Growth stocks have trounced value stocks for years now and that trend has accelerated in 2020, resulting in an unprecedented valuation gulf. Do expensive growth stocks merit their high valuations or are investors asking for trouble?
Such discussions often focus on today's dominant tech stocks – Facebook, Amazon, Netflix, Microsoft, Apple, and Google. In aggregate, the so-called FANMAG stocks trade on 7.7 times revenues and 55 times earnings, according to Verdad Capital – very steep, but these are incredibly profitable near-monopolies, arguably justifying the belief that you have to pay for quality.
In a report, Verdad asks: are there many companies that are more expensive than the FANMAGs with poorer financials? And the answer is yes: this description is true for 500 of 3,000 US companies with a market capitalisation of at least $100 million.
This group, which Verdad terms the Bubble 500, trade on 13–14 times sales and make “essentially zero” profits. The Bubble 500 has absolutely trounced the S&P 500 in recent years but historically, paying more than 10 times revenues for exciting growth stocks has been “one of the worst long-term investment methodologies ever”, the report warns.
The FANMAGs may deserve their valuations but the same cannot be said for such a “broad bucket of unprofitable hopefuls”, says Verdad. “We don’t know when this will end, but we are firm believers that that which can’t continue, won’t.”
