Growth stocks still winning in war with value

The current vogue for growth stocks over value investments is akin to the years leading to 2000 just before the tech crash, says one small cap investor.

Value investing has been out of favour for at least two years and is even moreso now as governments and central banks flood nations with cheap money, says Glennon Small Companies chair Michael Glennon.

“It’s very akin to 1999 when value companies were in the doldrums and everything was about tech and the new paradigm of market cap to revenue as the new metric of how to value a company,” he wrote in the company’s annual report.

Glennon believes many of today’s growth companies which are favouring revenue generation over profit and are seeing “stunning” share price appreciation are likely to disappear.

After the March market rout, money “fled” to bigger, more liquid growth companies that were perceived to be immune to recession, Glennon said.

This harmed the smaller value, micro and nano caps which had strong balance sheets but weren’t in vogue with investor thinking at the time.

Don’t fight the markets

The preference for growth is a trend with legs, says Saxo Bank Australian markets strategist Eleanor Creagh.

“With investors attempting to escape the secular stagnation that accompanies the present era of financial repression and state capitalism via the valuation premium provided by earnings duration, growing free cashflow and high forecast future cashflows in secular growth sectors, essentially means ‘value’ can be found in growth,” she wrote on Friday.

“Hence the perpetual bid for seemingly infinity bound momentum and growth stocks, with earnings duration pathways boosted by record low rates set to extend for years to come.”

Glennon says policy responses to the COVID-19 pandemic have created an artificial, short-term “sugar fix” that avoided a deep recession but at the same time won’t deliver long-term economic growth.

“What it has done however is create a speculative bubble in equity markets,” he said.

“The impact of these [Robinhood] traders, many of whom have an incredibly naive knowledge of markets, was to further exacerbate momentum in growth stocks [and] stretch valuations.

“It’s a recipe for disaster.”

Little room for error

However, while growth stocks are still the trend du jour, there is now little margin for error in the rocketing valuations given to companies from Afterpay (ASX:APT) to Nearmap (ASX:NEA).

Creagh says expectations are high for growth stocks, mainly in the technology and healthcare sectors which means investors still expect them to deliver on “lofty embedded expectations”.

“Although we believe the companies leveraged toward these secular growth thematics will outperform in the medium/long run, valuations and excessively one sided positioning make us tactically cautious with respect to entry or increasing allocations at present,” Creagh said.

“In other words don’t buy growth at any price!”

Value stocks’ time will come

Like many investment managers, Glennon is hopeful of a growth period for stocks generally once the pandemic has been brought under control, similar to that seen from 2011 to 2016 after the global financial crisis.

However, he’s circumspect as to how long it’ll take to get there.

“We expect the market will be more volatile in the coming financial year. We have geopolitical tensions between the US and China, which will impact our exports of resources, oil prices are depressed and we will have a swathe of small businesses under financial distress, causing longer term increases in unemployment,” he said.

COVID-19 treatments will help and he believes the disease is likely to disappear quickly because of the scale of infections, but continued outbreaks similar to those in Victoria, Hong Kong and Beijing will weigh on recoveries and investor sentiment.

Glennon has bought into gold an inflation hedge, suggesting he sees significant upwards movements in prices in future thanks to the amount of money governments are putting into their economies, and reduced exposure to the more illiquid nanocaps and microcaps.