Large-Cap Growth Stocks Still Hold Luster
Large-cap growth stocks, the darling of the bull market over the past 10 years, still hold promise for clients despite some elevated risks, according to advisors and market observers.Large-cap growth funds have proven winners in industries such as online retail, computer software, smartphones, and social networking that can be compelling for long-term investors despite recent volatility, rising trade tensions between the U.S. and China and seemingly high valuations, according to Robby Greengold, a fund analyst with Chicago-based research firm Morningstar.
“As large businesses, they offer resiliency in turbulent environments and as growth stocks, they can potentially build an investor’s wealth through capital appreciation,” Greengold said. “Those are elements that any investor should want in their portfolio.”
Investors in large cap growth stocks were shaken in the fourth quarter last year after stocks like Facebook (FB), Apple (AAPL), Amazon (AMZN) and Alphabet (GOOG), the parent of Google, fell hard, leading the group to an 11.3% decline in the final three months of 2018, according to Morningstar.
Many investors reasoned the earnings multiples on many of the market’s most dynamic and talked-about companies had gotten too rich, given the possibility of an economic downturn and the Federal Reserve’s ability to manage the situation.
But first quarter performance silenced many doubters of the long-term viability of large-cap growth. The Fed’s signal in January that it wasn’t planning to raise rates reignited enthusiasm for both the broader U.S. economy and the stock market. And over the past decade, those bullish signs for both the economy and markets have allowed large-cap growth to tower over the rest of the stock market.
In the 10-year period ending March 31, large-cap growth stocks have gained a remarkable 21.4% on an annualized basis, compared with only 10.4% for large-cap value and only 7.1% for small cap, according to Morningstar. And those gains have been achieved with only slightly more risk–as measured by standard deviation–than large-cap value funds.
To what degree your clients should invest in large-cap growth funds of course depends on their risk tolerance what they are willing to pay for a dollar of earnings. Large-cap growth stocks–which by definition generate above-average earnings growth–are trading at a forward price-to-earnings ratio of 37, more than triple the multiple of large-cap value stocks, according to Morningstar.
Still, Greengold contends that the valuation as a whole isn’t necessarily exorbitant given even more inflated P/E multiples in the past and the ability of many companies in the portfolio to increase earnings growth and expand their multiples.
To be sure, some advisors are steering away from some names they see as being overbought. David Kotok, the chief investment officer and co-founder of Cumberland Advisors, a Sarasota, Florida-based financial advisory firm, is underweighting large-cap-growth in the ETF portfolios his firm designs for clients.
He is particularly troubled by market-weighted large-cap funds whose performance is skewed toward mega-cap stars that have had outsized runs in the past year. Investors interested in capturing large-cap growth without heavy exposure to the FANG stocks (Facebook, Amazon, Netflix and Google) should consider equal-weight funds, he said, pointing to the Invesco S&P 500 Equal-Weight Technology (RYT) fund as one example.
That concern is justified, but investors sometimes understand they have to take additional risk if they want exposure to the market upside, said David Karp, co-founder of PagnatoKarp, a Reston, Virginia-based registered investment advisory firm.
“Anytime you are buying something that is three-and-a-half times the value of something else, there is an embedded level of risk and a reduced margin of safety,” Karp said. Even so, “everybody wants exposure to the market upside, just as long as you are willing to tolerate moves down in the market.”