Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 186

The market loves growth stocks – until it doesn’t

In light of the recent misfortunes suffered by high-profile ASX growth stocks (Bellamy’s, Estia Health, and iSentia Group to name a few), it’s worthwhile seeing if there are any obvious lessons investors can take into 2017.

Growth stocks by their nature tell a story that provides some justification of their future earnings potential. These stocks can dazzle as their futures unfold, but it’s important to remember the other side of the trade when things don’t go as planned.

High profile growth stocks volatile

Firstly, from a risk perspective, investors benefit from knowing how a growth stock will compare with the wider market. Beta is the measure of the volatility of a security versus the market. It can provide an indication of how volatile or ‘wild’ the ride might be, from both positive and negative sides. For example, if growth Company A has a market beta of 1.5 it is likely to be 50% more volatile than the market. That is, if the market goes up 1% then Company A should rise 1.5% and if the market falls by 1% Company A should fall by 1.5%.

Secondly, the cliché ‘up the stairs down the elevator’ is particularly relevant when looking at growth stocks. Put simply, a company is more likely to go from overvalued to undervalued far more quickly than from undervalued to overvalued. Growth stocks are either undervalued or overvalued but rarely fairly valued. We know the higher the price the higher the risk, yet our FOMO (fear of missing out) may cause us to jump into a growth stock, chasing and in fact promoting the ‘paper profits’ seen by the earlier investors.

On the flip side, our apprehension may cause us to sell out at a large and sudden discount even though the risks of the business are provided at a large discount.

Market has a short memory

If you ask the question (assuming business fundamentals remain), that if I was happy to buy stock at a 30% discounted price on the way up, shouldn’t I be considering buying it now?

The market tends to have a short memory and is always willing to be swept away by the next big growth stock. If we take a look back to calendar year 2015, the top 10 performers in the All Ordinaries Index produced an average return of approximately 400% (if you exclude resource companies, the top 10 performers returned an average of approximately 275%). Leading the charge were the market darlings, Bellamy’s and Blackmores, which had P/Es of 140 and 80 respectively during that time. The market is forward looking to a current P/E on a growth stock so it will invariably look high, but these figures also provide a sense of relativity to the general market P/E range of 15-17.

If we look at those same performing stocks in calendar year 2016 (so far), the return of the non-resource top 10 market darlings from 2015 is -18%, excluding one which has gone into liquidation. Of those which have produced negative returns, the average is -35%. A company reinvesting for growth often means you don’t have a dividend yield to soften the loss, and an investor that arrives late to the party can end up with negative returns quickly.

Here are four lessons to keep in mind before investing in growth stocks:

  • have a price level of where you think the stock is either undervalued or overvalued and write it down so you don’t forget
  • don’t ignore a company’s beta - the higher the beta, the higher the risk of a larger pullback
  • chasing someone else’s paper profit is not a sound investment decision
  • if you’re caught up in a large correction, take your time to weigh the options in the context of undervalued vs overvalued. Has the bubble burst or is this an opportunity to buy at a price you could only have dreamed of a few days ago?

 

Robert Miller is a Portfolio Manager at NAOS Asset Management. NAOS runs two LICs, ASX:NCC and ASX:NAC. This article is general information and does not consider the circumstances or investment needs of any individual.

 

RELATED ARTICLES

Six ratios show the market is off the charts

4 lessons from Marks on protecting capital

Insider sales can be a powerful warning

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

Latest Updates

Interviews

John Woods on diversification using asset allocation

All fund managers now claim to take ESG factors into account, but a multi-asset ethical fund will look quite different from a mainstream fund. Faced with low fixed income returns, alternatives have a bigger role.

SMSF strategies

Don't believe the SMSF statistics on investment allocation

The ATO's data on SMSF asset allocation is as much as 27 months out-of-date and categories such as cash and global investments are reported incorrectly. We should question the motives of some who quote the numbers.

Investment strategies

Highlights of reader tips for young investors

In this second part on the reader responses with advice to younger people, we have selected a dozen highlights, but there are so many quality contributions that a full list of comments is also attached.

Investment strategies

Four climate themes offer investors the next big thing

Climate-related companies will experience exponential growth driven by consumer demand and government action. Investors who identify the right companies will benefit from four themes which will last decades.

Investment strategies

Inflation remains transitory due to strong long-term trends

There is momentum to stop calling inflation 'transitory' but this overlooks deep-seated trends. A longer-term view will see companies like ARB, Reece, Macquarie Telecom and CSL more valuable in a decade.

Infrastructure

Infrastructure and the road to recovery

Infrastructure assets experienced varying fortunes during the pandemic, from less travel at airports to strong activity in communications. On the road to recovery, what role does infrastructure play in a portfolio?

Economy

The three prices that everyone should worry about

Among the myriad of numbers that bombard us every day, three prices matter greatly to the world economy. Recent changes in these prices help to understand the potential for a global recovery and interest rates.

Shares

Why green hydrogen is central to achieving net zero

Hundreds of green hydrogen projects show this energy opportunity is finally being taken seriously. While a cost disadvantage and technical challenges need to be overcome, it promises to deliver a path to net zero.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.