Last year was a mixed one for growth stocks. The ‘Magnificent Seven’ (Microsoft, Apple, Alphabet, Amazon, Meta, Nvidia and Tesla) all surged. However, that’s not reflective of all growth-oriented companies. That’s because those Magnificent Seven are by no means typical of growth companies. They’re very profitable.
Growth stocks are companies focused on growing their businesses, and this is normally reflected by strong share price growth.
However, there’s no guarantee these businesses will succeed. In fact, many nascent growth-focused firms don’t actualise their potential. And these failures become more frequent when we’re experiencing negative, slow, or slowing economy growth and high interest rates.
One of the reasons for this is that growth stocks often need to borrow to fund growth, and require a buoyant market to forge demand.
So why could 2024 be a stronger year for growth stocks?
Interest rates
Interest rates are projected to start falling in 2024. And growth stocks tend to prosper as interest rates fall due to a re-valuation of their future earnings potential.
There are several reasons for this. For one, lower interest rates reduce borrowing costs for companies, allowing them to invest more in innovation and expansion.
Additionally, the present value of future earnings for high-growth companies increases when discount rates, influenced by lower interest rates, decline. This enhances the attractiveness of growth stocks to investors seeking better returns.
As interest rates decline, growth stocks may experience increased demand, driven by the anticipation of favourable economic conditions for companies focused on innovation, technology and expansion.
And while challenging economic conditions can lead to more adoption of disruptive technologies (that’s what top investor Cathie Wood says) it’s also the case that business and consumers are more likely to take risks when economic conditions — in this case falling interest rates — are improving.
Equally, we’ve got to consider the next great technological leap. That’s the rise of artificial intelligence (AI), machine learning, and green energies. AI took a huge step forward in 2023 and will likely power broader growth and innovation in 2024.
My investment
I’ve been increasing my position in growth-oriented stocks as we’ve moved into 2024. So where have I put my money? One stock that performed extremely well in 2023, and could outperform the market in 2024, is Super Micro Computer.
Central to my investment thesis is the price-to-earnings-to-growth (PEG) ratio. Super Micro, despite surging, trades with a PEG ratio of 0.68.
This particular ratio is an earnings metric that’s adjusted for growth. It’s calculated by dividing the forward price-to-earnings ratio by the CAGR for three-to-five years. Anything below one is considered undervalued.
And this is reflective of my broader investment strategy. I invest in growth stocks with attractive metrics such as AppLovin, Celestica, and Gigacloud Technology.
Rather than just being growth-focused companies, these are stocks where, at least according to data, the market has undervalued their growth potential.
