Growth stocks like tech are still cheap, history suggests

Technology shares are under pressure this month on concerns that valuations are out of control, but a new report suggests growth stocks like the tech group can still post strong long term returns from these levels.

Even at a price-earnings ratio near 20 for growth stocks, history shows returns 10 years later were in the high-single digits, on average, according to a new study.

Source: Fred Alger Management

“Valuations for larger cap growth stocks may give pause to some investors, but history suggests that current price-to-earnings (P/E) ratios indicate the asset class remains attractive,” according to a report from Fred Alger Management earlier this month.

The Russell 1000 Growth index – which consists of a large number of technology companies – has a current price to earnings ratios of 19.7. At that level, Alger approximates potential 10-year returns of 7 to 8 percent based on historical analysis. Alger’s aggregate valuation looked at 10-year returns from December 1978 through April of this year.

The Alger report was distributed on the investor research network Harvest.

Further, Alger research compared the Russell 1000 Value and Russell 1000 Growth indices. The “Growth advantage,” Alger says, is in the index’s higher expected earnings per share growth, higher equity returns and a lowered risk via better balance sheets.

The investment manager believes this simple method of using the price to earnings ratio is the best way to predict future returns. According to Alger, just under 80 percent of 10-year returns can be statistically explained by this initial price to earnings strategy.