Several growth stocks have struggled in recent months, due to factors including inflation fears and high valuations. In some cases, this dip offers the perfect time to buy these quality companies, and I believe the upside potential remains massive. But with some others, I’m less optimistic. This is because I feel that growth is now slowing, and valuations are still too pricey. Here are two beaten-down growth stocks, one of which I’m very tempted to buy, and the other that I’m currently avoiding.
Chinese e-commerce giant
Alibaba (NYSE: BABA) has faced an extremely difficult few months, due to the regulatory crackdown from the Chinese government. This has included a fine of $2.82bn, equivalent to 12% of the company’s net income in the financial year 2021, due to its e-commerce business being anti-competitive. Since then, the Chinese government has continued its scrutiny of the e-tail giant, handing out several smaller fines over unapproved investments and acquisitions.
This has also extended to its affiliate, Ant Group, which has caused further problems for Alibaba. Indeed, in November last year, China suspended the record $37bn Ant Group IPO. It also called on it to restructure its business. This included folding its micro-loan services, Jiebei and Huabei, into a new finance firm. Recently, it has also declared that it wants to break up Alipay, the platform Alibaba uses to facilitate customers’ online transactions. As Alibaba owns a third of Ant Group, this is clearly all very worrying.
So, why would I still want to buy this growth stock? Well, despite all the regulatory issues, the company is still performing excellently. In fact, in fiscal year 2021, revenue rose 41% to $109.5bn. Despite the extremely large anti-monopoly fine, income was also over $13bn, just a 2% decrease year-on-year. Excluding the impact of this fine, net income increased 30%. As such, Alibaba is performing extremely well from a financial point of view. After its share price has fallen around 40% in the past year, it also has a price-to-earnings ratio of under 20. Accordingly, although regulatory headwinds are likely to cause short-term volatility, I think the recent dip in its share price makes Alibaba very tempting.
A US growth stock I’m avoiding
While a drop in a company’s share price can signal a great time to buy, it can also signal the start of a major decline. In this respect, I’m less convinced about Pinterest (NYSE: PINS), which has fallen over 30% in the past two months. This is because investors were disappointed in its recent trading update.
In many ways, this disappointment may seem unwarranted. In fact, Q2 revenues rose 125% year-on-year to $613m, and it reported net income of $69m. Reaching profitability is an excellent sign in any growth stock.
But the main concern was the fact that monthly active users had fallen 5% in the US. For me, this signals that growth is starting to slow. Further, Pinterest has a price-to-sales ratio of around 16 and a price-to-earnings ratio of over 100. This signals that investors expect very large growth. Due to monthly active users starting to fall in the US, I don’t think the company’s current growth prospects can justify this valuation.
Stuart Blair has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Alibaba Group Holding Ltd. and Pinterest. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.