After a rough year for growth investors in the market, the past few weeks have shown some promise. Many growth stocks have steadily risen from their lows, giving investors hope that the worst is over. As of this writing, Alphabet (GOOG 0.58%) (GOOGL 0.42%) is near $100 after falling to the low $80s, Upstart Holdings (UPST +2.33%) is threatening $20 after falling to $12, and Wayfair (W +2.62%) has roughly doubled from its low of $28.
But it's unlikely that every growth stock regains its former glory; the market is coming out of a bubble, so caution is warranted. These three stocks have the potential for tremendous investment returns moving forward, but realizing that potential could depend on how they address some burning questions about the underlying businesses.
Could a new lawsuit threaten Alphabet's advertising business?
Jake Lerch (Alphabet): Less than one month into 2023, Alphabet, the parent company of Google, has found itself in hot water with the U.S. Department of Justice (DOJ). The DOJ and eight U.S. state attorneys general have sued Alphabet alleging monopolistic practices in the digital advertising market.
This isn't the first time the DOJ has sued Alphabet. A lawsuit brought in 2020 alleged anticompetitive practices at the company's Google Search unit. That case will go to trial later this year.
This new lawsuit targets Alphabet's digital advertising market technology and alleges the company distorted and manipulated ad auctions for its benefit.
NASDAQ: GOOG
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On the face of it, getting sued by the DOJ is terrible news. Litigation costs alone will eat away at Alphabet's margins for years, even if it mounts a successful defense. The worst-case scenario, however, is even more alarming. The company could be forced to spin off portions of its advertising business. In its most recent quarter (the three months ending on Sept. 29), 78% of Alphabet's revenue came from advertising.
What's more, lawmakers on both sides of the political aisle have expressed frustration with the company. Thus, this lawsuit should be seen as a shot across the bow. And investors must take notice: The government has Alphabet in its sights. It may not win the case, but the threat of ongoing -- and future -- government action is a concern that should give investors pause.
Is Upstart Holdings a technology company? Or a lender?
Justin Pope (Upstart Holdings): Few stocks can return from a 95% decline, but lending technology company Upstart is trying. Management's flip-flopping on its balance sheet is a big reason why the stock's been so volatile.
NASDAQ: UPST
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Upstart wants to be a technology company; its platform uses artificial intelligence (AI) to originate loans. Ideally, Upstart sells them to institutional investors, keeping the business asset light. But rapidly rising interest rates have bond investors seeking higher returns. Some of Upstart's loans have poor unit economics, so rather than sell them at a loss, Upstart has held some on its balance sheet.
Image source: Upstart Holdings.
You can see above how Upstart's loans shot up from $140 million in the third quarter of 2021 to $704 million a year later. Management has commented that it will seek a more stable investor network for its loans over the long term, but that will take time. In other words, investors could see loans hang out on the balance sheet for some time.
An asset-light technology company will typically command a much higher valuation than a lender like a bank. Whether Wall Street classifies Upstart as a technology company or a lender will play a significant role in the stock's valuation -- and your investment returns as a result. Investors should monitor Upstart's balance sheet moving forward; increasing or decreasing loans on its books will help answer this burning question.
Will Wayfair's post-pandemic losses prevent it from ever recovering?
Will Healy (Wayfair): Online furniture and home goods retailer Wayfair benefited significantly from the pandemic. Both revenue and the stock price skyrocketed as the lockdowns left consumers with fewer furniture shopping options.
Amid the frenzy, Wayfair temporarily became profitable, and between March and August 2020, its stock rose by more than tenfold.
Today, its losses are back, and the internet and direct marketing retail stock has given back all of its pandemic-driven gains. This leaves investors questioning whether the short-term bump was a preview of Wayfair's future or a temporary phenomenon that will never return.
NYSE: W
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Unfortunately for long-term investors, the latter is the more likely scenario. Indeed, the company has honed its AI capabilities, fostered relationships with over 23,000 suppliers, and built a logistics network that, unlike Amazon's, can ship bulky goods.
However, big tech companies like Amazon can match or exceed Wayfair's AI capabilities without losing money. And though Wayfair's logistics network is not easy to replicate, Amazon likely could modify its infrastructure to compete with the online furniture seller if motivated.
Given these vulnerabilities, it should not surprise anyone that its $9 billion in net revenue for the first nine months of 2022 dropped 13% compared with the same period in 2021. That led to a loss of $980 million for the period, down from a profit of $71 million during the same period last year. Analysts also predict flat revenue growth and continuing losses for 2023, which could further discourage long-term investors.
Nonetheless, not all hope is lost. Its price-to-sales ratio of 0.5 is just above record lows, and Wayfair's logistics-related competitive advantages helped inspire an analyst upgrade. But unless it can drive double-digit revenue growth again, Wayfair offers no apparent path to return to profitability.
