Growth stocks were hit hard last year as inflation, and rising interest rates eroded purchasing power. Russia’s invasion of Ukraine, an energy crisis in Europe, and the pandemic also complicated matters. As the effects of inflation and tightening monetary policy filter through to the economy and corporate earnings, further volatility could be in the cards for stocks.
But in a white paper issued by T. Rowe Price, author Joseph Fath, portfolio manager for the T. Rowe Price Growth Stock ETF (TGRW), argues that not all companies will be affected equally by a possible economic slowdown, and amid uncertainty, investors should not lose sight of the longer-term opportunities that high-quality growth stocks can provide.
TGRW invests in growth stocks with one or more of the following characteristics: strong cash flow and above-average earnings growth; the ability to sustain earnings momentum in economic downturns; and occupation of a niche in the economy and the ability to expand during times of slow economic growth. Top holdings in the ETF as of December 31 include Microsoft Software, Apple, and Google parent Alphabet.
T. Rowe Price remains confident in the long-term value of growth investing. Per Fath: “The extended runup in growth stocks that occurred in the aftermath of the global financial crisis was supported by meaningful increases in free cash flow per share, not just expanding valuation multiples. We believe that some of the powerful trends that have driven outsized growth remain intact and should have room to run.”
Fath argued that long-term trends, like the transition from data centers to cloud-based technology and electric vehicles, favor long-term growth for many large-cap growth companies. Exposure to a compelling growth trend is not enough, so it’s critical to have a nuanced understanding of individual companies and industries.
When establishing its positions with established tech giants, TGRW’s management team considers valuations, how effectively they are investing in growth initiatives, the levers they could pull to create value, and the extent to which they are returning capital to shareholders.
While these businesses have advantages of scale, constant due diligence is needed to determine if they can overcome the law of large numbers. That’s where the fund being actively managed can come in handy.
Though possibly painful in the short term, the challenging economic environment should create compelling investment opportunities where there’s a mismatch between a company’s valuation and growth potential.
“In managing the fund, we are always on the lookout for companies that we believe are responding to the difficult environment in ways that can create value over a longer time frame,” Fath added.
TGRW carries an expense ratio of 0.52%.
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