A combination of factors could be creating a once-in-a-decade opportunity for investors in growth stocks. Here’s a closer look at why this segment of the market is looking more attractive than ever before.
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Growth stock bear market
Growth stocks have fallen out of favour for a simple reason: better alternatives. Why should investors wait for a loss-making company to eventually become profitable when they can earn 5% risk free from Guaranteed Investment Certificates (GICs) and Term Deposits.
If interest rates remain elevated, savers and investors have better (safer) options for their cash. That means paying 60 times revenue for a growth stock is unjustifiable. Unsurprisingly, the market has priced this in. Growth stocks like Shopify (TSX: SHOP) and Lightspeed Commerce have lost up to 37% of their market value over the past year.
However, the factors that made these stocks unattractive are quickly rolling over.
Interest rates and valuations
There are signs that interest rates have plateaued and could be heading lower in the months ahead. The Bank of Canada just announced another rate pause at 4.5%. The team published a Monetary Policy Report, which showed that inflation is rapidly decelerating and could hit a 2.5% annual rate by the end of the year.
Put simply, the central bank believes it is winning the war against inflation, and this could encourage it to start cutting rates, by the end of the year if not in the next few months.
Meanwhile, growth stocks have dipped to lower valuations. Shopify was trading at a ludicrous price-to-revenue ratio of 63.9 in September 2020. The stock is now trading at just 10 times revenue, while revenue continues to grow at 28% year over year.
The market is in a rare position right now. Valuations are still low, while macroeconomic tailwinds are gaining steam. This could be an ideal time for investors to plunge in.
The best growth stocks to buy
Companies that have sustained their pace of growth and seen their valuations drop lower than their historic average are probably the best targets. Shopify is probably part of this group. Analysts at JMP Securities upgraded their price target to US$65 this morning. That implies an upside of roughly 39% (on the U.S.-listed shares).
However, I believe small-cap tech companies like WELL Health (TSX: WELL) are better targets. These stocks have been overlooked and are trading at better valuations.
WELL Health offers virtual healthcare and clinic data management software. Last year, it acquired numerous startups to expand its portfolio and entered the U.S. market. These strategic moves ignited a growth boom. WELL Health reported $569.1 million in sales last year — 88% higher than the previous year.
In 2023, the company expects up to $685 million in total revenue. Meanwhile, the stock is down 45% from its all-time high. The company’s market value is just shy of $1.2 billion, which means the price-to-revenue ratio is 1.75.
WELL Health also delivered $76.6 million in adjusted EBITDA in 2022 and expects to generate $84.2 million in 2023. That means the stock is trading at a forward price-to-EBITDA ratio of 14.3.
Put simply, this could be a once-in-a-decade opportunity to buy this growth stock at an attractive valuation.
