E Boom In Growth Stocks Can’t Last Forever

Since the beginning of the bull market in March 2009, growth stocks have by far outperformed value stocks, as reflected by the iShares S&P 500 Growth ETF (IVW) versus the iShares S&P 500 Value ETF (IVE) chart below (306.26% vs. 202.98%, respectively). However, over the past two-three months, value stocks have begun outperforming growth stocks, and many believe this trend is likely to continue for the foreseeable future, given the relatively stretched valuations of the growth securities. In fact, the eventual bursting of the bond bubble is also likely to further induce out-performance of the value stocks relative to growth stocks amid rising yields.

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Source: Yahoo Finance

Unconventional Metrics

Tech stocks are the largest constituents of the growth sector, even making up 27.16% of the IVW ETF. In a previous article, it had been revealed that the ‘forward multiple’ gap between growth and value stocks are nowhere near the levels witnessed during the peak of the dotcom bubble. However, that being said, there are certainly other trends similar to ones witnessed during the dotcom bubble that do signal that growth stocks are in ‘overvaluation’ territory. More specifically, the fact that more and more growth stocks are being assessed using “nontraditional valuation metrics” that disregard the importance of revenues, profits and cash flows reflects the complacency of investors allocating capital to such securities. This is particularly true for companies with negative earnings and cash flows. Take for example Netflix, where ‘subscriber growth’ has been given great importance while driving the stock price higher over the past several years, despite its ballooning negative cash flow and debt levels.

This was the type of behavior that was witnessed during the dotcom bubble when companies were increasingly being valued using unconventional metrics such as ‘number of page views’. While some unconventional metrics are not necessarily indicative of stretched valuations, but when more and more stocks are being valued using such metrics as opposed to revenues/profits, it is certainly a troubling sign.

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