The guppies are finally swimming with the whales. The guppies, of course, are the highest growth stocks, and the whales are the Big Tech names.
Now comes the hard part for the little fishes. They have to keep cutting through the water fast. So don’t dive right in.
This year, the iShares Russell 2000 Growth Exchange-Traded Fund (IWO) is up about 15% this year—to $243. The growth fund bottomed out at $197 in a year ago, a 69% drop from its record high of $333 in early 2021. The reason: higher interest rates. Smaller growth companies, on the whole, take years to turn a profit and may struggle to secure financing when rates rise. In turn, their valuations get crushed.
Also up this year is the Nasdaq 100, home to the Big Tech companies that are generating big profits. That index, though, has gained 38%, pushed higher by artificial intelligence advancements, which increase earnings expectations.
As with all rallies, not everybody caught the entire wave in Big Tech stocks, with their higher valuations. Instead, they bought hey bought smaller names with solid relative value. And that is how the small got a boost from the big.
The Wall Street savvy might be asking: What about fundamentals? Exactly how did the rally play out?
First, fundamentals don’t explain much of the small-cap gains. And second, investor positioning drove both the Big Tech and the small growth rallies.
Portfolio managers had a lot of cash months ago that they poured into the large-cap players. Then, they bid up the smaller growth names.
At the same time, analysts have lowered—by 12%—their aggregate 2023 earnings-per-share forecasts for the growth fund, according to FactSet. With the growth fund up and EPS estimates down, its price/earnings multiple soared to 37 times from below 30. Given the rise in interest rates, the jump is particularly perplexing.
Especially now, companies in the growth fund now must generate far higher profits if they don’t want their stock prices to drop. And the money-losing ones better work to be in the black soon.
A couple of success stories are
Progyny
(PGNY), a provider of low-cost infertility benefits, and
GitLab
(GTLB), an AI-powered operations and security platform for businesses.
Shares of Progyny, which has a $3.6 billion market cap, are up more than 24% this year. Analysts expect more than 30% sales growth this year to over $1 billion and for profit margins to keep rising.
GitLab (GTLB) saw its stock pop after earnings in early June. The company beat sales estimates and posted a narrower-than-expected net loss. The stock is up about 15% this year.
To go back to our fish analogy, the ocean is getting choppy for the guppies. The growth fund is trading in the low $240s. Since early last year, sellers usually have knocked down the price when it hits that range. And it’s just too expensive for any wave of buyers to come in.
Sellers have beaten up Progyny and GitLab the same way. Progyny, at $38, is already flatlining just below $40, its knockdown price. GitLab, at $50, is near its low $50s level.
The point: The market isn’t just punishing poorly performing companies. In the case of small growth, it isn’t even fully rewarding the sturdy ones.
Keep your head above water. Now Isn’t the time to buy a lot of guppies.
Write to Jacob Sonenshine at [email protected]
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