Over the last 10 years, and particularly so since the beginning of 2020, companies categorised as ‘growth’ type businesses have been outperforming their ‘value’ counterparts, to the point where the differential has rarely been so great.
Growth companies are those defined as generating significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy and tend to have profitable investment opportunities for redeployment of their own earnings. The likes of Amazon, Apple, Netflix and Facebook fit into this category.
A value company is one whose share price trades at a lower price relative to its fundamentals, such as dividends, earnings or sales than the market appreciates and is thus at an attractive valuation. Often these are mature companies with stable businesses, paying away their earnings as dividends as they have few redeployment opportunities themselves but could be seen as ‘steady eddies’. Many financials, banks, energy (oil) companies, and basic materials firms fall into this category as well as firms like AT&T, Hewlett Packard and General Motors.
Whilst unusual in the context of previous market sell-offs when a shift back to fundamental value seems a defensive approach to keeping ones capital invested, the recent increased gulf in the outperformance of ‘growth’ over ‘value’ seems justified in light of the lockdown conditions brought about by the coronavirus. In relative terms, healthcare firms have performed well given the heightened medical emphasis, whilst IT, communications and tech firms have also been strong performers given their business models require little or no face-to-face interaction.
Simultaneously, firms carrying a lot of debt (common amongst value stocks) have been punished by the markets as the drying up of revenues for a couple of months of lockdown impacts their ability to service such debt. It seems reasonable, therefore, that those firms with strong balance sheets (common amongst growth stocks) are more likely to survive in an environment where the failure of indebted firms leads to reduced competition.
Given the extent to which both ‘growth’ and ‘value’ stock prices have responded to the pandemic, it seems reasonable to expect some unwinding of this phenomenon as we emerge from the lockdowns and has led to our neutralising our former ‘growth’ bias in clients’ portfolios. Nevertheless, some of the sectorial effects of the virus will take many years to reverse if they ever do entirely.