Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 409

Single-period measures do not work for great growth companies

The growth versus value dichotomy lies in plain sight, as broad market indices such as the S&P 500 have outperformed the tech-heavy NASDAQ in recent months. These gains are in contrast to movements in calendar 2020 where tech ran strongly ahead. Investors of both persuasions are wondering whether the price of growth companies has largely been captured with value companies yet to fully reflect the 're-opening trade' as vaccinations increase, borders reopen selectively and airline bookings pick up.

We think not. Earlier this month, the Wall Street Journal published the following chart with accompanying commentary, of the quite mind-bending revenue growth numbers produced by the disruption giants in the March 2021 quarter, relative to the same period last year. These numbers show a pattern of growth accelerating coming out of the COVID year.

Remember, this group picked up steam even as COVID hit. A fall in revenue growth could have been expected as the world began the slow climb to recovery.

Doing well, even in a pandemic

These companies are recording (for the most part) their strongest quarterly revenue growth in five years. Microsoft chief Satya Nadella, on the most recent earnings conference call, said:

"Over a year into the pandemic, digital adoption curves aren’t slowing down. They’re accelerating, and it’s just the beginning. We are building the cloud for the next decade, expanding our addressable market and innovating across every layer of the tech stack to help our customers be resilient and transform.”

But the share prices of these stocks did not rise following these blow-out numbers - indeed a couple fell. In truth, they mostly rose in the weeks leading up to the results, so perhaps no further lift on the result was to be expected.

Meanwhile, there is no doubt that some of the beaten-down value players are enjoying their period in the sun, as the chart below on growth versus value shows.

Our caveat is that this value resurgence should be regarded with some circumspection. Take for instance the European car makers. On the one hand, Volkswagen, the largest car producer in the world with production of over 10 million vehicles annually, has fully embraced the electric vehicle, committing to the virtual phase-out of internal combustion engines entirely within a decade. It has been reported that VW's admittedly smaller rival, BMW, has not committed to the electric switch, with the BMW board against it because the margins are lower than for the ICE cars. Frustrated innovative, creative, and smart engineers left BMW, partly founding their own battery electric vehicle startups in China or the United States, it has been widely reported.

Traditional valuation methods do not apply to strong growth stocks

In our view, there are value (lowly-priced) stocks, and there are value companies which have a plan for the future, and they are different. Disney is in the latter group, moving from a model in which it relies on cable companies to sell its programming in favour of a streaming service like Netflix.

Kodak is an example of a value company which failed to adapt, and so never realised its value promise.

The key is a systematic approach to valuation. We apply a multi-year discounted cashflow valuation process, designed to capture shifts in business strategy (positive or negative). We do not use single period measurement tools such as P/E or EV/EBITDA but consider the likely cashflows looking out over a number of years. This allows us to understand the prospects of the giants mentioned in the Wall Street Journal article as well as many other companies that we expect to be household names in the future.

For example, we have held Xilinx, Nvidia and Qualcomm for over three years as our expectation of the companies' valuation has emerged and the share prices rocketed. The earnings power of these companies cannot be assessed using single period measures.

The process is also useful in assessing the valuation of companies which are moving from loss to profit. We hold a small number of these companies because we consider that their growth potential is significant (meaning global). Netflix was only barely profitable when we initially opened the position yet this quarter announced a US$5 billion buyback of stock.

There are some years to go before Netflix reaches our future valuation of the company. Similarly, with the other FAANG companies (Facebook, Amazon, Apple, Google) we see multi-year growth paths for these companies.

It also helps us to screen out companies which have deep-seated problems which are not being properly addressed by management, notwithstanding how good their earnings may be in any given period.

 

Alex Pollak is Chief Investment Officer and Co-Founder of Loftus Peak. This article is for general information only and does not consider the circumstances of any individual.

 

RELATED ARTICLES

Reece Birtles on selecting stocks for income in retirement

Irrational exuberance in growth versus value

Is FOMO overruling investment basics?

banner

Most viewed in recent weeks

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

What to expect from the Australian property market in 2025

The housing market was subdued in 2024, and pessimism abounds as we start the new year. 2025 is likely to be a tale of two halves, with interest rate cuts fuelling a resurgence in buyer demand in the second half of the year.

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

Howard Marks warns of market froth

The renowned investor has penned his first investor letter for 2025 and it’s a ripper. He runs through what bubbles are, which ones he’s experienced, and whether today’s markets qualify as the third major bubble of this century.

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

The 20 most popular articles of 2024

Check out the most-read Firstlinks articles from 2024. From '16 ASX stocks to buy and hold forever', to 'The best strategy to build income for life', and 'Where baby boomer wealth will end up', there's something for all.

Latest Updates

Investment strategies

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

Shares

The case for and against US stock market exceptionalism

The outlook for equities in 2025 has been dominated by one question: will the US market's supremacy continue? Whichever side of the debate you sit on, you should challenge yourself by considering the alternative.

Taxation

Negative gearing: is it a tax concession?

Negative gearing allows investors to deduct rental property expenses, including interest, from taxable income, but its tax concession status is debatable. The real issue lies in the favorable tax treatment of capital gains. 

Investing

How can you not be bullish the US?

Trump's election has turbocharged US equities, but can that outperformance continue? Expensive valuations, rising bond yields, and a potential narrowing of EPS growth versus the rest of the world, are risks.

Planning

Navigating broken relationships and untangling assets

Untangling assets after a broken relationship can be daunting. But approaching the situation fully informed, in good health and with open communication can make the process more manageable and less costly.

Beware the bond vigilantes in Australia

Unlike their peers in the US and UK, policy makers in Australia haven't faced a bond market rebellion in recent times. This could change if current levels of issuance at the state and territory level continue.

Retirement

What you need to know about retirement village contracts

Retirement village contracts often require significant upfront payments, with residents losing control over their money. While they may offer a '100% share in capital gain', it's important to look at the numbers before committing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.