Momentum Stocks Getting Bid Up

While most equity market indices are up only a few percent year-to-date, momentum stocks with strong growth outlooks (particularly in the tech sector) have outperformed significantly. As an unrepentant value investor, this has been a source of deep frustration to me since most of these stocks hardly seemed like bargains going into 2010.

As demonstrated in the table below, I have selected a basket of 10 stocks that loosely fit the parameters of a “momentum growth” stock. The ten stocks include F5 Networks, Netflix, Akamai Technologies, Finisar, Salesforce.com, Citrix Systems, Riverbed Technologies, NetApp, VMWare, and Acme Packet.

Nearly all are up over 50% year-to-date, recently hit fresh 52-week highs, and have business models that fit squarely into the portfolios of managers seeking growth. Unlike the bubble years of 1999, when nearly any tech stock with a “.com” at the end of its name was bid up to ridiculous levels, these 10 stocks have strong competitive positions within very attractive secular growth markets. And most importantly - All are profitable and generating decent free cash flow.

My only contention (and of course the most critical determinant to a value investor) is the massive multiple these companies trade at relative to current and 1-year forward earnings estimates. As an experiment, I am going to pretend that I purchased $10,000 of stock in each one of these ten companies as of the close of 9/20/10. If a similar experiment had been performed at the end of 2009, one would be up 111% year-to-date.

It will be interesting to see how this basket of stocks performs 6 months out when I will evaluate the results on my blog. I honestly have little conviction on how things will turn out, but the value investor in me thinks that most will be substantially lower.

Now I always like to say that I passed on Google when it came public at $85 (and I evaluated it pretty extensively pre-IPO) so my opinion on growth stocks should be taken with a healthy dose of skepticism. However, the disconnect between growth and value seems more extreme than at any point since the waning days of the tech bubble. Perhaps this experiment will lend some credence to this view (or once again make me eat my words!)

I look forward to reporting back in March of next year.