Blue Chip Issue 79

EQUITIES
The value of growth
Do not underestimate the combination of quality and growth, says Gerrit Smit, Head of Equity
Management at Stonehage Fleming UK and Fund Manager of Global Best Ideas Equity Fund.
While value investors may not typically be buying for
growth, there is no escaping the fact that growth
is the ultimate source of equity returns. Yet in our
experience, investors regularly undervalue growth,
which can mean holding off on expensive purchases that over time
reveal themselves to be good value.
With growing concerns about seemingly overinflated tech
stocks, companies such as Accenture and tech giant Alphabet may
currently look pricey. However, data¹ shows that shares from both
firms have been materially undervalued for the last decade. Ten
years ago, an investor would have paid a 17.4 multiple to buy into
Accenture, and data confirms that even with a significantly higher
multiple of 44.1, the company would have still been able to deliver at
least the index return. Similarly, Alphabet reflects a 10-year historic
price to earnings ratio of 17.6, whereas investors paying a multiple
of 48.9 would still have received the index return as a minimum.
Both firms have also delivered double-digit earnings growth
throughout this period, and we expect them to continue doing
so. In the case of Alphabet, we anticipate compounding earnings
growth accelerating to over 20% over the next three years, despite
its size as a 22-year-old business already. ²
When considering the various ways to value growth, data
suggests that portfolios of high-value, sustainable-growth
businesses can provide a good, solid performance over time.
Investors would thus be wise not to underestimate a combination
of quality and growth when making strategic investment decisions.
When considering the various ways
to value growth, data suggests that
portfolios of high value, sustainable
growth businesses can provide a
good, solid performance over time.
Stable growth
The graph (top right) supports the principle of focusing on
sustainable growth. By illustrating the end value of a $100
investment at different compounding rates, it reveals how much
more valuable lower, stable growth is compared to volatile, cyclical
higher growth. While a stable 5% rate results in an end value of 1.6
times the original investment, a rate of 12.5% produces a doubling
end-value of 3.25 times. Critically, in contrast, when comparing the
varying results of much higher, but fluctuating growth rates (eg,
Source: Stonehage Fleming Feb 2021. Acronyms: CAGR = Compounded Annual Growth Rate
+2 %/-10%), it is striking that all their end values return less than
those of the stable compounding 5% growth.
Add stable, incremental growth to the above 5% growth
example, and the results over time illustrate the value in holding a
good investment for longer to benefit from the ever-compounding
growth. An additional 5% pa over five years can increase the end
value by more than a quarter of excess value ($33), and if that
investment is held for another two and a half years, the incremental
excess value almost doubles to $60. Held for another five years after
the initial five years, the incremental value almost trebles to $96.
Quality usually persists
Investors are often afraid to pay up for quality out of fear that a
business may not continue to deliver in the future. However, it
is our view that quality typically persists over time, and that the
same applies for low-quality businesses. One should not be overly
concerned by a high valuation for a high-quality company and by
contrast, investors should refrain from buying a weak franchise
on a seemingly low valuation in the hope that it will get better, as
typically low quality usually also persists.
Valuations
It may come as a surprise to some that, despite the strong market
performance under dire economic circumstances, the current 14%
upside to consensus bottom-up company valuations is marginally
higher than the 10-year historic average of a 12% upside for the MSCI
World Index. This is due to the high expectations for a strong economic
recovery on the basis of the successful vaccine rollouts and sharply
increasing company valuations. From a consensus target valuation
perspective, it therefore seems that the market is still fairly valued.
¹ Source: Bloomberg, Stonehage Fleming Investment Management Ltd, February 2021
² Forecasts are based on assumptions and are not reliable indicators of actual results.
The opinions or views expressed are for information purposes only and are subject to change without notice. The information does not constitute legal, tax or investment
advice, it is neither an offer to sell, nor a solicitation to buy, any product or services. All investments risk the loss of capital. Past performance should not be used as a guide to
future performance. Whilst every effort is made to ensure that the information provided is accurate and up to date, some of the information may be rendered inaccurate in
the future due to any changes. Issued by Stonehage Fleming Investment Management Limited, authorised and regulated by the Financial Conduct Authority, and registered
with the Financial Sector Conduct Authority, FSP No: 46194. © Stonehage Fleming 2021.