‘Growth’ to us means looking ahead 5 years and longer, seeking out companies that we believe can at least double earnings in this time frame, and that will still be growing rapidly when they get there. Ideally, we look for at least the possibility of much more.
‘Value’ on the other hand traditionally means investing in companies that are trading at a discount to some notional intrinsic value – buying them cheaply when investors have over-reacted to short-term news, and waiting for a reversion to historic mean. But this is equally a rather clumsy definition, and value investing can surely evolve its own definitions.
We’ve been writing for some time now about why the margin-of-safety, mean-reversion world that favoured value investors of old may not be a useful model anymore. We invest in a world where companies can grow at unprecedented rates and at little marginal cost, where intangible assets such as intellectual property, networks and data are the main determinants of future cashflows. Such assets create increasing returns to scale and winner-takes-all dynamics, often making mean reversion amongst the disrupted a forlorn hope. Value investing has often been promoted by emphasising downside protection for investors in a falling market, thanks to some notional floor on valuations (say book value). But this may not hold any more – let’s be tentative about concluding anything, but recent history suggests the security of growing and robust cashflows has outweighed the attractions of tangible assets. Why would oil company shares mean revert if renewable energy is becoming both cheaper and storable (and we’re finally pricing in the astronomical environmental cost of burning carbon)? Why would physical retailers mean revert when physically going to a shop isn’t necessary anymore? This is Schumpeterian Destruction on steroids.
History shows that the vast majority of long-term wealth creation in stock markets comes from a vanishingly small number of explosive winners. So, ‘Growth or Value?’ isn’t really the right question anymore (if indeed it ever was). Both growth and value fail as investment strategies - in index terms - when compared to the much narrower quest for exponentiality. The real question ought to be ‘how do we find the c5% that matter?’
Some relevant statistics
In US$ terms, over 10 years to March 2020, the MSCI AC World Growth index returned 127.7%. The equivalent value index returned 51.4%. Growth outperformed by 76%. But on its own this doesn’t tell us much unless all growth stocks performed alike and all value stocks performed alike – we need to dig deeper. The top 20 contributors (or c1.4% of names) in the growth index contributed more than half of its outperformance vs value. The top 170 stocks – that’s c12% - accounted for all of the outperformance vs value, and almost 2/3rds of the total return. Meanwhile, a balance of roughly 300 companies moved from Growth to Value, suggesting sustained growth is increasingly hard to find and not many value companies are becoming growth companies.
Turning to the very recent past, what have we learned from Covid-19? Of course, let’s acknowledge and take a moment to register the human cost. But financially? Well short-term individual share price returns are noise. But taking the markets as a whole, maybe we have learned something - the dawning realisation that we have whole other ways of going about our daily lives. Yet more economic and social activity has moved online. Massive online networks of people can be used for the common good. Many of us don’t actually need to leave home to go to work. We can at least hope to find medical solutions to totally new problems on a fraction of previous timescales. In short, habits have been broken and we adapt rapidly to our new norms. What investors may have realised is that a huge chunk of the index is heading for obsolescence, and a huge chunk of the new norm correlates to a tiny number of companies. Now is not the time to rebalance in the name of mean reversion, and the index is a dangerous place.