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On value versus growth and the China Contrarian Conundrum

24 June 2022 Gareth Stokes

This writer started his career as an editor for a share-tipping rag back in 2005, spending hours trawling the JSE listed share universe in the hope of finding the next big things. The process is quite repetitive and simple; you start with a trend analysis and then try to find a company that offers products or services that are in the sweet spot of that trend. The aforementioned information is further sweetened by considering what segment of the market is ripe for picking, bringing the good old growth versus value debate into picture. Of course, we published everything with a healthy disclaimer, similar two what one finds nowadays with any fund manager or financial adviser article or presentation.

Growth- versus value-based investing

Growth- versus value-based investing was under the microscope at the 2022 Investment Forum, hosted as always by The Collaborative Exchange, during a panel discussion titled ‘The long-awaited dislocation between value and growth stocks was evident in 2021; but will this now continue?’ First up was Simon Adler an equities fund manager at Schroders, also billed an advocator for value. “If you look at growth or quality today, it is still trading about 50% above long-term average valuation levels, so when you look at that area [of the market], the correction we have seen so far has hardly started; it has felt very painful for many investors who have enjoyed a very good decade from investing in growth shares,” he said. He also warned that the US stock market might offer zero returns over the next decade, before inflation. 

The discussion started out with a warning that growth and quality were expensive midway through 2022, as was the US market. However, avoiding the entire growth and quality segment is unwise, and risk missing out some imminently investible companies. “The sell-off in quality and growth has been indiscriminate, so we find some very attractive quality and growth companies by using a high discount rate to discount the cash flows of those companies, which gives us a conservative estimate of the upside of the stock price,” said Danni Yang, a client portfolio manager at Franklin Templeton. It might sound a bit technical; but what Yang was saying was that fund managers and financial advisers can still find consistent growth opportunities in value-friendly markets. 

The trick is to seek out companies that are structurally suited to growing their revenues under the macroeconomic reality of higher, stronger and lasting inflation, and rising interest rates. Yang’s 29-stock portfolio is filled with growth-focused companies that have strong pricing power and are able to protect their margins. “Growth sectors can be overvalued when viewed through a value investor lens, but if you go into each stock, you can find defensive attributes and long-term characteristics that can pull them through,” summarised Jennifer Henry, DFM at INN8 Invest, who was moderating the discussion. 

Out-of-favour stocks will turn around

Edward Blain, part of the investment team at Orbis, said the team was always looking for companies where the future was going to be better than investors expected. These are typically companies with a long track record of good performance that investors have cooled on in recent years. An example is British American Tobacco, a firm that has suffered as investors take a simplistic view of environmental, social and governance (ESG) factors by excluding tobacco stocks completely. These shares are trading on pedestrian price-to-earnings ratings despite having a long track record of superb dividends and earnings. “We are very happy owning the companies that were out of fashion a year or two ago, and now offer more value than they did before,” he said. 

Value and growth are only two of a number of factors that fund managers and financial advisers can consider when structuring an equity portfolio. Alongside growth and value, they also consider market trends, quality and sentiment. “We have the full flexibility of going for small and attractively priced companies, as well as holding high quality companies for which we pay higher prices,” said Amadeo Alentorn, a portfolio manager at the Old Mutual Global Equity Fund. The fund benefited from a shift towards value around November 2020 and has ridden the trend to market-beating returns over the 18 months since. “It is our belief that there is no single style of investing that will work consistently through time; there is further scope for growth stocks to fall, but it will end at some stage, and you need the flexibility to revisit them,” he said. 

Is China a contrarian play?

Henry steered the conversation towards China, asking about the prospects in the world’s second largest economy. “As contrarians, the Chinese market appeals to us at the moment,” said Blain. “Investing is a bit like happiness, good results come when reality is better than expectation; China today is a very different place to the US”. He offered an assessment of the US versus China circa June 2022. In the US, share prices and bond prices will go down as the US Federal Reserve adjusts monetary policy to rein in high inflation. In China the chances of being in the opposite space are higher because the economic is experiencing near recession conditions; entire cities are in lockdown; and there are continued and impactful regulatory crackdowns on businesses. The bottom line: expectations in the US are extremely high compared low expectations in China, making the latter an obvious risk to reward trade. 

Adler agreed with much of what Blain said, but he was concerned about the high risk that attached to the reward. “There are two significant tail risks in China: one is that they invade Taiwan; and the other is that the government get ever more involved in the running of businesses,” he said. Alibaba, a popular Chinese tech share offers a perfect illustration of the challenges facing investors in that market. The share, which has fallen significantly over the last few years, is being constrained by ongoing government interference, by additional competition entering the market and the fact they have not generated much cash over the last decade. “How do you value a business that has grown its top line enormously, but at the same time has generated zero cash,” asked Adler. “The upside is there, but the risks are too high!” Fund managers and financial adviser considering China have to control the risks for their clients by restricting absolute exposure to that market. 

Inflation lurking in the shadows

Employment, GDP, inflation and interest rates all ebb and flow over time, so it is near impossible to align portfolios with each of these factors. “Trying to build a portfolio for a specific macroeconomic outcome is extremely dangerous,” concluded Adler. He said that fund managers should consider a variety of ideas and catalysts and a variety of stocks that will do well in different environments. Then, stay in the cheapest sections of the market, invest for the long term, remain patient and reap your reward over time.

 

“You have to look deeper into each of the stocks, look for its drivers and catalysts, and sometimes it is not as simple as value versus growth,” concluded Henry, putting the closing remarks to what turned out to be another enthralling 2022 Investment Forum discussion, brought to the market by The Collaborative Exchange.

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