It’s time to take a more careful and critical look at growth stocks.
Growth investments have destroyed value in the first quarter. The Russell 1000 Growth Index is up nearly 14% in the first three months of 2023, while the market benchmark’s value share was virtually flat. Growth stocks dominated the value the most since the first quarter of 2020.
Nvidia (Ticker: NVDA), Meta Platforms (META), Tesla (TSLA), Advanced Micro Devices (AMD) and Salesforce.com (CRM) each scored 50% or more. The next set of gains might be less broad.
Much of those gains in early 2023 can be attributed to the effect of falling bond yields. Investors are expecting an end to the US Federal Reserve’s rate hikes and futures markets are pricing in significant rate cuts by the end of the year. The yield on the 2-year US Treasury has fallen below 4% from a peak of around 5.1% in early March.
The dominant expectation among economists and professional forecasters is a US recession as early as the second half of 2023 – as recent banking problems lead to tighter credit conditions and the lagged impact of Fed rate hikes is felt on the labor market.
Unless the economy achieves some fabled “soft landing” scenario in which inflation slows to the Fed’s target without a recession, growth-oriented companies with real earnings and pricing power are in pole position to outperform the broader market.
Advertisement – Scroll to Continue.
“As the economy avoids a recession, real yields are likely to rise and valuations of low-margin growth stocks are more sensitive to higher yields,” wrote Ryan Hammond, equity strategist at Goldman Sachs, in a recent report. “As the economy enters a recession, the stock market’s valuation of growth is likely to deteriorate, and history suggests that investors will reward ‘quality’ attributes, including high-margin stocks.”
The first quarter was a case in point. A Goldman basket of underperforming technology stocks outperformed value stocks by 22 percentage points in January and February as yields fell and optimism prevailed over a soft landing. They underperformed by a point in March – as yields continued to fall but tremors in the banking sector raised fears of a recession.
Large cap growth stocks with stronger profitability outperformed by 4 points in January and February and another 6 points in March alone.
Advertisement – Scroll to Continue.
Find stocks that would outperform in both a recessionary scenario with lower returns and a higher-return but faster-growth environment, Goldman strategists looked for stocks in the Russell 3000 index of most publicly traded US companies with the highest revenue growth and expected profit margins over the next two years.
Barron’s further narrowed the list to companies with a market value of at least $10 billion and an enterprise value of no more than six times the annual sales they are projected to generate in a year or two. That would cover the time when a recession may have occurred). For comparison: Nvidia is traded with a multiple of 17 according to this measure.
The screen revealed 13 names:
These include Take-Two Interactive Software (TTWO), Qorvo (QRVO), Unity Software (U), First Solar (FSLR), Palantir Technologies (PLTR), Workday (WDAY) and Airbnb
Advertisement – Scroll to Continue.
(ABNB).
Write to Nicholas Jasinski at [email protected]
Comments are closed.