The long period of quantitative easing (QE) by central banks has led to incredibly low interest rates and has pushed multiples for stocks delivering any sort of growth into quite stretched territory. This is particularly true of classic consumer staples companies, which will be here tomorrow and probably in 100 years, but at the moment are offering quite pedestrian levels of growth – and yet their valuations are very, very full.
Conversely, value investing, or buying stocks which trade at a discount to their intrinsic value, has really struggled for a decade since the financial crisis and the start of QE. A growth style is buying shares in companies whose revenues or profits are growing relatively quickly.
I have seen previous phases in which growth or value has, for a number of years, performed well and then less well. I’ve never seen anything as extended as the current bifurcation between value and growth styles. Even so, I cannot believe it is forever. Something will come along and change the investment environment – growth will accelerate and bond yields will rise, which will undermine the valuation of these stocks; or – who knows? – maybe one fine day there will be resurgence in inflation.
I continue to believe that the key to future returns is the price you pay for an asset. I still hold some reassuringly expensive growth stocks, and they are delivering reasonable levels of growth, but I’m absolutely not going to abandon the stocks that I think are ridiculously cheap and where a change in that growth/value trade-off could see them materially outperform.
It’s important to have a mix of good companies in a portfolio. Those who argue that value investing is dead – or `so 20th Century,’ as one of my investment peers recently said – are mistaken. I don’t think we’re in a new paradigm where the only way to deliver growth is to avoid anything financial or industrial. I’ve been meeting investors recently and talking about the different ways to make money in UK large caps.
Because value stocks are so out of favour, buying growth compounders such as Experian is seen by some investors as the only strategy to make money in UK equities. Actually, it is only one way. We’ve happily owned Experian for many years. We’ve also found good opportunities to generate attractive returns in addition to simply chasing growth.
We bought BP in a dark period when we were convinced the shares were undervalued due to weakness in the oil price. We’ve been proven right on BP. Similarly, there’s a recovery stock such as Tesco, where we backed the new management’s turnaround plan, and have profited.
Financials are deeply unpopular at the moment. But Barclays has been around 200 years and has seen a lot of different environments. It is trading at a 40% discount to book value. It is tough with gilt yields as low as they are and no prospect of an interest rate rise, but if Barclays deliver on their plans to improve the returns in the investment bank, and I happen to think it could, then the shares have considerable upside.
Likewise Lloyds, and the retailer Next, are cheap shares that – if we can clarify the outlook for the UK economy post-Brexit – will be shown to have delivered extremely good value to the market.
UK stocks have been heavily sold off by investors and are cheap versus their historic average valuations. At the same time, companies are delivering decent earnings growth – low to mid-single digits and even high single digits. When you add in the dividend, special dividend and buybacks, in many cases you can find solid double-digit total returns.
To be a pure growth investor is risky. In the Merian UK Alpha Fund, there is a mix of value and growth shares in our high-conviction portfolio of around 35 stocks. The euphoric belief that you can pay very high multiples and it won’t matter and all will come good in the end, is misguided. I don’t believe that you can just abandon valuation, and I’m confident that this will be demonstrated in the years to come.