Although 2022 was a rough year for the stock market, growth stocks took more of a beating than others. With so much economic uncertainty about 2023, many investors may be wondering if it's safe to buy growth stocks again.
The easy answer is yes. The better answer is that for investors who have a long time before retirement, it was never time to stop.
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Understanding the why
Stock prices are determined by supply and demand. If more people are selling a stock than buying it, the price will drop. If more people are buying than selling, the price will increase.
Investors moved away from growth stocks in 2022, which led to a dramatic drop in their prices. This shouldn't come as a surprise, however.
With not-so-ideal economic conditions, it makes sense investors would want to steer clear of growth stocks -- which are largely priced on potential -- and lean more on battle-tested and recession-resistant stocks. It seems a bit more logical that a blue-chip company like Walmart (WMT -0.65%) or Coca-Cola (KO 0.68%) will likely weather bad economic storms better than younger growth companies that may not even be profitable yet.
It's important to remember this because it helps put into perspective some of the why behind certain growth stocks' recent drops. There's a huge difference between a company's price dropping because something fundamentally changed with the business (like increased regulation or a change in business model), versus the price drop being a byproduct of broader conditions in the stock market.
Looking past the stock price
What makes a stock a growth stock is that it increases its revenue and earnings at a much faster pace than its industry/market average. If you're examining a beaten-down growth stock, it's important to focus on its financials and growth metrics to see if they match the trend of the stock.
Are revenue and earnings growing considerably? Is the company increasing customers? Is the total addressable market large enough to justify investing for potential? If the answer to these questions is yes, the stock's decline could very well just be a byproduct of broader economic and stock market conditions.
When it rains, it pours for growth stocks
Historically, growth stocks have always gotten the short end of the stick during market downturns. Let's look at the iShares Core S&P 500 (IVV -0.23%), which tracks the largest 500 public U.S. companies, and the iShares S&P 500 Growth ETF (IVW -0.59%), which tracks the growth stocks within the S&P 500. Here's how these two ETFs have performed over the past 12 months.
Data by YCharts.
Last years wasn't kind to the S&P 500, but it was especially brutal to growth stocks. Conversely, growth stocks often benefit more during the early stages of bull runs. From mid-February to mid-March 2020, the stock market plunged because of the global COVID-19 pandemic. After that point, the stock market went on an unprecedented rally until the end of 2021.
Here's how the iShares Core S&P 500 and iShares S&P 500 Growth ETF performed during that period. They were considerably different from one another.
Data by YCharts.
You don't want to assume the trend of growth stocks outperforming the market during bull runs will continue just because it's happened before, but it should be encouraging to investors nonetheless. The economy won't always be on the brink of recession, and at some point, brighter days will arrive.
The best thing you can do as an investor is make sure you're prepared when those brighter days come. A good way to do this? Grab some great growth stocks that may have "overcorrected" during this last bear market, and stay focused on your long-term plans.
