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Tech and growth stocks – what’s happening?

We look at the difference between growth and value, and what this means for tech investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The last few months have seen growth stocks fall out of favour. That’s why the NASDAQ, which houses many of the world’s tech giants, has suffered large losses, along with wider tech indices. But why is this happening, and should those looking for value abandon tech?

FTSE USA technology (dividends reinvested) - total return

Past performance isn’t a guide to future returns. Source: Refinitiv Eikon Datastream 21/02/2022.

First things first – what’s a growth stock?

Growth investors look for businesses they think are likely to grow. They hope to profit as the share price rises in line with improvements in the underlying business. This sometimes means paying a bit more for these perceived long-term strengths.

This is why technology companies are usually considered growth stocks. Exciting new tech tends to command a lot of excitement, even at a young stage, pushing their valuations up in the expectation that the share price will enjoy the benefits of the business building scale.

It’s also worth remembering tech companies are expected to grow a great deal, rather than plod along. Expectations are high.

There isn’t a hard and fast rule when it comes to which valuation makes something a growth stock. Generally, something with a price to earnings ratio over 20 is more likely to be considered ‘growth’. But this needs to be considered on an individual stock basis and you need to look at the whole picture.

This type of investing is geared towards a traditional ‘buy and hold’ approach. That means finding high-quality businesses and holding them for the long term, with the belief they can stomach the ups and downs of the wider economy.

What’s the opposite of growth investing?

The opposite investing style is ‘value’ investing. Value investors look for companies that appear undervalued – where they think a company’s assets or profit potential aren’t fully reflected in the share price. They hope to profit when other investors later recognise this value, and the share price rises to reflect it.

True value investing is notoriously difficult. It’s common for the market’s low assessment of a company’s worth to come from valid concerns over a business’s long-term prospects. But of course, this isn’t always the case. Sometimes a harsh market reaction can be overblown.

What’s been happening with growth and value?

During the pandemic, shown in the graph below, markets fell steeply. That came as investors questioned how companies would fare as the economy suffered. But in the case of value investments, the extent of the market’s reaction was, in many cases, overdone. The sell-off at this time was disproportionate to what was really going on. That’s why value investments have grown faster than we’ve seen previously.

At the same time, and as you can also see in the graph below, growth names have come under pressure more recently.

Russell growth vs. value (dividends reinvested) - total return

Scroll across to see the full chart.

Past performance isn’t a guide to future returns. Source: Refinitiv Eikon Datastream, 21/02/2022.

Why is growth less popular at the moment?

At times of rising inflation and interest rates, investing in highly-valued companies becomes less attractive.

That’s because investors can receive a greater interest rate on their cash savings, making the risks of investing feel less necessary, and therefore less appealing. (More on that later).

Inflation is rising at record rates in some major economies, including the UK and US. That means the cost of day-to-day living is on the up, putting household incomes under pressure. As you might imagine, that can mean investing for the future takes a backseat.

So overall, there’s less appetite to invest in more expensive companies. At the same time as the realisation that recent downward pressure on value names might have been unfair. The net effect is a rotation in what investors prefer.

Why has tech been so severely punished?

The world’s biggest tech stocks – the Apples, Alphabets and Amazons of this world tend to demand fairly lofty valuations.

For want of a better phrase, they’re the growthiest of the growth names. The market demands more per dollar of profit they’re expected to make in the future. That’s because, in general, they’re expected to grow quickly and without too much interruption. That higher entry point puts them at the coalface when there’s a knock to growth-stock sentiment.

Higher valuations also increase the market reaction for small missteps. The expectations for growth stocks are much higher in the current environment, in part because investors demand more for the risk they’re taking.

Today’s risk (high price tags for investing) requires a higher level of compensation (better performance from their investments). Tech stocks are seen as even riskier than ‘normal’ growth stocks, because in quite a few cases, lots aren’t turning a profit yet. Investors are being asked to part with their money on income and cash flow that will hopefully come to fruition down the road.

All in all, the fact tech stocks occupy a great deal of limelight, there’s a tough mix of high scrutiny and high expectations to contend with.

This article is not personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments can fall as well as rise in value, so you could make a loss.

What does this mean for investors?

The sheer size of the world’s biggest tech stocks means when they have a blip, they affect the whole market. That’s why the NASDAQ’s done what it’s done.

We don’t think investors should make investment decisions based on panic or short-term changes. It’s best to invest with the long term in mind. High-quality companies should weather ups and downs.

But with that in mind, now’s the right time to have a look at what you hold and make sure you’re diversified. A truly diversified portfolio means when some areas are struggling, another should, in theory pick up the slack. Now could be the time to add some value investments to a portfolio.

That doesn’t mean you have to stay away from tech. The recent sell-off and subdued sentiment mean the tech sector isn’t purely the growth-fest it once was. In fact, we think it could be an exciting time to consider this sector for those on the hunt for value.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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