The big casualty of this year’s plunging markets has been growth stocks—big technology firms and other companies whose shares investors pay a premium for because they can grow their earnings much faster than the overall market. Growth stocks have powered the bull market for more than a decade—but with the Federal Reserve the most hawkish it has been in two decades, there is a major shift in sentiment. Reason: Fast-growing companies are valued on the assumption that the bulk of their profits will come in the future. But higher interest rates and bond yields make the value of those prospective earnings less attractive.
Todd Ahlsten, lead manager of the Parnassus Core Equity Fund (PRBLX)—a “blend” fund with a balance of quality growth stocks and stable, quality value-oriented stocks—says long-term investors don’t have to give up on growth stocks. But you need to be realistic about how these stocks will fare in the new environment and adjust your approach…
One of my first learning experiences as an investor was in 1980, when my father was laid off from his job as a TWA pilot. Short-term interest rates were nearly 20%, and it was the middle of a recession. We’re a long way from that now, but I treat every environment as precarious and worry about worst-case scenarios. Even if inflation is peaking, as many suggest it is, getting it down to the 2% Federal Reserve target isn’t going to happen soon. At best, it’s going to take a few years, and that means higher-than-normal inflation and tighter monetary policy are likely, which will weaken the economy. Although the business environment remains prosperous, I am concerned about the potential for corporate earnings disappointments in 2022. Strategies I’m suggesting now…
Be sure your portfolio’s core holdings are “high-quality compounders”—resilient companies that are tapping into secular, long-term trends and that can improve and compound their earnings through all kinds of economic environments. Other traits these companies should have: A rock-solid balance sheet and ample cash to sail through tough times…wide moats, meaning that the companies have enduring competitive advantages in their industries and can raise their prices without losing customers …savvy management…and high environmental, social and governance (ESG) standards, which help avoid business problems such as customer boycotts, lawsuits and employee retention. Two of my favorite high-quality compounders now…
Danaher Corp. (DHR) is like the Berkshire Hathaway of life sciences and biopharma diagnostic tools, a diversified conglomerate with more than 20 leading companies. I especially like its biologics and bio-processing businesses, which are booming thanks to the development of gene and cell therapies. Recent share price: $255.78.
Mastercard (MA). Despite global economic slowdowns, this credit card giant will benefit as the trend continues toward digital transactions and away from cash. There is significant upside here as the global travel recovery picks up steam. Recent share price: $332.57.
Invest in companies that still can thrive with high inflation and volatile commodity prices. Stocks benefiting from the current environment…
Deere & Co (DE). The largest supplier of farm equipment and machinery in the US has become a leader in “precision agriculture.” Next-generation tractors use artificial intelligence, guidance systems and hands-free driver assistance to help farmers increase crop yields with less work, water and fertilizer. Also: High commodity prices are improving farmers’ profits, allowing them to upgrade their equipment. Recent share price: $297.70.
Intercontinental Exchange (ICE) is the parent of the New York Stock Exchange, which—along with the Nasdaq—has a near-duopoly on trading stocks in the US. But ICE also operates about a dozen financial exchanges worldwide, including futures exchanges in the US, Europe and Abu Dhabi, which trade options in agriculture, energy and metals. Recent share price: $95.83.
Conversely, I avoid companies hurt by inflation and decelerating economic growth. Example: I sold our fund’s position in FedEx. Its revenues are slowing as e-commerce wanes…and the company’s labor and energy costs are rising.
Look for beaten-down growth stocks. Large growth stocks have fallen about 26% this year in anticipation of a revenue slowdown. That’s creating the opportunity to scoop up long-term bargains. Look for companies that can innovate, improve profitability and rebound once the environment normalizes. Growth stocks selling at attractive prices now…
Adobe (ADBE). The digital-media software company sells a suite of tools to students and businesses to create online content and ads. The stock has fallen 34% as part of the tech-sector sell-off even though Adobe has nearly a monopolistic position in its market niches. Recent share price: $379.86.
The Home Depot (HD) also has lost around 29% of its value so far this year because Wall Street is worried that a housing-market slowdown will hurt the home-improvement giant’s revenues. Even if we have a recession in housing, The Home Depot will benefit from powerful tailwinds in the coming years, including a housing shortfall in the US…employees remodeling their homes to accommodate remote work…and the fact that 50% of homes are 40 years old or more, requiring increasing repair. Recent share price: $292.41.
Take advantage of deglobalization. For decades, businesses have become accustomed to the unfettered, cross-border flows of goods and services. But ongoing China-US trade tensions and the world’s supply-chain issues have made American companies realize the importance of having manufacturing capacity in their own regions. Railroads will become more valuable as we look to Canada for energy, chemicals and lumber materials…and to Mexico for auto manufacturing and vehicle parts. One stock that’s a major beneficiary of deglobalization…
Union Pacific Corp. (UNP) operates a railroad network that spans the western two-thirds of the US and serves Mexican gateways. It has invested more than $35 billion to modernize its 32,200 miles of track. Recent share price: $209.13.
Don’t give up on Big Tech giants—but be selective. The FAANG stocks (Meta, parent company of Facebook…Amazon.com…Apple…Netflix…and Alphabet, parent company of Google) have dominated market indexes and soared in price for more than a decade. But their individual outlooks are different depending on their valuations and their ability to navigate inflation pressures and labor and energy costs. One I’m avoiding: Amazon.com (AMZN). Even after a share-price decline of about 32%, the online retailer’s forward price-to-earnings ratio (P/E) is 68 (versus an average of 16 for the S&P 500 index). That’s too rich given that the company’ revenue growth is down sharply and that overhead and labor costs are squeezing profit margins. One Big Tech stock I am buying…
Alphabet (GOOG), one of our largest positions, is down about 24% in 2022 but has a P/E of 20, which is an even cheaper multiple than during the 2020 pandemic sell-off. Alphabet doesn’t face the inflationary pressures of Amazon.com, and it maintains a dominant position in Internet search and ad sales, generating $67 billion in free cash flow last year. Even if there is a recession, advertisers will continue to spend heavily on Google and YouTube. Recent share price: $112.77.
