The last two years have been a rough time to be an investor in growth stocks. With the economic climate rapidly shifting, the cost of capital has been rapidly rising. And valuations have tumbled into the gutter for many unprofitable growth-focused enterprises, especially in the technology sector.
In 2023, things have started to slowly improve as inflation begins to cool. However, many growth stocks are still trading firmly below their pre-correction prices.
That’s a far cry compared to the performance seen over the last decade. In fact, since the 2008 financial crisis, growth stocks have been vastly outperforming value stocks on an annualised basis.
There are multiple factors behind this performance, the primary of which was near-free money, thanks to record low interest rates. But now those days are seemingly over, are the golden days of growth stocks finished as well?
Growth versus value stocks
A recent study by the financial advisory group, Dimensional, compared the performance of growth stocks versus value stocks. And the results showed that between 2010 and 2021, growth has beaten value in nine out of the 11 years. And not by a small margin.
However, when zooming out over nearly a century since 1927, it seems that value has been the superior investment strategy, generating an average of 4.1% excess annual returns. And after taking a step back, this does make a lot of sense.
After all, a core tenet of investing is to buy shares in businesses for less than the present value of their future cash flows. That’s precisely what value investing is all about and is how investors like Warren Buffett built their fortunes. On the other hand, growth investing is mainly about buying companies with tremendous long-term potential, despite the valuations often being quite nonsensical.
Does this mean buying growth stocks in 2023 is a bad idea? Not necessarily.
Momentum may be just ramping up
While I’m sceptical that interest rates will return to near zero for quite some time, that doesn’t mean growth stocks can’t deliver value-beating returns. In fact, a closer look at Dimensional’s dataset reveals an interesting pattern.
Following almost every stock market crash and correction, growth stocks have outperformed. The lofty valuations pave the way for increased volatility within a firm’s market capitalisation. And during times of economic crisis, this can translate into massive downward momentum.
For some companies, a rapid decline might be well-justified. But for others, maybe not. Even today, technology stocks have fallen in excess of 60% despite the fact that some are actually free cash flow positive and financially independent.
When emotions begin to settle, these oversold enterprises are typically the ones set to benefit the most during an eventual stock market recovery. Therefore, growth stocks may actually contain some of the best opportunities for investors today.
So are growth stocks dead? In my opinion, that couldn’t be further from the truth.
