Whether or not the broader stock market is in a bubble, ultra-growth stocks seem to be, according to an analyst at
While some Wall Street analysts are concerned about a broader stock market bubble, JPMorgan’s Eduardo Lecubarri, global head of small- and mid-cap equity strategy, wrote in a note that ultra-growth equities are the area of most concern. “We have argued since the start of the year that investors needed to run away from stocks trading on high multiples over rich growth expectations,” said Lecubarri in a note. “Further analysis adds even more evidence to our claim.”
Russell 3000 Growth index
—which contains fast-growing and unprofitable companies—has underperformed its value counterpart by 10 percentage points since September when investors shifted into assets that benefit most from a strengthening economy. Still, Lecubarri is worried that there is trouble ahead for these stocks.
First, growth is so expensive that, history shows, future outperformance is unlikely. The difference in the average trailing price-to-earnings multiple for small- and mid-cap growth and value stocks is currently 42.5 points, according to JPMorgan data, the biggest difference since 2000. The bank’s data show that the more expensive growth is relative to value, the more growth is likely to underperform value in the following year.
Second, JPMorgan’s Lecubarri argued the rationale for buying these stocks is a losing strategy. Investors are paying top dollar for these highflying growth stocks because the expected near-term earnings growth is so high, which can offset any valuation decline. Lecubarri listed a few growth stocks—none above $4.8 billion market capitalization—with enormous earnings potential. One was
(ticker: CTM), worth $3.8 billion, that analysts expect to grow earnings per share by 171% in 2021. Buyers see “pie in the sky,” Lecubarri said. His data show share-price underperformance of such growth stocks in the year following extraordinarily high earnings growth.
Lecubarri wrote that’s because when valuations fall, near-term earnings growth may not offset the decline enough to move the stock higher. Currently, high growth companies are likely to see their valuations fall because interest rates are bound to rise. The 10-year Treasury yield is still below the expected rate of long-term inflation, whereas it historically sits above that. Higher bond yields erode the value of future cash flows and growth companies expect the bulk of uproots to come far into the future.
Be careful with growth stocks.
Write to Jacob Sonenshine at firstname.lastname@example.org
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