Growth Stocks Under the Microscope: What Investors Need to Know

High-Profile Growth Stocks Can Be Volatile

One key risk consideration is how a growth stock compares with the broader market. Beta, a measure of volatility relative to the market, can help investors gauge how turbulent the ride might be. For example, if a growth stock has a beta of 1.5, it is expected to be 50% more volatile than the market. If the market rises by 1%, the stock may increase by 1.5%—but if the market falls by 1%, the stock could decline by 1.5%.

The saying "up the stairs, down the elevator" is particularly relevant for growth stocks. These companies often move from overvalued to undervalued much faster than the other way around. Investor enthusiasm and FOMO (fear of missing out) can drive stocks higher, but the same momentum can work against them in a downturn. Conversely, investors may panic and sell at steep discounts when markets correct. This knee-jerk reaction can lead to missed opportunities, as the risks associated with a business may already be priced into the stock at a significantly lower valuation.

The Market Has a Short Memory

A critical question for investors is: If I was willing to buy a stock at a 30% discount on the way up, should I consider buying it again at the same discount on the way down—assuming business fundamentals remain intact?

The market tends to move quickly from one growth story to the next. Companies that reinvest heavily for growth often lack a dividend yield to cushion losses, making timing and valuation even more critical. Investors who enter late in the cycle may find themselves holding losses in a rapidly shifting environment.

For example, Peloton (PTON) experienced a meteoric rise during the pandemic as demand for at-home fitness soared, but once conditions normalised, its stock price collapsed, showing how quickly the market shifts from enthusiasm to disinterest – see chart below.

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The Growth Stock Landscape: What’s Changing?

In the current environment, market volatility has increased on the back of a changing geopolitical landscape, despite the current rate easing cycles being seen globally. High beta sectors such as technology and consumer discretionary, each have their own nuances however the very nature of them is to expect a more volatile return profile. The days of ‘indiscriminate’ buying may be behind us.

Five Lessons to Keep in Mind When Investing in Growth Stocks:

1. Set price targets and write them down. Define where you believe the stock is undervalued or overvalued to avoid emotional decision-making.

2. Work backwards. Have an understanding on what the market is implying with respect to growth expectations priced in at the current share price and compare that to your own growth expectations.

3. Consider a stock’s beta. Higher beta means greater volatility and the potential for larger pullbacks.

4. Don’t chase paper profits. Buying a stock solely because others have made gains is not a sound investment strategy.

5. Be patient during corrections. Assess whether a stock is truly overvalued or if a sell-off presents a buying opportunity at a dream price.

Growth investing can be rewarding, but success depends on discipline, valuation awareness, and an understanding of market cycles. Keeping these principles in mind can help investors navigate the inevitable ups and downs of high-growth stocks.