[Beginner's Guide to Stock Investing] Why Shouldn't You Buy Growth Stocks During Interest Rate Hikes?

[Image source=AP Yonhap News]

[Asia Economy Reporter Kwon Jaehee] "In a period of interest rate hikes, invest in value stocks rather than growth stocks"

If you have invested in stocks, you have probably heard this at least once. Especially recently, as the U.S. central bank equivalent, the Federal Reserve (Fed), has signaled a 'big step' (a 0.5% point increase in the base interest rate), discussions about growth stocks and value stocks have become even more frequent. So, what exactly are growth stocks and value stocks, and why are they sensitive to interest rate hikes?

What are growth stocks?

Growth stocks are stocks invested in with a focus on the future rather than the present. They refer to stocks that are highly valued for their current earnings growth rate and future potential. Even if they are currently operating at a loss, industries with high expectations of making significant profits in the future are typical examples. In the U.S., Amazon and Tesla are representative. In the Korean market, Naver, Kakao, and Samsung Biologics are examples.

Why are we told not to buy growth stocks during interest rate hikes?

[Image source=Reuters Yonhap News]

Growth stocks perform well during low interest rates and economic recessions. This is because growth becomes scarce when interest rates are low and the economy is weak. Typically, when the economy is poor, corporate earnings decline and investors leave. However, growth stocks expand the market even during recessions. Investors cheer for companies that grow despite the poor economy and buy stocks even at high prices. As a result, stock prices continue to rise and remain overvalued.

Then, what are value stocks?

Conversely, value stocks benefit when interest rates rise. Rising interest rates signal an improving economy, and as the economy improves, corporate earnings improve and the scarcity of growth disappears.

As COVID-19 ends and the economy recovers, investors who had focused on growth stocks are now turning their attention to value stocks. Typical value stocks include banks, insurance, petrochemicals, steel, paper, construction, shipbuilding, distribution, and automobiles.

Are growth stocks only good?

Growth stocks also have drawbacks. Because investors flock based solely on future expectations, stock prices are expensive, and the price-to-earnings ratio (PER) relative to corporate earnings is very high. While value stocks trade at about 10 times earnings, growth stocks can trade at 30 times or even over 100 times earnings.

Another downside is that the future cannot be guaranteed. If future predictions fail, investment losses can be very large. Biotech companies are a representative example. Their stock prices rise based on expectations for new drug development, but if they fail, they can be delisted from the stock market.

[Image source=Yonhap News]

Can growth stocks become value stocks?

Recently, the distinction between growth and value stocks seems meaningless in some cases. Tesla is a prime example. Tesla is a typical growth stock but has risen regardless of interest rates, so it is sometimes considered a value stock.

Among domestic stocks, Hyundai Motor Company is considered a stock that has the appeal of both growth and value stocks. It has consistently generated profits for several years, is currently profitable, and is expected to grow in the future. Hyundai Motor is investing in eco-friendly vehicles such as hydrogen cars based on its accumulated profits and is also investing in autonomous vehicles. Although Hyundai Motor is not a common case, there are companies whose perception changes from value stocks to growth stocks.

This content was produced with the assistance of AI translation services.