With inflation down to 3.9% in November, I think 2024 is shaping up to be a great year for UK growth stocks. It’s for this reason I’m rushing to make a shopping list of what to buy for my Stock and Shares ISA.
Why might growth stocks recover?
It’s worth just being clear on what I’m talking about here.
A growth stock has the potential to increase earnings at an above-average rate. While certainly not always the case, this sort of business tends to be smaller. Think FTSE 250 and below, rather than the heavyweights that make up the FTSE 100.
Growth stocks understandably tend to perform better when inflation’s falling. As this cools, central banks drop interest rates. This means any debt they may need to finance their expansion costs less.
Falling rates could also be good news for consumer-facing companies as shoppers feel more inclined to splurge.
Now, if we are to see a juicy recovery in these sorts of stocks next year, it makes sense to hold them in a tax-efficient account. Who wants to hand over a sizeable chunk of those lovely gains to the taxman?
That said, it makes no sense to go charging in and buying any old thing.
I want ‘quality’ growth
Like billionaire investor Warren Buffett, I hunt companies that have some sort of competitive advantage over rivals.
This doesn’t need to be a new product or service. It could come in the form of brands that people habitually buy. Or it may be based on the hassle involved in switching to another provider. The growth I’m looking for just needs to be decent.
Like UK super-investor Terry Smith, I also want to see evidence that these companies have compounded investors’ money at a higher-than-average rate over time.
One metric for judging this is ‘returns on capital employed’. This is how much a business gives back relative to the cash shareholders pump into it. Anything over, say, 20% is good enough for me. Some businesses, such as fantasy figurine maker Games Workshop, consistently post return on capital employed (ROCE) around 60%! Needless to say, I’m already invested.
I’m also wary of anything with a wobbly balance sheet. As mentioned earlier, companies often need to borrow money to expand. But this needs to be done with care, even in good times. So low or no debt is preferred.
What might go wrong
One thing worth remembering is that I have no idea where the markets will go next. I may think growth stocks will do well in 2024 but the opposite could easily play out. That rate cut (or cuts) may not come as soon as expected, or be less than expected. Some other random event could also get investors worried.
This is why I think it’s important to have some balance in my portfolio. This means holding some established blue-chips where jumps to revenue and profit are less likely.
On the flip side, this usually translates to a nice passive income stream via dividends. Importantly, these also escape the clutches of the taxman if held inside an ISA.
Armed with this diversified bunch of stocks, I should be able to get through whatever 2024 has in store. Fingers crossed, it will be the beginning of another bull market.
