Preserving Key Details and Retaining Structure
The recent decline in shares of small, fast-growing companies may have reached its lowest point. These companies have been heavily impacted by higher bond yields, which are not expected to rise significantly.
The iShares Russell 2000 Growth exchange-traded fund (ticker: IWO) has experienced a 12% drop since the end of July. During this period, the 10-year Treasury yield has risen to approximately 4.7% from just below 4%, driven by the Federal Reserve’s decision to keep short-term interest rates elevated to combat inflation. This poses a challenge for developing companies that anticipate the majority of their profits in the future, as higher long-dated bond yields diminish the value of those future profits.
However, there is a silver lining on the horizon. The 10-year yield is unlikely to rise much further, indicating a potential rebound for growth stocks, at least in the short term.
Inflation is not expected to sustain at levels high enough to support yields at their current state. According to St. Louis Fed data, the 10-year yield exceeds expectations for average annual inflation over the next decade by more than two percentage points. This compensation for inflation is at the upper end of the historical range. Consequently, buyers are anticipated to enter the market, driving up the price of the 10-year bond and causing its yield to decrease.
Small-Cap Growth Stocks: A Promising Opportunity
When it comes to smaller growth stocks, a decrease in yield can result in a significant surge. But how much growth can we expect? Let’s delve into the key levels for the Russell 2000 Growth ETF.
Currently priced at $225 per share, this ETF has consistently found buying support just above the $200 mark since the second half of 2020. On the other hand, sellers have been stepping in around the $250 level. To break above this level in the near term, the market would need to have confidence that yields will remain below recent peaks.
Let’s take a closer look at Progyny (PGNY), a reputable provider of low-cost infertility solutions and a component of the Russell 2000 Growth Index. While the company boasts a market capitalization of $3.2 billion, its stock price has experienced a decline of approximately 19% since the end of July. Interestingly, this drop seems to be tied more closely to the rise in yield rather than any company-specific performance. Fortunately, Progyny exceeded forecasts for second-quarter sales and earnings per share in early August, and analysts’ estimates have increased slightly since July according to FactSet.
Should the 10-year yield decrease, stocks like Progyny are expected to rebound. However, even if yields stabilize rather than fall, small-cap growth stocks still carry great potential over an extended period. This is because stable yields would allow earnings multiples to remain intact, propelling stock prices higher.
FactSet predicts that the ETF’s aggregate earnings per share will grow by over 40% annually over the next two years, reaching approximately $10.80 by 2025. Assuming a forward price/earnings multiple of around 30 times, the ETF could potentially trade at $324 by the end of 2024—a remarkable 46% gain from its current price.
With such promising prospects in store, small-cap growth stocks present an exciting opportunity for investors.