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Growth at all costs

Investors have never had so many choices for strategies that aim to gain returns in excess of the market.

These range from complex computer algorithms to factor-based approaches that group together ‘momentum’ or ’quality’ stocks. The two classic and opposing styles for investors have traditionally been growth and value. Growth investors believe that they will perform better by picking companies which are growing quicker than the market, whereas value investors believe that stocks priced cheaper than the market will outperform.

Since the financial crisis growth stocks have outperformed value stocks significantly with technology being the key driver. Chart one below shows the performance of the global benchmark MSCI World, along with the growth and value components of this and the information technology (IT) sector.

Companies that many of us had not heard of a decade ago are now household names and many of us could not imagine our life without them. Netflix is a great example of this; although in existence a decade ago, few would have thought that it would grow into the household name it is today and become so interlinked with society and our lives.


Chart one: MSCI World, Growth, Value and Information Technology performance

Netflix was founded in 1997 and was a loss-making competitor to Blockbuster. In fact, Blockbuster turned down acquiring the company for $50 million in 2000. It was only in the mid-2000s that the business started gaining momentum as it switched from mail order DVD’s to online streaming.

In 2002 the shares floated at what would today be worth $1.08 whereas now, (at the time of writing) they trade at $280, having gone as high as $385 a share. That’s a stunning near 35,000% return from IPO to the peak. It is stories like this and the tantalizing possibility of such huge returns that can lead investors to chase the next big trend, resulting in astronomical valuations put on relatively small companies.

Using the example of Beyond Meat (a plant-based meat alternative company), you see how things can start to get crazy. Having floated on NASDAQ in the US at the start of May, the hype surrounding the company pushed the shares up 820% giving it a stock market value of $13.75-billion by July! This was whilst sales for the whole of 2018 were $87.93-million, not to mention the company actually made a loss.

Using traditional financial valuation metrics can make numbers like this look a little absurd, as it trades on well over 100 times trailing revenues.

From a value standpoint, there is a strong case that the shares are overvalued. However, a growth investor might believe there will be huge demand for these products in the future. With sales forecasted to grow 500% this year, the company could grow into its high valuation. From the peak in July to now, the shares have lost over 50% of the value as the momentum has come out of the stock following the huge rally.

At the other end of the scale is the value opportunity in Japan, where it is estimated that the cash on company balance sheets listed would aggregate to 140% of GDP. Over a third of companies in Japan also trade at below book value. What this means, is that if the company were to be liquidated and shut down tomorrow, there would still be excess cash left over.

Whilst not the economic powerhouse it once was, Japan is still the third largest economy and has the second largest stock market by market capitalisation. Last year, I went to see a specialist Japanese smaller-companies value-focused investment trust, and I was amazed at just how awash with cash some of the companies were.

Looking at their portfolio as a whole, if we aggregated the value on the stock exchange of all the companies, they had an amazing 78% of this value in cash or easily sellable securities on the balance sheet.

There is of course a reason why Japan can look so optically cheap when compared to the rest of the world. There are concerns from investors about the ageing population, negative interest rates and low growth and inflation environment there at present. Japanese companies also tend to retain much more cash on the balance sheet than the rest of the world rather than invest it into the business or pay it back to shareholders.

Whilst we have used some extreme statistics to highlight what growth and value can look like in different markets, both are styles that have produced excellent returns over the long term. Warren Buffet, perhaps the greatest investor of all time, started out as deep value investor before evolving into the ‘quality’ approach he employs today.

At Equilibrium, we focus on constructing diversified portfolios that can perform in a variety of different market conditions and are not hinged upon one part of the world or style to drive investment performance.


The content contained in this blog represents the opinions of Equilibrium Investment Management. The commentary in this blog in no way constitutes a solicitation of investment advice. It should not be relied upon in making investment decisions and is intended solely for the entertainment of the reader.