A market driven overwhelmingly by sentiment has seen an indiscriminate sell-off in growth stocks year-to-date, presenting opportunities for investors interested in long-term quality.
Markets are often particularly choppy at the start of the year, due to a lack of data and company reporting in January. This means investors are more likely to lean on sentiment and macro events to direct their decisions. This was certainly the case in early-2022, as investors focused on inflation and rising interest rates. Earnings season began in mid-February and has in fact seen some strong numbers. However, investors have instead been focusing on the tragic events in Ukraine, further taking attention away from individual company fundamentals.
When inflation is feared, growth businesses tend to get punished. The theory is that since growth businesses are priced on their future cashflows – and that cashflow will be worth less as inflation and interest rates march upwards.
This is why we think it is key to invest in high-quality growth companies. Those that are cash rich now and where their market value is not purely a function of tomorrow’s earnings. And we see this market re-rating as a great opportunity to reassess the investment case of these quality businesses that have been, in our opinion, oversold.
Focus on today, and tomorrow
In reality, many companies classed as ‘growth’ stocks have strong earnings today and should not be priced solely on their future potential. These same high-quality, growing businesses have been caught in the downdraught of non-profitable growth companies and tech names in the US, which is why we think they represented a buying opportunity in recent weeks.
All our due diligence is completed ahead of time to ensure we are ready to capitalise when companies we like are unduly punished by spooked markets. As active managers, it is our role to take advantage of these phases and to hold strong to our convictions.
Every company we invest in must pass certain quality criteria: long-term revenue growth, strong management teams, good cash generation and a sound business model. We own no speculative, unprofitable businesses in our portfolio.
A track record of staying the course
This is because we believe in genuine long-term investing. In the Church House UK Equity Growth Fund, 21% of holdings have been held since its inception 21 years ago, and just under half (45%) have been held for the past 10 years. This is a number we would like to see increasing over time.
This is not the first time we have seen a value rally. As recently as last year, so-called value stocks were in favour (for many of the same reasons as they are today). But compared with the end of 2020 and beginning of 2021, this value rally has been quicker and sharper.
While last year there was the perceived potential for higher interest rates; this year that outcome is almost inevitable. The Bank of England has already raised rates twice in this cycle (December and January) and the Fed is expected to start hiking at its March meeting.
A look at the headline indices in 2022 tells you all you need to know about how inflation, Putin’s actions and this change in central banks’ policy intentions has affected markets in the first few months of the year. Banks, oil and gas, tobacco and miners (all seen to be value plays), have performed strongly. At the other end of the spectrum, the FTSE AIM All-Share, FTSE 250 and FTSE Small Cap indices have all had a year to forget so far.
Looking beyond indices
As active managers, we don’t pay too much attention to index returns, although we know they are a focus for investors.
We anticipate an improvement in the fortune of our high-quality names once fundamentals reassert themselves and have seen encouraging earnings reports so far in 2022.
It can be tough to stick to your guns in these sorts of environments. But with a fund born out of private client capital, our primary commitment is to the long-term objectives of our investors. Investing in unsustainable businesses that face significant headwinds down the line – such as oil and gas, banks and tobacco – purely because they are experiencing a knee-jerk revival is not in our DNA. It wouldn’t serve our fund, nor our investors in the years to come.
The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article.
Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.