More Room to Grow?
Investors are concerned that growth valuations are stretched and no longer supported by fundamentals. Harbor believes that there is more room to grow, and that we are not in Tech Bubble 2.0.
Earnings are Driving Share Prices
During the Tech Bubble, there was significant dislocation between actual earnings and stock prices. Today, S&P 500 earnings are trending much more in line with prices.
The chart below compares the level of the S&P 500 Index (black line) with the earnings of the underlying companies comprising the index (blue bars). During the Tech Bubble period from the late ‘90s to early ‘00s, you can see that there is a disconnect between the price of the S&P 500 and the earnings of its constituent companies. In contrast, during recent periods, earnings have risen in line with the index.
Source: Stern NYU, January 2020
Growth Stocks Now vs. the Tech Bubble
Few mega-cap tech names are dominating headlines and index weightings. But are valuations supported by fundamentals? Harbor believes so based on the actual profitability seen today vs. during the Tech Bubble.
Leading growth stocks have had a significant run, and while valuations are stretched, they are less stretched than during the Tech Bubble. As shown below, earnings, free cash flow multiples, book and sales multiples are significantly lower, and net margins have nearly doubled.
|Earnings and FCF Multiples are ~50% lower today than in the tech bubble||Growth companies are significantly more profitable today with operating margins near 30% and net margins that have nearly doubled||Book and Sales Multiples are ~25% lower today than in the tech bubble|
Source: FactSet, July 2020
Growth Performance in Drawdowns
The global pandemic has driven significant market volatility and led to sharp selloffs and steep recoveries. Growth has provided downside protection in recent major drawdowns vs other asset classes.
The chart below shows excess performance of the Russell 1000® Growth Index (bars) vs. the Russell 1000® Value Index (horizontal line) during recent market drawdowns. In four of the six time periods, growth outperformed value, providing excess returns during the Global Financial Crisis, the China Collapse in 2016, market declines in early 2018, and the early COVID-19 selloff period.
Source: Morningstar, July 2020
- Growth companies have had a significant run, but performance has largely been supported by fundamentals
- Growth has provided excess returns during recent market drawdowns
- A strategic allocation to growth remains an important aspect of a well-diversified portfolio
Legal Notices & Disclosures
The Russell 1000® Growth Index is an unmanaged index generally representative of the U.S. market for larger capitalization growth stocks. This unmanaged index does not reflect fees and expenses and is not available for direct investment. The Russell 1000® Growth Index and Russell® are trademarks of Frank Russell Company.
The S&P 500 Index is an unmanaged index generally representative of the U.S. market for large capitalization equities. This unmanaged index does not reflect fees and expenses and is not available for direct investment.
The Russell 1000® Value Index is an unmanaged index generally representative of the U.S. market for larger capitalization value stocks. This unmanaged index does not reflect fees and expenses and is not available for direct investment. The Russell 1000® Value Index and Russell® are trademarks of Frank Russell Company.
The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. The information provided in this article is for informational purposes only.
The information provided in this article should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, and countries mentioned may change at any time and may not represent current or future investments.
© 2020 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
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