Six Scenarios Where Growth beats Value

The tyrants of Growth and Value debacle continue to weigh on the revival of value investing following the significant outperformance of growth indices against value indices. However, value investing could not be fully accomplished if growth were to be ignored.

Looking back from Dutch tulips to dotcom bubble, the conventional wisdom suggests that unjustified optimism could bleed and hurt critically. Therefore, investors should not forget the past but learn from it.

Dutch Tulips/Tulip Mania was amongst the most famous market bubbles in history. In Holland, the unrelenting optimism for Dutch tulips in the mid-1600s drove the value of tulips to very high levels.

Affluent-class society was willing to pay extremely higher consideration for these tulips to be present in their gardens. Mostly, these tulips were purchased just because they were expensive. Initially arriving from Turkey, these tulips made way into the farms of professional cultivators.

Thus, the society started to cultivate tulips locally, and in turn, creating an industry that is alive to date. Some suggest that when the bubble burst, the Dutch economy drifted into a crisis, to levels where few cultivators drowned themselves in canals.

However, some also indicate that the burst was limited to a certain number of people who were engaged in the collection and trading of tulips. The disruption did not affect the broader economy of Holland. Moreover, the consensus suggests that people did lose fortunes.

Dotcom bubble, which occurred in the late ‘90s and early ‘00s, is referred to a period of extremely rich valuations’ of technology sector companies that were nosediving. However, the likes of PayPal, Amazon, and eBay (winners) did survive the crash.

Meanwhile, some of the losers (bankrupt) arena include names such as Pets.com, Webvan.com and flooz.com. And presently, these names would not be even known to many. Nonetheless, similar business models like these companies are working in some parts of the world today.

Value & Growth Investing

Value investing looks to target companies that are not much appreciated by wider market participants, and consequently, the earning multiple, tangible asset value/book value multiples appear to be suppressed comparatively.

Further, value investing seeks to capitalise on opportunities wherein the probable investment is presently available at a discount to its intrinsic value. Buying into stocks with a margin of safety is one of the principles of value investing, and margin of safety simply means a large discount to intrinsic value at a given point of time.

Growth investing seeks to target investments that could deliver explosive growth and have a favourable growth outlook. Mostly, growth companies are overpriced, expensive compared to their underlying fundamentals.

If discovered early, due to their relatively high potential, an investor could have favourable ramifications when the market starts to appreciate the high potential. However, growth companies have a higher risk in the first place that leads to higher returns, and investors should be willing to accept the higher risk prior to investing in growth companies.

Scenarios where growth beats value:

High Growth Potential

Budding and booming industries are likely to outperform value approaches until widespread disruption impacts such industries. Value names are more concerned in established businesses where the growth potential is relatively slow and concentrated.

Moreover, the growth approach often seeks to target opportunities that could deliver exponential growth due to comparative industry age, potential etc. High growth opportunities often command premium valuations which could be the driver of outperformance against value-driven opportunities possibly.

Unrelenting Innovation

Innovation continues to be at the heart of many high-powering growth businesses, and the pace of innovation sets the growth trajectory for businesses. However, the corporations would need efficient investment in research and development to produce innovative solutions.

In addition, innovation spending should be complemented with best-in-class talent and development of in-house talent. Moreover, the effectiveness of innovation and talent management is likely to drive growth.

Earnings Growth

Growth companies that are delivering prolonged earnings are likely to be the market darlings, as earning growth illustrates an improvement in the company’s underlying fundamentals, and in turn, valuations.

Technology companies are not only innovating at a rapid pace but are growing their earnings as well. Markets participants would not ignore such development until the growth potential dries up or there is potentially no more room left for growth in that business.

However, the earnings growth is also being delivered by using excess cash to buy-back shares in the company. Whether these programs would deliver any shareholder value remains a question an investor should ask.

Slowing Growth Means Premium

Amid slowing economic growth, investors are likely to prefer companies that would deliver growth in excess of a wider trend. As, even in weaker economic conditions, the growth companies carry the prowess to deliver organic earnings growth.

When broader market participants are bracing for slower growth trends, the premium on growth companies is likely to be justified due to their capacity to generate favourable results amid a wider slowdown.

Lower Rates Favour Growth

When central banks are taking up an accommodative stance, growth companies have the opportunity to acquire capital at relatively lower costs. Meanwhile, the servicing cost of floating rate debt also comes down.

Growth firms often capitalise in such a scenario with expansion through acquisitions to deliver favourable outcomes. The concept of the time value of money might help to explain why lower rates are better for growth investing.

When interest rates are lower, the future cash flows in a company should be worth higher than the present, and growth stocks have the potential to generate higher cash flows in the future compared to value stocks.

Secular Trends- Firepower for Growth

The rise of e-commerce, omnichannel retailing, premiumisation, capex-light business models etc. has given emergence to companies that are delivering customer proposition and shareholder value.

Moreover, the secular trend is not cyclical or seasonal, and exists for a longer period of time. And, the investment opportunities in this space are likely to deliver constructive results irrespective of the economic environment.

Further, the secular trend could be in both directions, positive and negative. In the past, we have seen the emergence of touch-based mobile phones at the expense of keypad-based mobile phones.

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