Much of the financial press focuses on the largest companies. Indeed, the top ten stocks make up 37 percent of the value of the Standard and Poor’s 500 Index. This means that the remaining 490 firms make up the remaining 63 percent. Sort of the tail wagging the dog.
This state of affairs is the result of the popularity of packaged financial products like index funds, which are invested by computers based on how much the sum total value of each company’s stock weighs on the portfolio. So, for example, Nvidia has a market value of $4,000 billion. It would be counted far more heavily than, say, Oil Dri, a company that has a market value of $0.852 billion. As professional investors push up the price of Nvidia they are assisted by the index funds, who
channel more money into stocks which are rising more rapidly than the overall market. This creates a virtuous circle of appreciation on the way up, and a vicious circle of depreciation on the way down.
Nvidia makes semiconductor chips for AI applications. Oil Dri refines a type of clay that was originally used to soak up oil and lubricants from the repair shop floors. Later it was discovered to be ideal for cat litter. Since the average American household has twice as many pets as children, demand for their product has taken off.
Nvidia’s earnings and stock price have been on a tear. The Price/Earnings ratio for Nvidia is 58.6. Oil Dri is 17.8. Nvidia’s earnings are forecasted by the 18 analysts following the company to be up 96% this quarter. Oil Dri is such a small company it has no analysts following the stock and thus has no earnings forecast. Telling are the estimates of future earnings for Nvidia. This year the increase in earnings for the company is estimated to be 45%. Next year 34%. The three years after
that, 30 % per year. Without delving into the dynamics of the company, the slowdown would be rational if only due to its size. Revenues are forecast to be over $130 billion in 2025. Five years ago, the figure was under $17 billion.
Nvidia’s profit margins are in excess of 50%. Needless to say, this attracts other companies that would like to poach revenues (and profits) from this company. FINVIZ, a firm that provides the data being quoted here, counts at least seven other large semiconductor firms who would like to take business from Nvidia. In time it seems certain some of them will.
Oil Dri has a profit margin of about 10%. While this is less than Nvidia’s, it tends not to attract competitors as voluminously either. Add to this the fact that only certain kinds of clay can be used for their products. There does seem to be a barrier to entry here which is not present in technology. In terms of revenues, Oil Dri has had sales grow 12% a year for the past five years. This may pale compared to Nvidia’s 64%, but it is more realistic in terms of forecasting going forward. The
overall economy grows in real terms by about 2% per year. Add inflation at 4% and you get total nominal revenue growth of 6%. To the extent you are predicting more than this, you are either looking for profit margin expansion, tax reductions on profits, or growth faster than the overall economy. Nvidia’s forecast of a 30% increase in revenues going forward is five times the growth of the overall economy each year for the next five years, minimum. Such growth does not go on forever, not even for AI.
Finally, there is the matter of dividends. Nvidia pays all of 4 cents per share, 1 cent per quarter. The yield on the stock is 0.02%. It is speculated that Nvidia pays this dividend to make the stock eligible to be purchased by bank trust departments, many of whom require their stocks to pay dividends to qualify for purchase. Oil Dri pays 62 cents per share, for a 1.02% dividend yield. The reason for the difference in dividend payout can be seen in the ratio of price to Free Cash
Flow. For Nvidia the ratio is 58. For Oil Dri the number is 18. In essence, all Nvidia’s profits have to be plowed back into the company to help it hopefully keep its lead over its competitors. The Faustian bargain of technology is that unit demand has to go up faster than prices fall to keep revenues advancing. Once demand is satisfied, falling prices result in revenue contraction which can cause the stock to crater. When that happens, something as mundane as cat litter does not look so bad.
The Economy
Economic activity continues to decelerate. While numbers are positive in the aggregate, they are less so than six months ago.
One area that is definitely slowing is housing. Housing is increasingly unaffordable for those starting out. While people blame interest rates, it is a foregone conclusion that were interest rates to fall housing prices would rise as an offset.
Add to this the issues of tariffs, export controls and in some cases workforce instability due to efforts to force deportations, and it is a wonder the economy is doing as well as it is. A resolution of these issues will be necessary to be able to regain economic stability. Unfortunately, resolution in the short term seems unlikely.
Interest Rates
Members of the political class feel that lower interest rates would lessen the financial impact of additional debt burdened on the federal government by the escalating fiscal deficits being run by the country. If only the Federal Reserve were less independent, they reason, borrowing costs would be less of an issue.
The reality is probably the opposite. With the majority of the nation’s debt held by foreigners, any effort to reduce rates will probably be met with withdrawals of foreign funds from this country. Were this to happen, interest rates would need to rise to a level that would again attract foreign buying. While no one knows exactly the number, it would probably be far higher than the current interest paid on the national debt. People should be careful what they wish for. Many countries with less independent credit regulators have gone bankrupt.
Inflation
Inflation is in uncharted territory. The arbitrary nature of tariffs and the way they are proposed and then dismissed has caused the market to believe that in material terms they will never be imposed.
This is a self-serving scenario. Should it not come to pass, there will be a great deal of upheaval when tariffs are finally applied to wide swaths of the economy. Further, the nature of deportation has gone from evicting criminals to meeting quotas. This is resulting in the removal of productive, law-abiding immigrants who have contributed to the economy in ways ranging from working in nursing homes to running bakeries and other small businesses as well as helping harvest crops.
Given that Congress is not willing to exercise oversight over the Department of Homeland Security, it is anyone’s guess as to how this will play out. The inflation consequences, to say nothing of the human cost, will be material.
The Stock Market
The stock market continues to grind higher, as funds are attracted by the rising price levels and in some cases to a casino mentality.
Tariffs, which are a cost to businesses and consumers, are beginning to make themselves more prevalent in the earnings reports for the quarter ending June 30. Additional tariffs and the cost of deporting productive workers will be more of a factor in the third quarter ending September 30. None of these impacts will be positive for stocks.
Warren M. Barnett, CFA
July 25, 2025
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