Looking Beyond the Growth Stock Shock

Growth stocks enjoyed a supercharged post-COVID rally before higher rates and inflation dealt a heavy blow in 2022. Are better days ahead? Phil Ruvinsky of Fundamental Equities’ U.S. Growth team says opportunity exists, but selectivity is critical.

The traditional question of whether to lean into growth or value stocks has no straightforward answer today. Value historically has had an edge in inflationary environments, while growth is typically preferred in a recession.

With the risks of persistent inflation and impending recession both at play, we believe the best course is to build both growth and value into portfolios, a view we detail in our latest market outlook.

Yet growth stocks have been particularly challenged by rising rates, leaving investors bruised and uncertain about the path forward. Phil Ruvinsky, a stock picker in the growth space for 20 years, is optimistic for the long term and preparing his shopping list for the shorter term. Here he addresses five key questions about growth stocks:

Is this the time for growth stocks?

We believe there is always a place for growth stocks in a portfolio, and their long-term track record is a strong endorsement. Over the past 10 years, the Russell 1000 Growth Index has provided an average annual return 2% above the broader Russell 1000.

This year brought the first sizeable challenge for the growth style in over 10 years. Some repricing was warranted, such as cases of COVID-inflated earnings that were not sustainable or businesses lacking a path to profitability. But there was also indiscriminate selling that has created some great opportunities for stock pickers.

Many growth stocks have regained more than 20% from their June bottoms, but we still see attractive entry points into businesses with exciting long-term prospects. The key is to be selective and risk aware, particularly in this highly uncertain macro environment. Our experience has shown us that entry points like some we’re seeing today can reward patient investors.

How do you manage through drawdowns or high volatility?

These are times when we focus in on our highest-conviction positions. That means selling more stocks than we buy. We tend to add to our top 10 to 20 positions while also shopping for new ideas ― seeking companies that have been unduly punished.

What areas of growth look particularly attractive now?

We are targeting companies that sold off sharply but appear well-positioned to deliver on their long-term growth objectives. The extreme repricing in these cases has given us a greater “margin of safety.” Even if markets retest their June lows, we believe the entry prices are compelling enough to compensate for the added risk.

Particular areas of interest include e-commerce, software and communication services. We’re also targeting companies that didn’t reach peak earnings post-COVID and those we expect to be resilient in a recession.

What are you avoiding?

We’re staying away from businesses with high expectations but unclear competitive advantages. We’re also steering clear of companies whose road to valuation recovery appears difficult, such as those that have weaker balance sheets or tenuous paths to profitability. Our goal in the current environment is to amp up quality and resilience.

What is your long-term outlook for growth stocks?

We are very optimistic. Growth stocks are about innovation, and innovation is not stopping. Trends toward digitization, e-commerce and artificial intelligence, to name just a few, are firmly intact. We believe the challenges companies face today will only motivate more innovation. A tight labor market and rising input costs will fuel the search for industrial and technological improvements and efficiencies. Such advancements will accrue to those companies that are addressing the needs and demands of the futur

“We are very optimistic. Growth stocks are about innovation, and innovation is not stopping.”

It’s an exciting time to be an active growth investor. We see the large-cap universe teeming with high-quality companies, and the mid-cap space boasting a combination of niche market leaders and up-and-comers that have unique products and solutions we believe can enable them to take market share and grow. Ultimately, history has taught us that financial markets reward earnings and earnings growth over time, and that is what we’re focused on as long-term fundamental investors.

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Originally Posted October 7, 2022 – Looking beyond the growth stock shock

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