Growth Traps

Growth stocks soared 42% in 2023,* but with a slowing economy and possible recession in 2024, investors need to be wary of growth traps. A growth trap is a relatively pricey stock that seduces you into paying a premium because Wall Street analysts believe the company will see rapid revenue and earnings growth in the future. Problem: If that growth misses consensus estimates by even a small amount, the stock price often gets crushed. Example: Discount retailer Dollar General reported modest revenue and earnings growth in the first half of 2023, yet its stock plunged nearly 40% in value, and by September its shares were half the price they were at the start of the year. Reason: Analysts expected budget-conscious consumers to flock to Dollar General amid high inflation and interest rates.

If there’s a recession this year, expect plenty of growth traps to collapse. The most expensive stocks with the highest valuations likely will get hit hardest. To avoid getting burned…

Stick with high-quality, growth-at-a-reasonable-price (GARP) stocks. They are more resilient in recessions because they have strong balance sheets and cash flow…consistent growth and lower investor expectations.

Consider investing in the recent top-10 holdings of the GMO ­Quality Fund, which invests in large-cap growth stocks—Microsoft Corp. (MSFT)…UnitedHealth Group (UNH)…Johnson & Johnson (JNJ)…Amazon.com (AMZN)…Apple (AAPL)…Alphabet (GOOG)…French aerospace and defense manufacturer Safran (SAFRY)…Meta Platforms (META)…Irish IT-services giant Accenture PLC (ACN)…and Oracle Corp (ORCL).

*As measured by the Russell 1000 Growth Index through December 29, 2023.