Value or growth
There has been a lot of discussion in the investment management industry about a decline in the value style of investing that started after the 2008 global financial crisis. Value style investing at its core seeks companies that currently trade at a ‘cheap’ valuation but with an expectation that there will be a recovery in the medium to long term. Usually these companies have found themselves in unenviable competitive positions, possess unremarkable assets and lack near-term earnings growth.
Investors are able to invest in these companies at a ‘cheap’ valuation due to these unremarkable qualities, but face the potential for significant profit if their fortunes change in the future. In contrast, growth-style investing favours companies that currently represent significant growth and where the market expects that trajectory to continue – it’s this expectation that leads to an ‘expensive’ valuation. However, if the growth of the business does in fact continue and exceeds the current expectations of the market, then the investor is rewarded with stock price gains despite the seemingly ‘expensive’ valuation today.
In the recent past, growth style investing has been much more profitable than value style investing and financial commentators frequently make predictions about when this trend might reverse. At ELM Responsible Investments, we don’t blindly subscribe to one style over the other, but instead follow our own Investment Framework based on evidence and empirical studies to construct a portfolio that we think will generate strong long-term returns for our investors.
The global trends influencing company valuation
Our Investment Framework helps us identify and invest in innovative high-quality companies with strong competitive positions in industries that are rational and favourable, and possess valuable and irreplaceable assets. Additionally, our Sustainability Framework helps us identify and invest in companies that contribute positively to the world, achieving positive social and environmental outcomes. Once we have identified high-quality companies, we then make sure that the shares are available for investment at a reasonable price, with sufficient potential for future capital gains. We see two inter-related global trends that are here for the long-term that make it vital for investors to seek out high-quality companies:
Low global growth rates, low global inflation rates and low global interest rates
Availability of capital and increased competition for all companies
When we have low global growth rates and low inflation rates, companies are no longer able to rely on a profitability ‘free kick’ from a buoyant economy. Previously all companies benefited from a robust economy, but in today’s world, only forward-looking and innovative companies will succeed.
Given the availability of capital today, and heightened awareness of the importance of innovation, there is ample appetite for investment in this area. This means that there is increased competition for companies in all industries (a double whammy given they are already facing lower global growth).
Our approach
Taken together, the two important forces mentioned above make forecasting future earnings of unremarkable companies very difficult, and successfully following a value style investment strategy even more difficult. Our approach identifies the truly high-quality companies that are innovating and possess long-term sustainable competitive advantages. We then only invest if we think that there is still significant potential for shareholders. By having two steps, we seek out companies that we believe have excellent long-term prospects, but we reduce the risk of investing in companies that may be permanently disadvantaged due to the changing global environment.
This note has been prepared by ELM Responsible Investments (‘ELMRI’) ABN 70 607 177 711 AFSL 520428, for Australian wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth).
The information is not intended for general distribution or publication and must be retained in a confidential manner. Information contained herein consists of confidential proprietary information constituting the sole property of ELMRI and its investment activities; its use is restricted accordingly.
This note is for general informational purposes only and does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of preparation and presenting and all forecasts, assumptions, opinions, data and other information are not warranted as to accuracy or completeness and are subject to change without notice. This is not an offer document and does not constitute an offer or invitation of investment recommendation to distribute or purchase securities, shares, units or other interests to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this note. Any potential investor should consider their own circumstances and seek professional advice.
ELMRI funds, its directors, employees, representatives and associates may have an interest in the named securities.
Past performance is for illustrative purposes only and is not indicative of future performance.