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Warning: Growth stocks mirror dot-com bubble and pandemic premiums

How to spot a bubble: Signs your investment may be overvalued
Ana Zirojevic

Although the stock market has slightly retreated following the comments from a Federal Reserve policymaker reflecting a lack of urgency in cutting interest rates due to the economy’s strength, the premium of growth stocks relative to value stocks has grown to a level witnessed only twice before in history.

Specifically, the valuation of high-growth stocks has grown 120% in relation to value stocks, regardless of the sector, which is close to the extent seen just two times before – during the dot-com bubble and the Covid pandemic period, according to the data shared by Barchart in an X post on March 5.

Growth stocks vs. value stocks valuation since 1985. Source: Barchart

Indeed, during the dot-com era in the early 2000s, growth stocks premium relative to value stocks reached a massive 145%, and the next growth occurred at 125% during the Covid pandemic start in 2020, each time reflecting a significant distortion in market dynamics and investor preferences.

Possible correction in sight

In other words, it is during these times that investors were willing to pay a more significant premium for the potential growth and future earnings of certain companies experiencing substantial, above-average growth rates and positive cash flow while undervaluing those with a focus on intrinsic value metrics.

This means that the high premium of companies like Amazon (NASDAQ: AMZN), Meta (NASDAQ: META), Netflix (NASDAQ: NFLX), and Nvidia (NASDAQ: NVDA), with revenues increasing much faster than those of their industry peers, might reflect investor expectations for more rapid growth, further innovation, and/or other bullish factors.

On the other hand, it is important to note that such extreme premium levels historically happened alongside intervals of market excesses and preceded periods of market correction and downturn due to overvaluation and investors’ unmet expectations of fast profits from growth stocks.

All things considered, the growth stocks’ premium at historical highs relative to more traditionally valued investments is a warning signal for potential risks associated with such extreme valuation discrepancies, taking into account the already demonstrated trends of subsequent price adjustments.

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