Growth Stocks

While we achieve the most eye-watering returns (and of course losses) on early stage exploration stocks, we also maintain a part of our Portfolio in revenue generating businesses, looking to grow.

Growth companies are established businesses that are making money, and focus on growing key financial metrics, typically cash flow and/or profits.

They tend to have easy-to-follow business models, with readily identifiable success based on earnings/revenue growth.

A “bad” year for a growth stock is nowhere near as bad as it is for a high risk exploration stock.

Growth stocks still give us the chance for great returns, but make up a more stable part of our portfolio, which is heavily weighted to way more risky bets.

As listed companies are often valued at multiples of these financial metrics, growth companies tend to deliver capital appreciation IF they can grow.

They also tend to be less volatile compared to junior explorers, emerging tech and/or biotech companies, with less downside as well as lower upside returns.

These stocks generally represent up-and-coming companies in the early-to-mid phases of their life cycle.

It is not uncommon for these businesses to fund growth via debt, and hence they can be particularly susceptible to rising interest rates. They are also often reluctant to pay dividends - even with strong cash flow - as they can use funds to chase further growth instead.

Last year was a poor year for growth stocks in general, battling higher interest rates combined with an inflationary environment contributed to lower investor confidence in several sectors.

Looking ahead to 2023, there still appears to be choppy conditions for growth stocks, as inflationary pressures and high interest rates appear to be slowing consumer and business spending.

However, a mid-year bottom for growth stocks is not off the cards if inflationary pressure eases, rate hikes pause or reverse and more capital is freed up for higher risk growth companies.

Our view is that the opportunity for cash generating businesses is through acquisition, and we wouldn’t be surprised if in the next 12-months lots of industries undergo consolidations.

Despite a difficult period ahead for the sector, well run companies with disciplined spending can emerge stronger as the industry consolidates around them and unprofitable competitors (or competitors with no clear roadmap to profitability) fall away.

What the analysts say

Hyperion Asset Management’s Mark Arnold has a long track record of investing in high quality growth businesses. Over the past five years, their Australian Growth Fund has delivered strong returns in excess of 10% per annum.

QVG Capital’s Josh Clark also has a strong track record of investing in quality growth stocks. His long-short fund was crowned the No. 1 Australian equities strategy in 2020.

What about the bear case?

Typically, growth stocks do well during prosperous economic periods, as consumers and businesses spend.

On the flip side, a recession could have a lasting impact on the desirability of growth companies.

With increasing labour and energy costs driven by inflation, could hurt the bottom line of some growth businesses.

Growth companies funded by debt will need to continue to generate cash flows to pay off the liability - which can be difficult when rates are rising and costs are going up.

If revenue generating businesses continue to tap the market for funds during this period to maintain operations, it could be at steep discounts to current share prices.

Should a broad bear market arise (especially in conjunction with higher inflation), consumer spending tends to dry up, further impacting cashflows for many growth companies.

This could certainly be the case for the year ahead, which would adversely affect growth stocks.