In the popular press, the recent decline in equities has become an opportunity to stoke fear and anxiety. Whether it’s saying that “This is the most dangerous stock market since 2008” or pointing to ebola, crashing oil prices, income inequality, or some other cause of the market collapse, this is a great time for financial journalists to get clicks and increase ad revenue for their companies. While this might be enough to frighten retail investors into locking in losses in their IRAs, it will not be taken seriously by any professional asset manager, portfolio manager, or analyst.

Their response to the current market downturn will be quite different. For one, there’s a bit of relief in long/short shops. 2013 was a horrible year for hedge funds, because the S&P 500 (SPY) provided a Herculean benchmark: returns of 30%, dividends included. With everything going up, long/short strategies did not work, and hedge funds saw redemptions that may have culminated in Calpers’s recent decision to divest $40 billion from hedge funds. Now with the market going down, alpha is becoming easier to achieve.

Additionally and more importantly for hedge funds, mutual funds, and all sorts of money managers, this correction is providing a buying opportunity. While “buy the dip” is a mantra for some, for others a more strategic attempt at finding and investing in low-cost growth will keep them busy in the coming months.

To understand what market participants are thinking, we need to take a historical view at P/E ratios. Whether long/short or long only, analysts right now will be scouring the equity markets for any significant drop in P/E ratios that offers them a chance to buy into a high growth story at a low cost. To see how this works, let’s consider a portfolio of large cap stocks, some growth and some value, with varying P/Es:

Oct 13 P/E Jan 14 P/E June 14 P/E Current P/E
GOOG 23.7 29 29.3 27.1
AAPL 12.4 13.5 15.3 16.2
FB 121.4 98 84 80.1
PG 20.3 22.2 21.6 21.24
GE 18.3 21.2 22.1 18.9
DIS 19.6 20.7 21.3 20.2

Here we see that, compared to a year ago, the earnings of only one stock are cheaper today: FB, which has seen its P/E ratio fall by a third in a year at a time of steadily decelerating growth after a quarter of extreme growth acceleration that no one on Wall Street expected. Other than that, two stocks are roughly the same price (GE, DIS), and PG, AAPL, and GOOG have all become much more expensive.

The year-to-date and year-over-year performance of these companies is interesting, in that there is tremendous divergence:

Corrrections

So far this year, GE and GOOG are laggards, while the highest risk stock of the bunch (FB) is also the best performer. AAPL is another strong performer, which is more expected given its low P/E ratio yet high growth and massive TAM. GE’s underperformance is surprising; a stable large-cap dividend payer with a healthy margin and stable growth is the kind of stock most people invest in for safety and security, but it’s not doing so well. This is one of countless examples of how investing on platitudes about reward and risk yields underperformance.

The same is true if we go back a full year:

Corrections 2

GE has underperformed, and FB is still our leader, while AAPL looks even stronger. GOOG, however, comes out as a strong performer, as does DIS and to a certain extent PG. Yet at the time, people decried FB as too expensive with a triple-digit P/E ratio, and GOOG’s P/E ratio was considered overly high given its size and growth potential.

By taking this historical view, we see that an investment in these growth stocks at the end of 2013, when fears of the government shutdown, the looming taper, and slow global growth were causing a temporary spike in the VIX and overall fear in the market. Those fears cost investors substantial returns, especially if they decided to play it safe with so-called “stable” large-caps like GE.

Now that the taper is coming to a close and we see another VIX spike as major governments downgrade growth targets and disinflation becomes the biggest risk, we are seeing a pullback to these hypergrowth stocks and P/E ratio declines that make these growth stocks slightly cheaper than they were a month ago. Less than a month ago, FB’s P/E ratio was 84.4, over 5% above its level today. A fundamental investor who believes that nothing has changed in FB’s business model or growth momentum can dismiss the current price decline not as a sign of dangers to holding the stock, but as a buying opportunity. Facebook’s future earnings are now cheaper than they were, providing an opportunity to pick some up. Larger portfolios can stagger entries into the name if their managers believe this correction is not yet over. Likewise, they can add to more established companies like AAPL, GOOG, and even GE which have become more expensive relative to a year ago, but remain lower risk because their revenue streams are more mature. In this way, growth investors can take advantage of market corrections by looking at P/E ratios and deciding which names are on sale, and which offer limited risk.