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Growth Stocks and the New Definition of GARP

By Mohit Oberoi, CFA - Published 8 Months ago. 0 Comment
Growth Stocks and the New Definition of GARP
  • Growth stocks have outperformed value stocks hands down over the last decade. The divergence has been quite stark during the pandemic.
  • Once markets used to talk about GARP or growth at a reasonable price. However, in their craving for growth, investors now seem to resort to a new GARP—growth at a ridiculous price.

Growth stocks

Growth stocks have helped US stock markets recover from their March lows. The tech-heavy Nasdaq has hit new all-time highs. The price action seems to defy conventional wisdom and it looks like markets don’t seem to care about the pandemic’s economic costs. To be sure, there are some businesses that have benefited from the shutdowns and stay at home orders.

The great 2020 electric vehicle euphoria

But then, growth stocks’ valuation is now reaching absurdly high levels. Let us look at a few examples and begin with the electric vehicle industry. Tesla, which expected to produce half a million cars in 2020 before the pandemic, has a market capitalization more than Toyota and Volkswagen. Toyota sold 10.7 million cars last year while Volkswagen sold almost 11 million vehicles. Let us not get into the profitability comparison as Tesla has never made an annual profit and in all likelihood wouldn’t make one this year as well. To be sure, as I noted in Why Tesla Cannot be Valued the 'Purist' Way, it wouldn’t be prudent to compare the company to legacy automakers. But then, one has to draw a line somewhere when it comes to Tesla’s valuation.

Electric vehicles

Nikola has also joined the great 2020 electric vehicle frenzy. Its market capitalization soared past Ford’s as markets are excited over the prospects of its semi-truck. While Nikola touts $10 billion in pre-orders, these vehicles are yet to be built and sold. But then, even with no current revenues, Nikola can have a higher market capitalization than Ford, or at least that’s what the market thinks.

Other growth stocks

Shopify, another growth stock trades well above 60 times its trailing sales. There have been instances when on a single day its market capitalization has soared more than its annual revenues. Some tend to draw Amazon’s example but even at the peak of the dot com bubble, Amazon did not go beyond 42 times its trailing sales. Furthermore, that was very briefly and now as we know it with the benefit of hindsight, it was a bubble that eventually burst.

Zoom Video Communication is another growth stock with eye-popping valuations. Valued at more than 70 times trailing sales, it commands a market capitalization of $72 billion.

Growth stocks have outperformed value stocks over the last decade and the divergence has been quite stark over the last couple of years. Famed value investor Warren Buffett is underperforming the markets by a wide margin since the beginning of 2019 and Berkshire Hathaway’s returns are trailing the S&P 500 by around 20% this year as well.

Now, would growth stocks continue to outperform value as the definition of GARP seems to have changed? It might continue to do so in the short term. But then, at some point realism would set in and GARP would be back to what I learned in finance, ‘growth at a reasonable price.’ Also, value investing is not exactly dead. Read Is Value Investing Dead as Many Proclaim for more analysis.



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