Cathie Wood has made a name for herself promoting "disruptive innovation" and the stocks leading that charge. Her Ark Innovation ETF (ARKK 0.19%) has driven market-beating returns over the last five years despite the massive sell-off in tech growth stocks over the last six months.
Admittedly, the short-term track record of that fund paints a more negative picture. However, over a long-term time horizon, these stocks should not only rise but also outperform the indexes for two key reasons.
1. Tech growth stocks are the future
Innovative tech growth companies tend to succeed because they redefine certain aspects of our lives. Perhaps no company demonstrates this point better than Netflix (NFLX 2.25%). Even after a massive drop, its stock has risen by more than 17,000% since its 2002 IPO.
Netflix drove change by pivoting increasingly to streaming media as the technology became available. Over time, its easy availability and lower cost drove consumers away from video stores and cable TV plans.
Today, Netlfix has numerous competitors. Consequently, the massive sell-off and the multiple contractions in the stock signify one major change -- Netflix is no longer a stock of the future but one of the present.
In other words, it is now the mainstream and will likely lose its designation as an emerging growth stock. As mentioned before, the Ark Innovation ETF seeks to invest in the stocks that could become the next Netflix. It bought Tesla early, and in 2019, Cathie Wood said it would rise to a split-adjusted level of $800 per share. Three years later, it sells for about $1,000 per share.
Moreover, the fund invests in companies that could become the next Netflix or Tesla. Ark Innovation components such as Teladoc Health, Coinbase, Roku, and Block hold the potential to drive massive returns through disruptive innovation within their respective industries.
2. Valuation will work in its favor
Unfortunately, the mass sell-off in tech growth stocks outlines the risks and uncertainties of such investments. The Ark Innovation ETF has fallen by almost 60% from its high, and high-growth stocks like Upstart (UPST -4.52%) are off by more than 80%.
Upstart has the potential to change the loan evaluation business, and it carries important risks investors should know, making success far from guaranteed. Still, in economics, the law of demand states that as prices fall, demand increases. Although emotions can counter the law's effects for a time, buyers and sellers eventually react to price.
Analysts forecast that its earnings will grow by 30% per year over the next five years. Such predictions are notoriously inaccurate (the company predicts a 65% increase in revenue for 2022), but such hypotheses illustrate the point.
Its price-to-earnings (P/E) ratio stands at 55 as of the time of this writing. If the stock price stayed constant amid 30% net income growth, the P/E ratio would fall to 42 next year, 33 the following year, and 25 the year after that. At some point, this pattern takes valuations to low levels, leaving the stock nowhere to go but up. Such a trend makes these secular growth stories hard to ignore in any market environment.
Don't give up on tech growth stocks
Indeed, the recent drop in Netflix stock signified the end of its time as a growth stock, and other tech growth stocks have suffered amid a painful sell-off.
Nonetheless, disruptive innovation investors such as Cathie Wood continue to beat the indexes in the long term. Moreover, growth tech companies continue to change aspects of our lives and drive massive revenue and stock price growth in the process. As such stocks become cheaper, history shows that these are times to add positions, not run away.