Rethinking The Growth vs Value Debate
Value vs. growth is a long-standing debate within the investment profession. For decades, growth critics have pointed to outrageous valuations while voicing uncertainty about future growth prospects. On the other hand, value critics have argued that it’s worth paying higher prices for leading-edge businesses. Over the last year, this debate has become the topic du jour and both parties acknowledge that the answer includes a mixture of both philosophies. Here are some considerations:
Own great companies
Great businesses share similar qualities: a first-rate management team, a strong balance sheet, opportunities for productive reinvestment of capital, and durable competitive advantages. There are great businesses in both the value and the growth classifications.
I would argue, however, that the key to the success of the growth factor in the last decade has been its ability to productively reinvest capital into rapid innovation cycles. There are more companies in the growth factor that rely on code and engineering activities. Code-based companies are often asset-light and able to scale farther and faster to bigger networks than non-code business models.
The value factor has excluded leading companies like Facebook, Microsoft, Google, Amazon, etc, due to their valuation. This approach missed the tech boom almost entirely. However, famous value investors like Seth Klarman and Warren Buffet own these companies today, marking a shift in how value and growth are defined.
We wrote in the Triumph of Intangible Assets that brand, supply chains, access to data, patents, etc. make it more difficult than ever to apply a concrete valuation. Today’s great companies have large portions of their value in intangible assets. Not everything that counts can be counted.
For protection of assets, growth won in 2020 because it recovered first.
When a market crashes, all daily market prices fall together as liquidity becomes scarce. What’s important as you enter a crash is that you hold assets that will recover quickly in the recovery. There’s no question that in March of 2020, growth assets recovered far faster than their value counterparts.
Google, Facebook, Amazon, and any number of cloud computing or semiconductor companies accelerated as their businesses are based on technical talent and revenues that were healthy and growing prior to the pandemic. After a crash, healthy high potential businesses recover first.
For 2021 so far, value is mostly in the lead.
The energy sector, the banking sector, cruise lines, airlines and restaurants have been notable winners so far in 2021. This is known as the COVID recovery trade. For long term investors, many of these business are still well below pre-COVID highs. The recovery trade hasn’t been the only winner as the semiconductor industry has continued its momentum from last year. Semiconductors have a natural consistent tailwind as almost every modern tool or task involves some form of integrated circuit.
Don’t fight the Fed
Shifting to the bigger picture for a moment, we all need to thank Jerome Powell and company for leading the way on keeping the global economy out of a major prolonged depression. Over the past year, +$12 Trillion in COVID-related stimulus has been approved by the Federal Government. $6T was allocated to supply liquidity to markets, and we’ve used about $3T so far. The other $6T was allocated to direct stimulus spending in the form of grants, tax deferrals and direct income support, and we’ve used about $4.2T so far.
For context, US GDP in 2019 was $21.4T. On top of that stimulus, interest rates were cut from 1.5% to 0%. International central banks have followed a similar path.
The US Government still has access to another $4.8T to support our economy until COVID is fully under control. Under control means we have a fully functional hospital system without backlogs in the ICU, vaccinations are widely available and lockdowns are not in effect in the US or neighboring countries. One consideration for investors, there are no rules or laws against creating more stimulus if it’s needed over the coming 12 months.
In short, the primary investment factor of the past year was government stimulus. Without it, we would be in a very different situation. Don’t fight the Fed.
High growth businesses are often acquired
The world’s most successful firms rely on acquisition to achieve their strategic goals. LinkedIn was acquired by Microsoft and is a tremendous network business today.
YouTube was a fantastic opportunity for Google when they acquired them for $1.65B in 2008. Today YouTube generates $1.65B in ad revenue for Google every three weeks. There is no financial model that would have projected that result.
Livongo – one of my favorite growth health tech companies, was acquired last year by Teladoc. Prior to the acquisition it was growing revenue at well over 100% year over year. You can’t own it today without owning all of Teladoc as well, which is also a great company, but not quite as impressive as Livongo was on its own.
Intel acquired autonomous vehicle pioneer MobileEye back in 2017, which today is expected to be a major contributor to Intel’s future. Recently Microsoft announced their acquisition of Nuance, a pioneer in conversational AI tools whose stock price soared last year.
Growing businesses with exceptional talent often get acquired. They also tend to trade at higher multiples.
Entry point, the price you pay when you buy, plays a huge role in both value and growth investing. The lines between the two camps are continuing to blur as technology and innovation find their way into more business models. A high valuation doesn’t mean a company is overpriced, and a low price doesn’t mean a company is undervalued. Investors should seek to own great businesses with rock solid management teams, competitive advantages, healthy balance sheets and continuous opportunities to reinvest capital over time.
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