Week 20 Day 1: Growth Stocks: Betting on the Future

Growth stocks include companies like Amazon, Tesla, Nvidia, and Netflix. They typically have high revenue growth, low or no dividends (profits are reinvested), and high price-to-earnings ratios (investors pay a premium for future growth). Amazon's stock rose from $18 in 1997 to over $180 in 2024 -- a 10x return that rewarded believers in its growth story.

Growth stocks dominate during periods of rapid innovation and low interest rates. From 2010-2021, growth stocks (as measured by the Russell 1000 Growth Index) returned approximately 17% annually versus 12% for value stocks -- a massive outperformance driven by the tech boom, low rates making future earnings more valuable (lower discount rate), and a 'winner-take-all' dynamic in technology platforms. Key characteristics: Price-to-earnings ratio above 25 (often 40-100+). Revenue growth above 15-20% annually. Little or no dividend (all cash reinvested). Stock price driven by expectations and narrative. The risk: growth stocks are priced for perfection. If a growth company misses earnings by even a small amount, the stock can drop 20-40% in a day. When interest rates rise (as in 2022), future earnings become less valuable in present terms, and growth stocks get hammered. ARK Innovation Fund (ARKK), a concentrated growth fund, fell 75% from its peak. Many individual growth stocks (Peloton, Zoom, Rivian) fell 80-90%.

Growth investing's theoretical basis rests on the present value of expected future cash flows: P = Sum[CF_t / (1+r)^t] for t=1 to infinity. Growth companies have cash flows heavily weighted toward the distant future (low current earnings, high expected future earnings). This duration effect makes them highly sensitive to changes in the discount rate r. A 1% increase in r has a disproportionately large negative impact on stocks with cash flows far in the future -- explaining why growth stocks sell off sharply when interest rates rise. The Fama-French growth factor (low book-to-market) has historically delivered negative excess returns relative to value, approximately -3% annually since 1926. However, this masks enormous time-variation: growth dominated 1995-2000 (tech bubble), underperformed 2000-2007, dominated again 2015-2021 (big tech era), and underperformed in 2022. Novy-Marx (2013) showed that adjusting for profitability, the value/growth distinction becomes less meaningful: profitable growth companies (Google, Apple) have genuinely higher expected returns than unprofitable growth companies (speculative startups). The modern understanding is more nuanced than 'value beats growth' -- quality-adjusted growth stocks can be excellent investments.