Don't give up on growth stocks – especially those that have been trading at a premium to their peers. These stocks could be well poised to deliver outsized returns compared to the rest of the market.
It's an idea that might sound counter intuitive on many levels. First, growth stocks have been on the nose with risk appetite quickly fading in more recent months. You only need to look at the underperformance of small to midcap stocks to see evidence of this.
Secondly, a number of market darlings have fallen hard from grace. Fast food chain Domino's Pizza Enterprises Ltd. (ASX: DMP) and baby food maker Bellamy's Australia Ltd (ASX: BAL) come quickly to mind.
In the meantime, growth stocks have to battle the rising risk to global growth with political uncertainty and patchy economic data from a number of major economies – not least Australia's most important trading partner and frenemy, China.
But this isn't the time to be throwing in the towel as I think so-called "expensive" growth stocks are better placed than most other class of stocks to outperform this calendar year. Call me an eternal optimist, but there are a few reasons that are giving me hope.
For one, the lack of value among value stocks makes me think a turning point is near. As expensive stocks have fallen out of favour, investors have been scrambling to snap up value stocks. I like value stocks but there's almost always a reason why they trade at a discount to their higher quality peers. The fact that value stocks have significantly closed the gap with the higher-end of town rings an alarm bell for me.
This has effectively pushed the price-earnings (P/E) ratio for the S&P/ASX 200 Index (XJO) to levels not seen since 2002! According to data from Market Index, the Australian benchmark trades on a P/E of around 18.6X.
In contrast, construction materials company Boral Limited (ASX: BLD) is looking increasingly attractive on a relative basis despite the stock trading on a P/E of around 20X after surging ahead nearly 27% since the start of this calendar year.
I believe the stock is well placed to continue climbing given that its average P/E over the past few years is actually falling when the broader market is trading on ever higher premiums.
Furthermore, its exposure to the US housing market, a sector that I am bullish on, is a big plus in my view.
Another "expensive" growth stock that is well placed to outperform is gaming machine maker Aristocrat Leisure Limited (ASX: ALL). Its half year results that were released three weeks ago gave analysts and shareholders reasons to cheer as it beat market expectations.
Aristocrat has a habit of under promising and over delivering means the stock should be trading at a healthy premium to the market. But this isn't really the case, particularly on a forward basis given that earnings are tipped to grow by double digits over the next two to three years.
Price, as they say, is really a matter of perception.
