In space, when a giant star runs out of the gas that fuels it, it will collapse spectacularly in on itself. The collapse creates a crushing gravitational pull from which nothing, not even light, can escape. Hence its name; a black hole.
When a company with a popular growth story runs out of gas, the same thing can happen. The investor expectations that fuel the glowing share price run dry and the implosion that follows can wipe out years of gains.
In more than 10 years of investing I have never seen this to be as dramatic as in the last 12 months. In my view, a lot of ASX growth shares have high expectations, higher valuations and there seems to be little consideration for margin of safety.
Even before the February reporting season took off we saw large share price falls as companies with strong expectations like Gentrack Group Ltd (ASX: GTK) and Nearmap Ltd (ASX: NEA) revised guidance down. As reporting season gathers pace, other stars have also imploded.
Last week, investors in WiseTech Global Ltd (ASX: WTC) rudely discovered the strong expectations for growth were over-done. Share price declines in Citadel Group Ltd (ASX: CGL) and the cooling-off of Altium Limited (ASX: ALU) and EML Payments Ltd (ASX: EML) are further examples.
Most of these are great businesses which in years to come will continue to grow steadily. But the huge demand for companies with growth narratives and high valuations means it's time to be extra vigilant.
How to avoid getting crushed
As investors, our job is to evaluate the narrative around a company and decide 1) if it is reasonable and 2) if the share price reflects this. It is not easy, but it is essential if we are to avoid getting crushed.
For a long time, the management team of utility billing software company Gentrack was telling a story of "15%+ long‐term organic EBITDA growth", caveated with the specific timing of projects. It appeared realistic and the share price rose along with investor expectations.
I certainly believed it. But I should have been more skeptical when the chief operating officer suddenly departed and the company started machine-gunning warnings to the market that growth was in doubt.
Foolish takeaway
To safely navigate the pull of star ASX shares, don't be afraid to stay skeptical and stay diversified. It can be exciting to find a company with great growth prospects, but having a sense of valuation is critical to prevent your money from being lost into the investing void.
