CONTRIBUTORS
Andy Dinnhaupt, CFA
Director of Research
Franklin Mutual Series
While investors were focused on the dizzying rally in artificial-intelligence (AI)-related stocks over the past year, not all tech firms marched higher unimpeded. We have seen missteps related to investment plans, antitrust challenges and other concerns knock individual stocks down from their lofty valuations. For value investors, we believe compelling opportunities emerge when a growth company seemingly breaks.
“Broken growth” doesn’t mean a broken business. It describes a shift in the market’s perception of a company’s growth trajectory. When a company’s earnings momentum falters, investor enthusiasm evaporates and valuation multiples compress (a stock’s market value relative to a financial metric such as earnings or other measures); a company that growth investors once loved can suddenly fall into value investors’ domain. That creates opportunities for value investors to invest in growthy stocks at value stock prices.
The value of growth
Growth and value are not mutually exclusive concepts. As disciplined value investors, our goal is to buy a good company at a price below its actual worth, then rely on a catalyst to close the pricing gap. We think a thorough analysis of growth prospects is necessary to assess a company’s value. Sales growth, margin trends and free-cash-flow trajectory are all part of this equation. Alone, a low price-to-earnings multiple is not sufficient criterion to identify a value company.
Often, growth stocks’ faster earnings growth is priced at a multiple too rich for value investors. But when the price of a growth company falls, or breaks, this dislocation can offer opportunity to unlock exceptional value creation where strong fundamentals meet attractive pricing.
Fundamental value is future value
Recognizing broken growth opportunities requires a forward-looking mindset, deep fundamental research, and an appreciation for how cyclical sentiment interacts with intrinsic worth. Relying solely on static measures, like price-to-earnings ratio or book value, offers a limited view into analyzing a business. Instead, we advocate for a more dynamic approach comparing today’s price not just to current performance but to the fundamental value implied by forward forecasts. This analysis allows an investor to identify companies that, while temporarily out of favor, may be significantly undervalued relative to their future potential. Markets often misjudge companies in the short term, but we believe rigorous research guides us toward those companies with intrinsic strength and long-term potential.
Exhibit 1: How to Invest in “Broken Growth”
The chart illustrates a hypothetical scenario where a company's stock price falls sharply after a disruption in expected earnings growth leads to negative investor sentiment. This can suggest a potential investment opportunity. If strong corporate fundamentals remain intact, earnings expectations can recover and investor sentiment may improve, leading to renewed stock price appreciation. The chart is not country-specific.
Case study 1: Into the multiverse
One example of broken growth can be found in a leading global digital platform that connects billions of people online. Once considered the ultimate growth stock, its shares declined sharply following concerns about app tracking rules, competitive pressures and a sizable increase in spending. For many investors, these issues signaled the end of the company’s high-growth era. Growth investors piled out, sending the valuation plummeting despite several of the company’s competitive advantages remaining intact. For value-oriented investors, however, this pivot in investor sentiment marked the beginning of a new opportunity.
Despite near-term headwinds, the company retained one of the most powerful advertising ecosystems in the world, enabling highly efficient, targeted marketing for millions of small and mid-sized businesses. As global digital advertising continued to expand, the firm’s scale and data advantage remained unmatched.
When management pivoted toward cost discipline and operational efficiency, sentiment began to recover—but valuation had already reset to compelling levels. What the market viewed as a broken story, disciplined investors saw as a reset: a dominant franchise temporarily mispriced by fear.
Case study 2: A growth wolf in value clothing
This next illustration comes from a global technology leader whose core business sits at the intersection of digital advertising and cloud computing. Once celebrated for innovation, the company became the subject of intense skepticism as the emergence of AI sparked fears that its dominant search and data businesses were at risk of disruption. As a result, investor sentiment turned sharply negative—even as the company’s revenue growth and profitability remained robust. As with the prior example, the valuation multiple contracted and became more attractive, but the company’s fundamentals remained intact.
Over time, that perception began to shift. Stronger-than-expected earnings demonstrated the resilience of its core operations, while management actions restored confidence. Investors also began to appreciate the breadth of the company’s capabilities across the AI value chain—from foundational research and model development to proprietary hardware and global data infrastructure. The multiple recovered as the company’s strong fundamentals and growth prospects once again became the focus.
Down but not out
For a value investor, recognizing a broken growth opportunity requires a solid understanding of business fundamentals, insight into the industry landscape and a firm embrace of the temporarily misunderstood. When a high-quality growth company faces disruption and dislocation, its multiple compresses—but its long-term potential may remain intact. By focusing on future fundamental value, rather than short-term momentum, an investor can turn volatility into opportunity.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
The investment style may become out of favor, which may have a negative impact on performance.
Equity securities are subject to price fluctuation and possible loss of principal. Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks. There can be no assurance that multi-factor stock selection process will enhance performance. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods.
Active management does not ensure gains or protect against market declines.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
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