Large-Cap Growth: Brace for Earnings Revisions

Director, Asset Allocation
Follow Jeff Weniger
05/01/2020

So much for crashes bringing valuations back to Earth.

Here we are in the middle of an economic depression—one that maybe that lasts a few months, or maybe one that goes on for a long while—and yet the Russell 1000 Growth Index is still trading for 27 times trailing earnings (figure 1).

Figure 1: Price-Earnings Ratio (Trailing 12 Months)

Figure 1_Price-Earnings Ratio Trailing 12 Months 

For definitions of the terms in the chart, please visit our glossary.

Why the robust valuations?

Because Wall Street still hasn’t gotten around to looking in the mirror when it comes to the beloved U.S. large-cap growth style investment box, the asset class that could do no wrong for the last decade.

Estimates from Bloomberg for the Russell 1000 Growth Index call for earnings to compound at a double-digit rate for 3 to 5 years—from a starting point of record pre-coronavirus earnings (figure 2).

Figure 2: Bloomberg Long-Term Operating Earnings Growth Estimate

Figure 2_Bloomberg Long-Term Operating Earnings Growth Estimate

The thing about forecasted 15% earnings growth from now until 2023, 2024 or 2025, should that somehow come to pass, is that it would blow away historic precedent.

Going back to 1994, Russell 1000 Growth Index earnings increased at a 6.7% annualized clip, only slightly faster than the Russell 1000  Value Index’s 5.9% annual growth rate (figure 3). Relative to supposedly stodgy value stocks, the “growth” in growth stocks has largely been an illusion.

Figure 3: Growth of Earnings, U.S. Large Caps (12/30/94 = $1)

Figure 3Growth of Earnings US Large Caps

Coincidentally, in the five years to the first quarter of 2020—a period of economic expansion, not COVID-19-inspired malaise—the Russell 1000 Growth Index saw earnings increase at exactly the same pace as history: 6.7% annually (figure 4).

To grow 15% for several years from the current starting point is, let’s just say, a stretch.

Figure 4: 5-Year Annual Earnings Growth

Figure 4_5-Year Annual Earnings Growth

Investors have found relative safety in growth stocks in 2020 on account of fears of economic contraction.

Interestingly, both the Russell 1000 Value Index and our main value index, the WisdomTree U.S. LargeCap Dividend Index, which weights stocks by their dividend as a proportion of the total dividend pie, grew earnings faster than the Russell 1000 Growth Index since the credit bubble (figure 5).

Figure 5: Calendar Year Index Earnings ($bn)

Figure 5_Calendar Year Index Earnings ($bn)

Logic says to brace for downside revisions to the market’s expectations for growth stocks in the coming years.

The Russell 1000 Growth Index is at 1,7111 and earned $62.42 in the year through March.

Earnings will decline from the economic shutdown; the question is how much.

But I wouldn’t hold my breath waiting for Russell 1000 Growth earnings of $95.02 by this time in 2023 or $125.75 in the first quarter of 2025 (figure 6). Such figures seem fantastical.

Figure 6: Russell 1000 Growth Index Earnings per Share (EPS)

Figure 6_Russell 1000 Growth Index Earnings per Share (EPS)

Figure 7 plots five WisdomTree ETFs on the growth-value spectrum:

DGRW (WisdomTree U.S. Quality Dividend Growth Fund)
EPS (WisdomTree U.S. LargeCap Fund)
DLN (WisdomTree U.S. LargeCap Dividend Fund)
DHS (WisdomTree U.S. High Dividend Fund)
DTN (WisdomTree U.S. Dividend ex-Financials Fund)

Figure 7: WisdomTree Returns Attribution

Figure 7_WisdomTree Returns Attribution 

For definitions of terms in the chart, please visit our glossary.

Sooner or later, we believe the face of disappointment in this market will be in U.S. large-cap growth.

It will likely not be a one- or two-month problem either. It could be something akin to the seven-year struggle of growth stocks after the dot-com bubble started to unwind.

Let the spectrum chart in figure 7 be your guide as you engage our strategies.

Unless otherwise stated, data source is Bloomberg, as of 4/23/20.

 

 

1As of April 27, 2020

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About the Contributor
Director, Asset Allocation
Follow Jeff Weniger
Jeff Weniger, CFA serves as Director, Asset Allocation at WisdomTree. Jeff has a background in fundamental, economic and behavioral analysis for strategic and tactical asset allocation. Prior to joining WisdomTree, he was Director, Senior Strategist with BMO from 2006 to 2017, serving on the Asset Allocation Committee and co-managing the firm’s ETF model portfolios. Jeff has a B.S. in Finance from the University of Florida and an MBA from Notre Dame. He is a CFA charter holder and an active member of the CFA Society of Chicago and the CFA Institute since 2006. He has appeared in various financial publications such as Barron’s and the Wall Street Journal and makes regular appearances on Canada’s Business News Network (BNN) and Wharton Business Radio.