Warren Buffett once told investors they must remember two things: "First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy."
Those words are worth revisiting in today's economic climate. During the past year, all three major U.S. stock market indexes fell into bear market territory, dragged down by high inflation, rising interest rates, and recession fears. But smart investors know that fear-driven downturns are buying opportunities -- not because every beaten-down stock will recover, but because they leave many companies brimming with potential trading at discounted valuations.
Here are two growth stocks that fit that later description that I see as excellent buys before the next bull market.
Roku: The most popular streaming platform
Many brands have cut their ad budgets as discretionary consumer spending has softened in response to high inflation. That trend led to disappointing third-quarter results for Roku (ROKU 5.41%). Its revenue climbed just 12% to $761 million -- a considerable deceleration from its 51% growth in the prior-year period -- and it reported a GAAP loss of $0.88 per diluted share, down from a profit of $0.48 per diluted share a year earlier. Those results contributed to the continued sharp decline in Roku's share price, which was set in motion by broader economic uncertainty and business challenges.
This is a good time for investors to step back and consider the big picture. Streaming media is undoubtedly still taking audience share from traditional linear television, and Roku is the most popular streaming platform in the U.S., Canada, and Mexico as measured by streaming hours. In other words, Roku is engaging viewers more effectively than its competition, which makes it a particularly valuable partner to content publishers and advertisers.
Additionally, management has outlined an ambitious growth strategy that aims to supercharge engagement and strengthen the moat around its business. The company is investing in content (licensed and original) for its ad-supported streaming service, The Roku Channel, and those investments are paying off. In the third quarter, The Roku Channel once again ranked among the top five channels on the platform in the U.S. in terms of engagement.
Roku is also expanding into smart home devices, including cameras, video doorbells, and lighting. That may seem like an odd direction for the company to grow, but Roku is already the top-selling smart TV operating system in the U.S., so the company has the "technology and expertise in hardware, software, and services to deliver a smart home ecosystem that is simple, powerful, and delightful," according to CEO Anthony Wood.
Finally, Roku is expanding internationally at a measured pace. It brought its ad business to Canada in 2021, and it brought its ad business and The Roku Channel to Mexico in 2022 -- expanding its revenue opportunities in two nations where it ranks as the top streaming platform.
Looking ahead, Roku may continue to struggle in the near term, but its strong market position and the secular shift toward streaming media should allow the company return to profitability in the future. According to research firm Omdia, online video ad spending is expected to grow at an annualized rate of 14% over the next five years to reach $362 billion in 2027, which puts Roku in front of a big addressable market. And with shares trading at 1.7 times sales -- the cheapest valuation since Roku went public in 2017 -- now is a good time to buy this growth stock, especially because the company has a great shot at reaccelerating sales growth when the economic climate becomes more favorable.
Upstart: Disrupting the multitrillion-dollar lending industry
The shaky condition of the economy has been even more troublesome for Upstart Holdings (UPST 3.90%), a fintech company that operates an artificial intelligence-powered lending platform. Default rates on loans have trended upward as inflation has put financial pressure on consumers, and banks have tightened their lending policies in response. Meanwhile, rising interest rates have made it more costly to borrow money, causing demand for credit to decline.
That one-two punch led to dismal third-quarter results for Upstart. Loan origination volume dropped 48% year over year to $1.9 billion, revenue fell 31% to $157 million, and the company posted an adjusted loss of $19 million, down from an adjusted profit of $57 million in the prior-year period. Worse yet, management expects its revenue to fall by more than 50% year over year in the fourth quarter. That gloomy outlook, coupled with its disappointing financial results and uncertainty surrounding its novel business model (i.e. using artificial intelligence to assess credit risk), has the knocked the stock down 97%.
However, the stock is now trading at 1.1 times sales, its cheapest valuation ever. More importantly, the underlying investment thesis for the fintech is still intact: Traditional FICO-based credit models consider a limited number of data points, meaning banks often make lending decisions without understanding the true risk a borrower presents. That results in higher loss rates and drives interest rates higher for all borrowers, as those who repay their loans will eventually subsidize those borrowers who default. Upstart aims to remove those inefficiencies. Its platform considers far more data in its analysis than FICO-based models, and it uses artificial intelligence to correlate those data points with the risks of fraud and default.
That ultimately results in lower loss rates for lenders. In fact, one study found that Upstart reduced default rates by 53% at the same approval rate compared to traditional credit scores. Better yet, for all loans originated since 2018, Upstart's artificial intelligence engine has separated high-risk borrowers from low-risk borrowers with five times more precision than FICO-based models. If the company can produce similar results through this tightening phase of the credit cycle, adoption of its platform could skyrocket when inflation cools and interest rates fall. Until that happens, Upstart shareholders can expect extreme volatility.
With that in mind, Upstart estimates its addressable market to be $1.5 trillion, a massive opportunity compared to its loan origination volume of $1.9 billion in the most recent quarter. That's why risk-tolerant investors should consider buying this growth stock today.
