Growth investing is not the opposite of value investing. Growth investors should in my view be concerned about valuation but, given the nature of the companies they will be interested in, higher short-term valuations may be justified.
It should go without saying, however, that not all growth companies are good investments. The long-term growth investor will be looking for sustainable, profitable and self-financed growth, with one or more of these attributes to some extent underappreciated by the market. Patience and courage in your convictions will also be required at times, to weather the occasional period of rotation into deep-value names.
While not all growth funds have ‘ESG’ or ‘sustainable’ in their names, I believe they should have been integrating these concepts into their process for some time now. This is because we are concerned not only about the sustainability of a business model, but also about the sustainability of the whole business.
As shareholders, we know that we are not the only stakeholders. We sit alongside the employees, the management, and also the society in which the company operates. To be truly sustainable, all stakeholders need to be happy. Growth companies tend to have a younger workforce, if only because they tend to be recruiting, and a younger workforce embraces environmental concerns more enthusiastically. If management teams then embrace environmental issues to do right by the society in which they operate, they will have a happy and engaged workforce, and may even find their business holds advantages in customers’ eyes too.
What about the sustainability of the business model? Ideally, the business will operate in an industry demonstrating superior growth, it will have a scalable business model, and have a lasting competitive advantage. Barriers to entry (remember them?) are rare in many sectors now, thanks largely to advances in technology, but competitive advantages may come in the form of scale, technology or superior products.
ASML* is an example of all of these advantages, in my view. It is the dominant producer of manufacturing equipment for the semiconductor industry, having seen off all competition. Its end market is growing rapidly and it continues to develop its technology, reducing the risk of a new entrant. Ocado* is in a similar position, although it does have some competition around the edges of its market. It has the clear market-leading technology among online grocery companies and continues to invest in developing its technology further, and to enhance its product offering. The growth profiles of both companies have good visibility.
The other aspect of sustainability is financial. We like to see a company in a strong growth position that is able to invest, organically or inorganically, in order to take advantage of opportunities to further that growth. High returns on invested capital (ROIC), high margins, and a growing top line lead to strong cash generation and an ability to self-fund growth. If a company is not in such a position, we would need a clear line of sight to show how it will get there; for example, Ocado currently has a negative ROIC as it invests heavily in developing customer fulfilment centres around the world, but we can see the potential for this to become positive in a few years’ time.
Companies that have a sustainable competitive advantage in a growing market and that generate the free cash flow to invest further in that growth don’t grow on trees. We spend a lot of time searching for opportunities and researching the businesses and their markets. When we find such gems and are comfortable with their valuations, we tend to be very long-term holders. We consider that these companies are simply the best.
*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.