Don't chicken out now
Some experts suggest that after three years of big returns by growth companies, it's time for a defensive posture. We asked the experts.
Growth companies tend to be viewed as young-ish companies that operate in sectors that have yet to reach maturity or have taken on a new lease of life. They are more likely to grow jobs than older 'value' companies entrenched in mature industries," says Richard Middleton, Manager of the Capital Growth Fund at STANLIB.
Economic fundamentals
Internationally, commodity demand remains high, with positive ramifications for our resource companies, explains Richard. "At home, we see higher fixed investment spending by government to accelerate job creation.The infrastructure investment is good for construction companies and their suppliers. Meanwhile, strategic job creation encouragement means many growth companies will be working in a benign policy environment for some time.
Results evident
Results are already evident, Richard continues. "In the unit trust industry, the one-year performance of growth funds is 38.59% versus 32.15% by domestic general equities. Over three years it's 46.66% versus 39.7%. The growth sector was also recently trending about 35% higher than the Alsi for the year to date.
"South Africa is achieving GDP growth of more than 5%. Consumer confidence is high despite two interest rate rises in 2006 and an uptick in inflation; which means fast food chains and other retailers are also growing at pace.The earnings of many growth companies continue to surprise on the upside and are rising solidly. Growth companies are operating near capacity and will soon be investing in new plant or looking to grow through acquisition."
Stick with growth
Richard says that this is precisely the stage in the corporate lifecycle to stay invested and look for an even bigger pay back in a few years' time. "Spurning the growth sector because it's done so well seems perverse," he says.
Finding value in the bull market
Claude van Cuyck, head of equities for Sanlam Investment Management (SIM), agrees that the market has entered a 'momentum phase'. "Value opportunities are diminishing, however there are always mispriced opportunities in the market.
"At SIM, we take a pragmatic, long-term view and make our investment decisions based on normalised and realistic assumptions when making investment decisions. Hence, we focus primarily on the intrinsic value of stocks. So, while it is interesting to observe the current musings about growth versus value investing, from our perspective, such discussions are a bit superfluous."
Onus on investors
Claude explains that while the bull market continues, the onus is on investors to be more judicious when picking shares and, in the face of relatively high prices, they should find shares with compelling business economics i.e. companies with pricing power, sustainable competitive advantages, and dominant market share positions in industries with high barriers to entry. They should back management teams that have a history of allocating capital efficiently.
Higher growth
The markets are running hot and many investors are still willing to pay for higher growth. Three to four years ago, return on equity was 15 percent. Today, it's closer to 25 percent. Investors are starting to pay fair intrinsic value verging on a premium. Relative to April 2003, we're now paying double the valuations on twice the earnings base.
Although the long-term value opportunities are diminishing, the banking sector, for example, offers a glimpse into the subtleties of absolute versus relative value. While some stocks are priced highly, there still remains intrinsic value.
