In the last few days Tesla has hit a forward price to earnings ratio of 278 (share price up 620% over the last 12-months), Bitcoin has hovered around $35,000 (up 282% during the same period) and online broker Robinhood has raised $3.4 billion to shore up its financial position following wild trading activity amongst its customers.

Commentators are warning of bubbles developing in pockets of the capital markets. In the US, the S&P 500 – driven by a high concentration of tech stocks – has powered through Covid-19 to generate a 15% return over the last 12-months. Meanwhile, the FTSE 100, with its dependence on unfashionable sectors like financials, natural resources and industrials, is down nearly 14%.

As we begin to recover from the pandemic, pundits predict that we’ll see a rotation from growth stocks like Tesla to the value stocks which dominate the UK market. This would create exciting opportunities for hitherto unloved listed UK companies, and potentially complications for the tech companies which are rumoured to be considering IPOs. It would also be a major change for the fund management industry, which has spent the best part of a decade jettisoning value portfolios.

Fund managers need to say where they stand

If you look around for star value investors, you’re more likely to compile a casualty list than a hit list. Neil Woodford famously called the dotcom bubble, but his eponymous fund management group is closed for business following a controversial liquidity crunch. Alastair Mundy was replaced at Temple Bar Investment Trust after his value-orientated portfolio took a beating in last year’s sell-off. Highly regarded Ted Aronson of AJO Partners called it a day in October.

As they’ve had their time in the sun, so growth investors have generally been the more impactful communicators, with their prescient appeals to new products and services which can transform the ways in which we live. Yet value investors have a rich folklore from which to draw, not least the great Benjamin Graham and Warren Buffett. Hard metrics like a company’s intrinsic value and return on capital employed (ROCE) are certain to find renewed appeal in the event of a market rotation.

And value investing is still visible, although not so much amongst mainstream public equity fund managers. Private equity continues to “hoover up” lowly valued old economy assets, such as pubs where last week an approach was announced for the Marston business; and many of the Robinhood customers have been piling into discarded stocks like Gamestop.

There has always been some problem of definition here. Value investors have traditionally focused on low traditional valuations, like the price earnings ratio, together with high tangible asset backing.

The problem for them today – as pointed out in a recent memo by legendary distressed investor, Howard Marks – is that intangibles like intellectual property and talent play a much more important role in driving business performance than they did during Graham’s heyday over 50 years ago. And so, Marks believes that today’s value investors need to be more flexible: “The fact that a security carries high valuation metrics doesn’t mean it’s overpriced, and the fact that another has low valuation metrics doesn’t mean it’s a bargain.”

Marks’ intervention in this debate could be significant. It suggests that there is an opportunity for fund managers to strike out a middle ground between the two extremes of growth and value investing. But this will involve blending relative judgements with absolute ones, meaning they will have quite a job to do in defining, articulating and building support for their strategies. Either way, any fund managers hoping to gather assets will need to think hard on this debate before pinning their colours to the mast.

Listed companies need to be realistic on strategy and communicate accordingly

The cult of growth investing has undoubtedly had a major impact in the last decade on both corporate strategy, as well as on how companies have communicated. Look at the global tobacco industry, which has lost a quarter of its market value over the last four years. This has traditionally been seen as one of the most defensive of sectors, with strong cashflow and potential to pay dividends, despite a lack of volume growth.

However, the lure of “growth” was too hard to resist and most of the companies invested massively in the new technology of vaping as the way to find it. With little success. Only a week ago the tobacco company Imperial Brands turned its back on seeking new growth and has gone back to basics.

This may be an extreme example, but the cult of growth is visible across many “old economy” industries. Most bricks and mortar retailers have been trying to expand online, with mixed results; the new breed of online retailers seem to have been more successful in picking up “old economy” retail brands whilst leaving behind the physical assets. Beer and spirits companies have paid big money for “craft brands”; oil and gas companies are chasing green investment for growth; industrial companies have put the emphasis on added value service to create growth with their customers.

As new strategies falter, companies here are going to have to revisit their messaging toward “more balanced growth”, extolling the virtues of matrices like net asset value, free cashflow and ROCE, rather than just targeting topline growth.

This will require some major overhaul of the investment case and corporate materials, following on from the rethink on strategy.

And there is an argument for doing this sooner rather than later, if institutional investors are starting to question a strategy of growth for growth’s sake.

 

 

 

 

 

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