Are Growth Stocks Overpriced? It Depends.
Valuations are also tricky (Display above, right). Based on price/forward earnings for 2022—perhaps the most popular valuation metric—value stocks are trading at an 85% valuation discount to growth stocks, which are trading at 25.7 times estimates earnings for 2022. At face value, growth stocks look more expensive.
Yet when accounting for the higher level of growth that these companies are expected to deliver, those valuations are actually much more reasonable. Indeed, based on price/earnings to growth (PEG) for 2022, when earnings are expected to stabilize after this year’s collapse, the value index is twice as expensive as the growth index.
Nearly two years ago, we looked at similar trends and argued that a simplistic choice between value and growth was inappropriate after a nine-year bull market and at a late stage in the US economic cycle. While market and macroeconomic conditions have changed dramatically since the pandemic began, we believe the statement is still true today. That said, volatility is likely to stay elevated and market risks are much greater today, given valuations, macroeconomic and regulatory risks (such as potential legislation for the technology industry). For many companies—particularly within the value universe—solvency concerns are much greater than usual because of the pandemic.
Selective investors can find attractive candidates in both styles. Companies with solid balance sheets and low levels of debt that don’t depend on the economic cycle for growth are good growth candidates to pull through the crisis, in our view. On the value side, stocks with attractive valuations that have higher quality balance sheets and cash flows are worth considering. Investors should look beyond the style indices for active strategies that aim to find the most promising sources of return potential through the coronavirus crisis and the long-term recovery.