From this side of the pond, the track record of US growth companies in the past couple of decades can look impressive. From Apple to The Trade Desk, lots of American business have grown fast by understanding evolving customer demands. As an investor though, the valuation of many US growth shares has put me off them in recent years.
With shares like Amazon crashing in the past year, some valuations may now start to look more reasonable. So, could this be the time for me to shift some of my attention Stateside and start buying US growth shares for my portfolio again?
Relative valuation not relative cost
I must admit, I am tempted. I previously sold Google parent Alphabet (NASDAQ: GOOG) when I felt its valuation was too stretched, for example. But I am tempted to add the company back into my portfolio thanks to what I perceive as its long-term prospects.
In the past year, the Alphabet share price has fallen 35%. That, of course, makes the shares look cheaper than they were one year ago.
But just because the price of a share is cheap relative to what it cost a year ago, that does not mean its relative value has improved. Value is a judgment of what a company is worth, not just its current market price. There are different ways to value shares, but one method I use is looking at its discounted cash flow. In other words, how much spare cash do I expect a company to throw off in future and how does that compare to its enterprise value today?
In its most recent quarter, Alphabet threw off $16.1bn in free cash flow. That is a huge amount, which I think highlights the financial potential of the company in the long term. But it was still 14% lower than in the same quarter last year.
How to value growth shares
So, Alphabet shares have been falling in price. But if current business trends continue, maybe Alphabet shares deserve a lower valuation than before as its long-term free cash flows may be smaller than previously expected.
If so, maybe Alphabet shares are not attractively priced enough for me to buy them again for my portfolio, even after the recent share price fall.
Taking a long-term view
That is where I think I can benefit from taking a long-term approach to investing. With advertising revenues falling, sales and profits at Alphabet risk falling in coming years. The recent quarter may only have been the start: things could get worse from here.
But there are long-term strengths that I see in the business. That includes its huge installed user base, unique technology and strong brands. These remain powerful assets, in my view. In the long term, I see Alphabet as a great business that I expect to generate strong free cash flows. A falling share price makes its valuation increasingly attractive to me.
If I had spare cash to invest today, I would buy Alphabet for my portfolio. Even if some US growth shares fall further in coming months, I think they currently offer good value for me as a long-term investor. Rather than trying to time the market bottom, now seems like a good moment for me to start buying attractively valued shares for my portfolio.
