Growing companies that previously traded at a big premium have been hit hard in this market downturn. Higher inflation and interest rates have presented headwinds for the economy, and when uncertainty increases in the near term, Wall Street typically sells first and asks questions later.
But this downturn will eventually fade away and lead to another bull market. Whether you already own several stocks or are just starting to put together a diversified portfolio, investing $1,000 in growth stocks should pay off nicely down the road. Here are two to consider.
E-commerce stocks offer attractive value now
The U.S. e-commerce market is projected to cross $1 trillion in 2022, according to Insider Intelligence. It's a massive opportunity for a differentiated marketplace like Etsy (ETSY -1.27%), which specializes in handmade or vintage items. Yet, investors are completely overlooking the value in e-commerce stocks right now because of difficult growth comparisons with the acceleration in online orders during the pandemic.
Etsy's gross merchandise sales in the second quarter were down 6% year over year but more than double the level in the same quarter in 2019. Most importantly, Etsy doesn't have an inventory like traditional retailers, which helps it achieve higher margins. Amazon, for example, is entering an aggressive spending cycle to expand fulfillment capacity, which has wiped away its profitability this year. Meanwhile, Etsy generated $530 million in free cash flow on $2.4 billion in revenue over the last four quarters.
Etsy should be able to grow revenue and free cash flow at double-digit rates for many years. It has significantly less penetration and brand exposure in the next 15 largest markets outside the U.S. and U.K. At the current price-to-free cash flow ratio of 29, investors could earn a return on their investment over the next 10 years that reflects the underlying growth of the business. If Etsy grows its free cash flow by around 15% per year, which is lower than its past record, and trades at the same valuation, that means investors could quadruple their money by 2032.
Value merchandise is always in demand
Five Below (FIVE 1.88%) has been a fast-growing retailer over the last decade, expanding to over 1,200 stores. Last year, sales were up 24% on a two-year annualized basis, reaching $2.85 billion. However, the weakening economy has pressured sales growth this year, sending the stock down 32%. This is a great opportunity to add this growth stock to your portfolio as the business continues to open new stores and invest for long-term growth.
Five Below is popular with value-conscious shoppers who are attracted to its wide variety of merchandise priced between $1 to $5. The brand's growing appeal can be seen in the success of the new Five Beyond concept, where stores are offering value items priced above the traditional $5. Five Beyond shoppers typically buy more items per transaction, which can help stores increase inventory turnover and earn better returns on invested capital.
Management isn't letting the soft economic environment stop its long-term plans. Executives see room for more than 3,500 stores by 2030. That would put the company on pace to double sales and more than double profits by 2025, based on management's calculation.
The shares currently fetch a price-to-earnings (P/E) ratio of 33. While that is higher than the S&P 500 average P/E of 23 right now, investors can expect growth retail stocks to trade anywhere between 20 to 40 times earnings over the long term.
S&P 500 P/E Ratio data by YCharts.
If Five Below earns $10 per share in three years, consistent with management's target, the stock could be worth $200 or higher. At these share prices, Five Below should deliver market-beating returns for shareholders.
