This year’s tale of woe for growth stocks, particularly those in the disruptive/innovative camp, is well-documented, but those declines could be creating some valuation opportunities in a corner of the equity market that rarely offers discounts.
That could be good news for disruptive growth exchange traded funds, including the ARK Next Generation Internet ETF (NYSEArca: ARKW). ARKW typically focuses on blockchain, cloud computing, e-commerce, and fintech equities, among others. All of those groups have been badly battered this year, but ARKW is also home to several tech names that qualify as undervalued today.
“Many technology stocks were overvalued in 2020 and 2021, a lot of these stock prices were too high to begin with,” Morningstar’s equity research director for technology Brian Colello says.
A prime example of a stock that benefited from during the early days of the coronavirus pandemic that rapidly fell out of favor as the reopening trade took hold is Zoom Communications (NASDAQ:ZM). That stock is now down more than 80% from its pandemic highs, but that may be a case of too harsh a punishment. At the very least, it’s no longer accurate to say that Zoom is too richly valued.
“But the market momentum has swung so far in the other direction that some names are now cheap,” adds Colello.
Some previously expensive tech stocks, including some ARKW components, are now more reasonably valued than they have been in some time.
“A total of 69 companies, more than half of the 136 U.S.-listed technology stocks covered by Morningstar, are now considered undervalued and have a rating of 4 or 5 stars,” notes Morningstar’s Jakir Hossain. “That is a more than four-fold increase from a year ago when just 15 technology stocks were considered undervalued. Since then, the appetite of investors for riskier growth stocks has soured as more aggressive interest rate hikes and concerns about a potential recession have dampened investor expectations for the sector.”
The impact of rising interest rates on growth stocks is playing out this year. In simple terms, rising rates create headwinds for companies with longer-dated cash flows.
While it’s hard to see the forest through those trees today, the result is more attractive valuations on stocks such as crypto exchange operator Coinbase (NASDAQ:COIN) and software provider Splunk (SPLK). In order, Coinbase, Zoom, and Splunk combine for more than 14% of ARKW’s weight.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.