Growth stocks typically witness high interest from investors when the rate hikes peak and the prospects of cuts emerge.
While a cut in interest rates is highly improbable at this juncture when inflation is yet to come down sustainably, a pause in rate hikes may lure investors toward growth stocks.
Market participants tend to choose growth stocks anticipating a rapid increase in their earnings which make them more appealing in the future and boost their prices.
Value stocks, on the other hand, trade at a reduced rate than their inherent value. Investors prefer value stocks when there is much uncertainty on the economy and market front.
Value stocks are inexpensive and have the potential to expand and provide significant profits in the long run.
(Read more about value and growth stocks here: What are growth stocks? What are value stocks?)
With interest rates at their peak, inflation easing and the economic outlook better than many countries in the world, it looks like an opportune time to bet on growth stocks.
Analysts agree with that. But they underscore that growth stocks can give good returns if their valuations are reasonable. In simple terms, don't make aggressive bets on growth stocks. Look at their valuations and then decide.
Aamar Deo Singh, Head Advisory at Angel One, believes growth stocks are definitely a category to watch out for given the signs of plateauing interest rates but the million-dollar question is, at what price-to-earnings ratio (PE)?
(PE Ratio is the ratio between a company's stock price and its earnings per share. It is used to determine the market value of a firm.)
It is important to consider the valuations of the stock before taking a bet on growth stocks.
"Given the higher inflationary trajectory, the real growth of growth companies is sure to be impacted, hence, a more prudent approach shall be to study this category on a case-to-case basis. For those investors, who are looking at a steady growth, but not superlative growth, it makes more sense, as the risks to the downside also stay mitigated," said Singh.
Mitul Shah, Head of Research at Reliance Securities, underscored that growth-oriented strategies take the front seat when interest rate peaks out, growth companies reorganise their capex plan factoring appropriate debt-equity combinations.
He pointed out that in expectation of better growth prospects driven by capex and higher earnings, such stocks witness earnings upgrades and valuation relating. Therefore, investors prefer growth stocks in such scenarios.
Shah said investors can start accumulating good quality mid-cap growth stories at this level.
Deepak Jasani, Head of Retail Research at HDFC Securities, pointed out that the relationship between the rate cycle and growth stocks works on most occasions mainly because the discounting factor for future earnings comes down. However, there may be times when this relationship fails.
"While interest rates seemed to have peaked for now, growth stocks could be going by historical trends and coming back in favour. However, one will have to take into account the following i.e. their current valuations (how much did this fall when rates were rising?), their current earnings growth outlook, their institutional ownership pattern and the current and probable disruptions in their business model. So this choice is more stock-specific and cannot be generic," said Jasani.
G. Chokkalingam, Founder & Head of Research at Equinomics Research & Advisory, also said once the economy stabilises, rates start correcting downward to reach long-term equilibrium. This reversal of the rate cycle improves aggregate demand and hence, growth stocks become major beneficiaries.
However, he added that the end of the rate hike cycle helps rate-sensitive sectors more.
In other words, investors should not just focus on the growth stocks at this moment and look for opportunities in sectors that have a direct correlation with the rate cycle.
"Rate-sensitive segments like banks and real estate companies get more benefits. They not only benefit from an upward shift in demand but also from improved profitability. For instance, banks get the opportunity to make profits from gains in bond prices, apart from higher demand for credit growth. Real estate companies, apart from seeing a spurt in demand, their interest costs fall which in turn lifts profits directly," Chokkalingam observed.
Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.
