by Frank Caruso, CFA| Chief Investment OfficerâUS Growth Equities, AllianceBernstein
Itâs been a tough year for investors, particularly in growth stocks. But the sharp declines have also dramatically changed the valuation landscape. Long-term investors can now find attractive entry points for companies with quality businesses that can navigate a growing list of uncertainties and deliver solid growth over time.
Growth stocks have fallen sharply this year. Even after modest gains in the third quarter, the S&P 500 Growth Index was down by 28.2% this year through September 23, while the S&P 500 declined by 21.6%. Even before Septemberâs declines, the forward price to earnings ratio of the Growth Index had fallen to 20.4Ă through August 31, taking its valuation spread versus the value index close to its 10-year average for the first time in nearly four years (Display).
Highfliers Return to Earth
During the growth-stock rout, high-flying technology stocks were hit hard. The Goldman Sachs Non-Profitable Technology Index tumbled nearly 70% from its peak last year to the end of August. Investors have clearly fled from the crowded trade in stocks promising extremely high future growth, often with questionable managerial and competitive differentiation to build and sustain a great business.
But where have they gone? Among other things, this yearâs flight to safety led many investors to shift toward low-volatility stocks, such as utilities and consumer staples, which offer more stable trading patterns for turbulent times. In some cases, these stocks have become quite expensive. Of course, there are good strategies for capturing lower volatility stocks at attractive valuations. But paying too high a premium for safety could backfire if market trends shift again.
Sustainable Profitability Points to Solid Growth Companies
We believe growth stocksâ valuations are far more attractive today than they were a year ago. Yet at the same time, macroeconomic and market conditions are especially challenging. Rampant inflation is prompting interest-rate hikes that are compressing equity valuations, with growth stocks disproportionately affected. Consumers and investors are bracing for a recession.
What should growth investors do in this environment? We think active investors should focus on companies with resilient business models and high, consistent profitability, based on metrics such as return on assets and return on invested capital. These are good signs that a company has sturdy underlying business drivers and is capable of self-funding investments to support long-term growth.
It may be harder to find companies like these today. But theyâre likely to be trading at much more attractive valuations than in recent years. Positioning in growth companies with these features can help create a portfolio that is built to navigate todayâs tougher business environmentâand reward investors with better risk-adjusted returns over time.
About the Author
Frank Caruso is a Senior Vice President and Chief Investment Officer of US Growth Equities, a position he has held since 2012. He has led investment teams since 2004 and was a portfolio manager from 1995 to 2004. Caruso joined the firm in 1993, when it acquired Shields Asset Management, where he had been director of Equities. Previously, he was a managing director at Shearson Lehman Advisors, as well as CIO for Shearson Lehman Asset Management's Directions and Capital Management businesses. Caruso was also formerly the lead portfolio manager for Shearson's family of growth and income mutual funds and a senior member of Shearson Lehman Advisors' Investment Policy Committee. He holds a BA in business economics from the State University of New York, Oneonta, and is a member of the CFA Society New York and the CFA Institute. He is a CFA charterholder. Location: New York
