s been in at least a half-decade. It also represents a 34% discount to its average forward P/E ratio over the trailing five-year period.
The Dow component investors would be wise to avoid in May: Nvidia
On the other end of the spectrum is one of the Dow’s newest components, which makes for an easy avoid in May. I’m talking about semiconductor behemoth Nvidia (NASDAQ: NVDA), which has been riding the artificial intelligence (AI) wave.
Nvidia’s claim to fame is its Hopper (H100) graphics processing units (GPUs) and successor Blackwell GPU architecture, which dominate as the brains of AI-accelerated data centers. Nvidia’s hardware is superior, in terms of compute potential. Additionally, with demand for AI-GPUs overwhelming supply, it’s been able to charge a premium for its GPUs, which pumped up its gross margin to more than 78% one year ago.
While the long-term future for AI remains bright, multiple headwinds stand in the way of Nvidia stock in the coming quarters (and perhaps next couple of years).
To begin with, the Joe Biden administration and Trump administration clamped down on exports of high-powered AI chips and AI-related equipment to China. The world’s No. 2 economy by GDP generates of billions of dollars in quarterly sales for Nvidia, which are at risk of shrinking considerably due to ongoing trade tensions between the U.S. and China.
We’re also witnessing a significant uptick in competitive pressure. Aside from direct competitors rolling out less-costly GPUs, Nvidia could have the rug pulled out from under its feet by internal competition. Many of its top customers by net sales are internally developing GPUs and AI solutions for their respective data centers. These chips and solutions are considerably cheaper and more readily accessible than Nvidia’s hardware. Nvidia’s steadily declining gross margin since the fiscal first quarter of last year strongly suggests that its pricing power is waning.
To build on this point, it’s also possible Nvidia’s rapid upgrade cycle — it’s planning to bring a new AI-GPU to market annually — could lead to rapid GPU depreciation and irritate businesses that have already made sizable investments. In other words, we might be talking about its customers delaying future upgrade cycles.
Lastly, every next-big-thing innovation for more than three decades has worked its way through a bubble. Investors consistently overestimate the adoption rate and early stage utility of game-changing technologies. With most businesses lacking a clear blueprint to maximize their AI solutions, we appear to be careening toward another bubble-bursting event. Should one occur, no AI stock would feel the brunt more than Nvidia.
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Sean Williams has positions in Visa. The Motley Fool has positions in and recommends Nvidia and Visa. The Motley Fool recommends UnitedHealth Group. The Motley Fool has a disclosure policy.