Growth stocks like tech are still cheap and can post strong returns from here, history suggests

  • The Russell 1000 Growth Index historically posted strong long-term returns even from valuations equal to today's levels.
  • Fred Alger Management correlated current price-earnings ratios with future 10-year returns of 7 to 8 percent.

Technology shares are under pressure this month on concerns that valuations are out of control, but a new report suggests growth stocks such as 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 the report by Fred Alger Management.

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," Alger wrote in the report earlier this month.

The Russell 1000 Growth index — which consists of a large number of technology companies — has a current price-earnings ratio 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 indexes. 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 management firm believes this simple method of using the price-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-earnings strategy.