There is a feeling in financial markets right now that the U.S. and global economic environments are actually improving. Look no further than Citi’s Economic Surprise Index, which measures how economic data is coming in relative to expectations. For the first time since early 2019, this index has poked into positive territory.
If the U.S. and global economic environments are actually improving, then the long end of the U.S. Treasury yield curve shouldn’t be so low. Right now, the long end of the curve is basically screaming “recession.” The data disagrees with this assessment. Almost always, the data wins out. Thus, there are murmurs out there that the long end of the yield curve should actually move higher over the next few months.
While that is great news for the economy, it’s bad news for growth stocks. Low rates inflated growth stocks, because as rates went lower, so did the discount rate for which investors used to discount future profits. Growth stocks get all of their value from future profits. Thus, as the discount rate on those future profits tumbled, the present value of those future profits soared, and so did growth stocks.
The opposite could happen, too. Rates could rise, and if and when they do, growth stocks could drop.
Of course, this blanket assessment doesn’t apply to all growth stocks. For many of them, this unwinding of the growth trade that was inflated by low rates will just be a blip on the radar. Once rates stop moving higher, these stocks will stop moving lower, and they will continue on their secular up-trends.
But, for some growth stocks, this unwinding could be more serious. Which growth stocks could get hit hardest in this unwinding period? Let’s take a look at five growth stocks to sell as rates creep higher.
Growth Stocks to Sell as Rates Move Higher: Chipotle Mexican Grill (CMG)
Source: Northfoto / Shutterstock.com
YTD Gain: 88%
One growth stock which looks like it could get hit particularly hard if/when rates move higher as the U.S. economic outlook improves is Chipotle Mexican Grill (NYSE:CMG).
Shares of the fast-casual Mexican eatery are up more than 88% year-to-date, mostly because the company has successfully and impressively executed on its turnaround initiatives, including building-out the digital delivery business, expanding the menu, and re-branding the chain as a “healthy ingredients” restaurant. Comparable sales have turned into sharply positive territory. Margins are have run higher. Profits have soared. So has CMG stock.
But part of this rally has unequivocally found support in low rates. How else do you explain a restaurant sock trading at over 45-times forward earnings? The average forward earnings multiple in the restaurant sector is 28, less than half of Chipotle’s forward multiple.
As such, if/when rates creep higher over the next few months, CMG stock could get hit particularly hard — not because the fundamentals here aren’t good, but because the valuation looks almost entirely dependent on rates remaining low.
Source: Sundry Photography / Shutterstock.com
YTD Gain: 9%
One growth stock which has already been hit hard in the unwinding of the growth trade in anticipation of higher rates is Workday (NASDAQ:WDAY).
Workday is a market-leading provider of cloud-hosted enterprise resource planning solutions. The cloud growth narrative has been on fire this year. So has Workday’s growth narrative. In 2019, Workday’s revenues, profits, and stock have all marched higher. But, as I’ve pointed out before, WDAY stock has marched into aggressively overvalued territory, and investors are finally starting to notice as the company’s numbers have shown signs of weakness.
Over the past two months, WDAY stock has shed more than 20%, mostly thanks to slowing growth trends in the company’s most recent earnings report. During those two months, the 10-Year Treasury yield actually dropped from over 2% to about 1.6%. Thus, even with the long end of the curve dropping, WDAY stock has still dropped big over the past two months because the growth narrative here is losing momentum.
If the long end of the yield curve reverses course here and starts to move higher, that will add more pressure to what is an already pressured WDAY stock. That added pressure should result in material weakness in Workday stock for the foreseeable future.
Match Group (MTCH)
YTD Gain: 80%
Another growth stock that seems aggressively overvalued and which could get hit hard in the event that rates do move higher is Match (NASDAQ:MTCH).
MTCH stock is up 80% year-to-date — and up 400% over the past three years — as the company has emerged as the unchallenged leader in the secular growth online dating space. Specifically, two things have happened here. One, Match has acquired all of its competition (ex: Bumble) and now holds a portfolio of apps which cumulatively dominate the entire online dating landscape. Think Facebook (NASDAQ:FB) of online dating. Two, online dating has turned into a super valuable industry, as consumers have expressed ample willingness to pay up for premium and exclusive online dating services and perks.
Consequently, Match’s user base, revenues, and profits have all expanded dramatically over the past few years. This big growth has fueled big gains in MTCH stock. But, this is now a stock which trades at 37-times forward earnings, on revenue and profit growth that was under 20% last quarter. That’s a really big multiple for not-that-big of growth. Excluding legal fees, Facebook is growing revenues at a faster rate and profits at a comparable rate. And FB stock trades at just 19.5-times forward earnings.
From this perspective, it does appear that low rates are inflating the valuation underneath MTCH stock. If/when rates do move higher from today’s all time low levels, then MTCH stock could suffer from material multiple compression.
Source: Michael Vi / Shutterstock.com
YTD Gain: 388%
It’s tough for me to put streaming device maker Roku (NASDAQ:ROKU) on any “stocks to sell” list. The long-term growth narrative is just so good. But, ROKU stock has come so far, so fast, that I do think this stock could get hit hard if/when rates creep higher.
Big picture, ROKU stock is a long-term winner. The company is transforming into the cable box of the streaming TV world, and in so doing, will one day have over 100 million active accounts, from which the company will be able to extract tons of high-margin dollars through TV ad sales and subscription sharing agreements. This company is in the first few innings of a very big long term growth narrative — and that narrative will ultimately end with ROKU stock being way higher in the long run.
In the near-term, ROKU stock is ahead of itself. See the math here. It’s tough to justify a price tag above $150 today for this stock, even under aggressive long-term growth assumptions. The only justification for a price tag above $150? Low rates support it. But, if that low rate support disappears, you could see a big sell-off in ROKU stock.
As such, while I love the growth narrative underlying ROKU stock, I’m also worried that the stock could give back gains in a hurry if/when rates move higher.
Source: monticello / Shutterstock.com
YTD Gain: 41%
Joining Chipotle as the only other non-tech growth stock on this list, coffee retail giant Starbucks (NASDAQ:SBUX) seems susceptible to a sizable pullback in the event rates move higher.
The logic here is simple. Starbucks is firing on all cylinders today — positive comps, upward moving margins, double-digit profit growth, etc. That’s why SBUX stock has rallied 41% year-to-date to fresh all-time highs.
Starbucks is also growing at a slower pace than it has over the past several years. Sure, profits are expected to grow at a 10%-plus pace for the foreseeable future. But since 2014, EPS growth has been largely north of 15%, and often north of 20%.
During that 15%-plus profit growth stretch, SBUX stock averaged a 25-times forward earnings multiple. Today, during a slower growth era, SBUX stock is trading at 29-times forward earnings. A bigger multiple for slower growth? That doesn’t make sense … unless you consider that today’s valuation is inflated by low rates.
That’s exactly what is happening. SBUX stock is trading at a bigger-than-normal multiple today for slower-than-normal growth because low rates support a bigger multiple. That low rate support could disappear over the next few months. If it does, SBUX stock could be due for some serious pain.
As of this writing, Luke Lango was long FB.
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