Is there safety in Value as Growth is pounded by Covid-19?
Sébastien Galy, Sr. Macro Strategist at Nordea Asset Management
As the Covid-19 virus spreads globally, the debate between value and growth stocks comes anew. In times of trouble value stocks tend to outperform, but beyond this over the past decades they underperformed. Warren Buffet, a keen value investor, once admitted that investors were potentially better off buying the S&P500 than Berkshire Hathaway. Not now though. We find that while growth can be clearly described as a style, value is only one quality in portfolio construction and this quality shows itself best in times of market turmoil and recession. The rest depends in part on good portfolio construction — which includes various techniques such as deep value, absolute value and relative value. Note also that there are classic ways to mitigate downside risks, e.g. Listed Real Estate and Listed Infrastructure as well as Covered Bonds.
What is the growth style?
New companies emerge fast, from birth to IPO, into the Nasdaq or S&P500 in periods of very low interest rates. These companies challenge incumbents with new technologies and open new markets, as Tesla did. Eventually, the likes of Amazon establish dominant positions buying emerging technologies and markets. Their cash flows move from negative to positive as demand increases along with markups courtesy of differentiated products such as Apple.
Younger generations prefer to experience a product rather than own it. This behavior is capping markups and forcing them into the volume business. In some cases, growth stocks get into a dominant or oligopolistic position by underpricing their services, but find that as they mature, their ability to markup is limited, e.g.UBER. More broadly, these companies represent the emergence of the new economy from the old in a perpetual cycle of renewal.
The transformation of stable/value companies
Technology quickly spread vertically and horizontally pre 2008 leading to a higher productivity rate than we see now. But this process of transformation, espoused by growth companies, also can be found in some companies that offer value. For example, McDonalds adapted to the use of kiosks for ordering and added delivery to its services. Many malls that are under severe pressure due to changes in taste are adapting successfully. More broadly, such companies started by cutting costs before being forced to innovate to better target their customers. In Europe, we see more companies like these than Googles and Amazons.
Value companies – the good, the bad and the ugly
Value can be analyzed through a series of simple metrics, such as the Price to Earnings Ratio, the dividend yield and, more thoroughly, Discount Cash Flow models.
If companies can’t switch to Growth by leveraging the right economic mechanism or technology, then by definition they underperform Growth. We can safely assume that some growth stocks eventually will make the switch to Growth, while others will fall to Value. Another way to see this is that in the underlying rating from Growth to Value there is a series of ratings, e.g. Fitch’s credit ratings. One important point to realize is that not all low beta stocks are Value ones, some are simply a function of the business cycle or on the way out. The job of analysts is to isolate from Value stocks those that might emerge towards Growth from those that are on the way to obsolescence. Either way an emerging Growth stock in Value is unlikely to stay cheap for long.
Our conclusion is that Growth stocks will see 2 to 4 weeks of difficulty, but that this eternal process of renewal will eventually make them quite attractive. Value stocks, as part of a well-built portfolio, offer the advantage of diversification and resilience.
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