Why growth stocks plunge, part two

growth stocks plunge

It has only been more than three months since most U.S. growth stocks reached their all-time highs in October last year to January 2022. During this period, the three major U.S. stock market indexes ended at 1/27, from the highest point in history; the Dow Jones fell 8%, the S&P 500 fell 11%, and the Nasdaq, which represents growth stocks and technology stocks The index fell 17%, and the Russell 2000, which represents small-cap stocks, has already fallen into a bear market (see Figure 1 in “Why growth stocks plunge, part one“).

The article is divided into two parts. This article is the second one, which mainly discusses the second biggest reason for the plunge in US growth stocks ─ ─ the comparable base period is too high in the past two years. Another big reason for the slump in U.S. growth stocks discussed in the part one, “Why growth stocks plunge, part one“, which has been published, is monetary policy.

Too high comparable base in past two years

13 years bull market ended

In addition to the two external factors mentioned in the part one, the monetary policies to growth stocks is an external factor that all companies cannot resist, another major factor lies in growth stocks themselves. Because the past 13 years have been a rare bull market for U.S. stocks. From the financial tsunami to the Codvid-19 pandemic in 2020, the central banks of various countries have resorted to all kinds of tricks to stabilize the performance of the stock market, making the business environment conducive to listing, financing, and business operations. The result is to push up the stock market.

Businesses benefit from Covid-19

The Covid-19 pandemic that started at the end of the first quarter of 2020 has caused governments around the world to conduct multiple national or partial city lockdown in order to prevent the epidemic. Thpandemic and the lockdown have benefited most industries from the pandemic (because people and companies need to stockpile additional goods), but large companies have a large market capitalization, and their stock gains are not as obvious as growth stocks.

It also accidentally created many new industries, and caused many business outbreaks in the technology and biotechnology industries, many of which happened to be small or newly listed companies in industries that benefited the most from these epidemics and lockdowns.

Some of these new growth stocks (e.g., e-commerce, fintech, vaccines, retailers) have even achieved impressive triple-digit revenue growth in consecutive quarters over the past two years, making lot of money in the past two years, individual stocks have skyrocketed as if popeye ate cabbage, and the stock price has risen by 300% or 500% in the past two years, which is amazing. Of course, starting from the end of the second quarter of 2021, with the generalization of vaccination, and the trend of abandoning the city lockdown in Europe and the United States, most industries have gradually returned to normal.

Slowdown of pandemic is negative to business growth

But here comes the problem. These growth stocks that have benefited from the epidemic in the past two years and the lockdown, after the pandemic has slowed down, people have gone out and returned to normal life, and no longer stockpiled additional goods. In the past two years, the quarterly growth rate of more than 50% or more than 100% has been raised after the base period of the business index has been raised.

From now on, there will only be two situations. No matter which one, the high growth rate will definitely not be sustainable; the first is to continue to grow, but due to the higher comparable base period in the past two years, the future growth rate will definitely decline. Especially the growth rate in 2022 will be ugly, which is the main reason for the collapse of the stock price, and it is reasonable. The second is to return to flat, demand returns to the level before the pandemic, and the company is brought back to its original shape.

It may become negative growth this year because the base period of the past two years is too high. And the unattainable share price pushed up by the explosive revenue growth caused by the pandemic in the past two years must also be revalued with these two possible outcomes. No matter which one (especially the second), if you can’t maintain a double-digit percentage of revenue growth, you will definitely be abandoned by investors in the future.

Market start a full correction

Correction is not a bad thing

It is good for stock prices to correct due to unreasonable valuations, otherwise all stock market bubbles are likely to burst, the only question is when. The longer it goes and the higher the stock price goes, the more dangerous the uncorrected stock market is, because once the bubble starts to burst, it will take many years to recover.

As mentioned earlier, Nasdaq fell by as much as 78% during the dot-com bubble in 2020. But what everyone forgets is that it took 15 years for the Nasdaq to return to the level of the Internet bubble in 2015, which also caused the S&P 500 index, which represents the U.S. stock market, to be negative in the 10 years from 2001 to 2010. Reward 0.49%! This is the price of stock market madness!

But in fact, this time the growth stocks fell sharply, and there were still some signs to be found before. Growth stocks have risen sharply for two years. In 2020, the Nasdaq index, which represents the growth stocks of U.S. stocks, rose 43.64% in 2020 alone, but the S&P 500 index rose only 16.26% in the same period. In 2021, the Nasdaq rose only 23.2%, but the S&P 500 rose 26.89% in the same period. Investors want to make money in the stock market, long-term investment and focusing on long-term annualized returns are the only unchanging and simple truths.

Investors can’t expect stocks to rise every day, as Buffett said, “Even a great company will have a tough few years.” As an investor, there is only one thing that matters—find companies with sustainable growth and value, don’t sell them after buying them; the word “sustainability” is particularly important. Now is the time to do just that, and give us an opportunity to re-examine the companies that are sustainably competitive and to identify companies that deliver superior long-term returns for investors.

Regarding the importance of the long-term annualized rate of return, interested readers can refer to my other blog article “Investors should pay attention to the annualized rate of return (IRR), How to calculate?“.

Lessons from the dot-com bubble

At that time, the culprit companies that caused the dot-com bubble almost had no profit at all, and some even had no revenue at all, and there was no fundamental support at all, resulting in many small stocks whose market capitalization is not purely speculative, and most of the investors’ fantasy at that time was the dream of getting rich overnight.

Although there are many growth stocks in this wave of negative cash flow, the big difference is that many of them have a market value of hundreds of billions of dollars, and there are also many large stocks with long-term stable earnings. This wave of growth stocks is the largest. The common point is that the valuation is too high, but it is not crazy speculation without fundamentals.

How should investors respond?

Growth stocks have collapsed across the board, providing an opportunity for a comprehensive review. During this slump in growth stocks, investors should calm down and do some homework. Sort out the stocks that have fallen sharply in the past two years . You can enter the market to pick up the bargins during a major downturn and become a winner in the once-in-a-decade property rebalancing opportunity.

Revenue comparison before and after the Codvid-19

As shown in Table 1, the revenue growth rate in the third quarter of 2020, when the pandemic was the worst, and the comparison of the company’s revenue performance in the same period in 2019 before the epidemic, according to my opinion, I divide these stocks into the following three categories:

TickerRevenue growth rate of Q3 2020 Revenue growth rate of Q3 2019

Table 1: Comparison of the revenue performance of companies in the third quarter of 2020, when the pandemic was the most serious, and the third quarter of 2019 before the pandemic

Find the stocks that were killed by mistake

Stocks that were hit by the pandemic and killed by mistake

These stocks have been suppressed due to the epidemic or the lockdown, causing people not to travel far, canceling cross-border business trips or vacations, and spending large sums of money. But once people return to their pre-pandemic lives, based on the steady growth and profit performance of these companies in the past, they are definitely stocks that were mistakenly killed by the epidemic.

Among them are the two major credit card network Visa (ticker: V) and Mastercard (ticker: MA). The past two years have been the weakest period for the stock prices of these two major credit card network companies since they went public. The other is Booking.com (ticker: BKNG), an online travel booking giant. After the pandemic, people will resume booking hotels, flying, and traveling remotely. Of course, the new generation’s favorite, Airbnb (ticker: ABNB), which advertises short-term rentals that can experience the customs and customs of the world, will of course recover after the pandemic.

Stocks whose businesses benefited from the pandemic will continue to exist

These stocks have greatly benefited from the epidemic, but after the epidemic, the business of these companies will still exist, or people’s consumption habits will be changed due to the epidemic. It is still a good investment object in the future, but the growth rate will decrease. The most representative of them are Shopify (ticker: SHOP), the parent company of Shopee (ticker: SE), Mercadolibre (ticker: MELI), etc., as well as contactless payment and financial innovations. PayPal (ticker: PYPL) and Block (ticker: SQ). And vaccine stock Moderna (ticker: MRNA) has proved the huge potential and excellent protective power of mRNA vaccines through Covid-19, and there should be a lot to do in the future.

growth stocks plunge
Credit: Ogutier

Stocks that have benefited from the pandemic but have a bleak outlook

These are stocks that have benefited significantly from the pandemic, but post-pandemic business may disappear or slow down dramatically as people return to normal glory. The companies represented include Zoom (ticker: ZM) for online video conferencing, DocuSign (ticker: DOCU) for online electronic signature and contract management, and Peloton (ticker: PTON) for home fitness equipment.

This arrangement is only my personal opinion and is only for the reference of all investment friends. Remind you that you still have to make necessary judgments based on your own analysis, and then decide on your own to take the next investment that is most suitable for you according to each individual’s situation.

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I am the author of the original text, the abridged version of this article was originally published in Smart monthly magazine.


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