The stock market has always been full of ups and downs, but few stocks have been victims of volatility as much as growth stocks. After a bull run from mid-2020 to late 2021, 2022 proved to be the "return to reality" year for many growth stocks.
For Gen Z investors, this dip in growth stock prices shouldn't be discouraging; it should be viewed as an opportunity.
What are growth stocks?
Growth stocks are companies expected to grow at above-average rates compared to other companies in their industry. Below are examples of growth stocks and how their revenue growth year over year compares to their sector's median growth rate.
| Company | Revenue Growth Rate | Sector Median Growth Rate |
|---|---|---|
| Tesla (TSLA -1.06%) | 38.3% | 9.5% |
| CrowdStrike (CRWD -1.82%) | 54.4% | 13.3% |
| Shopify (SHOP 1.03%) | 22.3% | 13.3% |
Data source: Seeking Alpha. Percentages rounded to the nearest tenth.
Many investors flock to growth stocks because they present an opportunity for higher growth than many other types of stocks. This can be very lucrative for those who invest in them. The above three companies have far outperformed the S&P 500 -- which many use to gauge the overall stock market's performance -- over the past five years.
Data by YCharts
The short end of the stick
It isn't all smooth sailing with growth stocks. Unfortunately, when it rains in the stock market, it often pours for growth stocks. For example, the S&P 500 declined by over 19% in 2022. The S&P 500 Growth Index -- which tracks the growth stocks within the S&P 500 -- declined by over 30% during that span.
Data by YCharts
Growth stocks are more volatile than other stocks because they're more sensitive to economic conditions and investors' reactions to these conditions.
When the economy is good, investors are usually more willing to take risks with growth companies still in their early stages. When the economy is not so good, investors usually turn to more stable, proven companies that have more resources and have stood the test of time.
This exit from growth stocks causes prices to drop, which is a great opportunity for younger investors.
Gen Z has one of the best resources on its side
One of the most powerful forces in investing is time. Gen Z investors may not have as much money to invest as older generations, but they have something that can't be replicated, no matter how much money someone has: Time.
With growth stocks, time is important because a lot of those companies are priced on potential and expectations, as shown by their often high price-to-earnings (P/E) ratios. A company's P/E ratio tells you how much you're paying for each dollar of a company's earnings. The higher the P/E ratio, the more "expensive" a stock is.
Growth stocks usually have higher P/E ratios. Investors are willing to pay more for them because they expect the companies' earnings to keep growing at high rates. Younger investors are in a good position because they have the time to wait for growth stocks to produce good long-term results.
Older investors may not have the time to wait for growth stocks to grow into their valuations. And many don't want to deal with the volatility that comes with growth stocks -- especially if they'll need access to their money relatively soon for something like retirement or a child's college tuition.
The upside can be worth the wait
Nobody can say with 100% certainty what will happen in the stock market. That's even more true of volatile stocks like growth stocks. However, history has shown that although growth stocks get the short end of the stick during downturns, they reap a lot of benefits when the market is on the up.
Instead of shying away from growth stocks because of the drastic drops many of them have had over the past few years, look at it as a gift. Market dips allow investors to buy promising companies at "discounted" prices. In the case of the current dip, many of these growth stocks are trading around their pre-COVID-19 pandemic levels.
You don't want all of your stock portfolio to be growth stocks because of their volatility, but they can play a good role for many investors. It's best to make them part of a well-diversified portfolio that includes other types of stocks, such as dividend or value stocks.
Having a diversified portfolio reduces some investing risks and ensures you're not too reliant on too few companies, sectors, or types of stocks. It's one of the key ways to produce great long-term results while lessening some of the risks along the way.
