US growth stocks have enjoyed a strong run and we believe there is further upside potential over the long term, particularly for high-quality innovative names.
We believe that an actively-managed approach that targets companies with durable competitive advantages that trade at a reasonable valuation can generate alpha for the astute investor over the long term.
Investing in US growth stocks has proved particularly rewarding, and this is even more so the case relative to value stocks over the past decade or so. Such a prolonged period of outperformance versus value has prompted many to question whether they should be investing in growth stocks at this point in time. But to reduce the argument to one of time rather than substance is to miss the point — the length of past relative outperformance is largely immaterial to the opportunities in the growth space at present.
Is it a growth or a value market? The Fundamental Growth and Core Equity team does not try and second-guess the short-term style preferences of the market and doesn’t think investors are well served in trying to do so either. We believe that growth companies in the United States offer many dominant, high-quality, innovative, asset-light business models capable of compounding strong double-digit sustainable growth at very high returns on invested capital. The US equity market, especially growth stocks, provides access to some of the world’s most innovative companies in the semiconductor, software, medical technology, internet services, ecommerce, robotics and industrial automation sectors, to name but a few. Many of these operate on a global scale, driving improvements in operating leverage, returns, and free cash flow generation — and resulting in increased capital for companies to reinvest in further innovation that enhances their competitive advantage.
Figure 1: US Premier Growth Strategy: Higher Growth, Less Cyclical
In our view, investors should have an allocation to US growth equities because we believe this area of the US market offers potentially the greatest long-term opportunities for capital appreciation — something that is not as readily seen in other asset classes, styles or geographies. Unfortunately, this part of the market also contains companies with unproven business models or high leverage, fad stocks that can fall as fast as they rise, and sky-high valuations that create massive downside risk. Without a doubt, it pays to be selective when investing in this segment.
US Premier Growth Equity Strategy
State Street’s US Premier Growth Equity Strategy is an all-weather growth strategy centered around quality growth at a reasonable price principles. It is not just a collection of high-growth momentum names that are the mainstay of many other portfolios in the category. After a strong run by the Russell 1000 Growth Index, we believe our discerning approach is a better way to harvest the opportunities among large- and mid-cap growth equities in the US. This strategy depends not on style momentum, but instead on the ability of its holdings in aggregate to compound at a mid double-digit rate throughout the economic and market cycle.
Valuation Discipline Underpins Approach
Attempting to time market valuation swings and sentiment changes is a notoriously difficult job for investors. Our valuation discipline underpins the portfolio strategy that aims to keep up with or beat the benchmark in strong ‘up’ years while providing downside protection during market corrections. We do this by investing in a concentrated collection of high-quality companies offering consistent, largely secular, mid double-digit aggregate earnings growth at reasonable valuations. We believe the strategy is not only an excellent way to participate in exciting long-term growth opportunities but is also a relatively secure port in a market storm.
Our concentrated US Premier Growth Equity Strategy has historically offered a three-to-five-year earnings per share (EPS) growth rate in line with or better than the Russell 1000 Growth Index,1 but the aggregate price-to-earnings (PE) multiple has been substantially lower than that of the aforementioned benchmark. Additionally, the Premier Growth Equity strategy has in recent years had a lower standard deviation and beta than the benchmark, further reflecting relatively lower risk and volatility.
Portfolio Construction: Adopting a Longer Horizon
In constructing the portfolio, we apply a rigorous bottom-up approach to unearthing quality sustainable growth companies that trade on reasonable valuations. We seek companies that can reliably compound their earnings at a minimum 10% rate over the following three-to-five years. Most sell-side analyst models only go out three years, and some for even shorter periods, and conservatively assume a natural fade in growth and returns. This means that if we can identify companies that can sustain growth beyond this short horizon, they are likely to be undervalued by the market, as illustrated in Figure 2
Identifying Opportunities: The Confidence Quotient (CQ)
How do we unearth such undervalued companies? After intense fundamental analysis and proprietary modeling we score each name on our proprietary Confidence Quotient (CQ) framework. This is unlike traditional measures of quality that emphasize a simple combination of historical returns, earnings volatility and debt. Instead, we define quality on a forward-looking basis and focus on qualitative measures such as the competitive moat, our confidence in the management team, the appropriateness of the capital allocation strategy, the transparency of the business model and the fundamental momentum of the business drivers. We leverage our long-tenured research team (with an average of 20+ years of experience) to quantify these “soft” metrics using our detailed CQ framework. The higher the CQ score, the higher our conviction in our projection of the duration of growth, creating substantial stock outperformance potential as compounding growth is realised over time. The sustainability of growth is key and we spend a lot of our time on this because the market often undervalues high growth that is truly sustainable — for example, by using simple near-term PE multiples on one-year forward earnings.
Figure 3 shows the premium to the market that durable growth is worth. In this hypothetical example, the valuation premium warranted to the market rises exponentially as the number of years of excess growth increases. We expect the strong quality attributes found in our high CQ companies will lead to steady predictable earnings growth, while our valuation discipline provides downside protection as the growth compounds.
Figure 3: The Market Often Undervalues Persistent Growth
Justified Market Premium for Different Durations of High Growth
Prospects for US Growth Stocks
US equity investors have enjoyed many years of strong growth, and the low interest rates and easy money over the past decade have resulted in stretched valuations in certain areas of the market. We think this will change as the economy, markets, and rates normalise, leading to less correlation and unidirectional movement that results in a better environment for active fundamental stock pickers like ourselves. Many high-growth firms, especially in the technology sector, fail or are disrupted. As beta and momentum decline as leading market drivers, the benefits of an experienced disciplined team to select your stock exposure becomes clearer.
In recent years, multiple expansion has been a big contributor to total return, especially for long-duration high-growth equities. However, with interest rates under upward pressure due to strong economic growth from the post-pandemic reopening and higher inflation, multiple expansion will be less likely going forward. In fact, high-multiple names are more likely to experience contraction through such a period, while the sustainable mid-teen growers at reasonable valuations that we hold in the US Premier Growth Equity strategy don’t need multiple expansion for their stocks to advance. That, combined with our valuation discipline, should provide some ballast compared to our momentum-oriented peers who will be more likely to suffer significant multiple compression in a rising rate environment given their greater allocation to previously high-flying stocks.
A Portfolio of Innovative Long-Term Winners
In summary, we aim to consistently compound our portfolio over the long run by investing in quality companies with sustainable mid-teens growth and consistently high returns on invested capital that trade at reasonable valuations. Our approach is aimed at giving clients a portfolio of innovative long-term winners that we expect to provide excess returns while at the same time providing downside protection because of our valuation discipline and deep emphasis on quality.
1 Source: State Street Global Advisors, Bloomberg Finance L.P., as of 30 November 2021.
State Street Global Advisors Worldwide Entities Abu Dhabi: State Street Global Advisors Limited, ADGM Branch, Al Khatem Tower, Suite 42801, Level 28, ADGM Square, Al Maryah Island, P.O Box 76404, Abu Dhabi, United Arab Emirates. Regulated by the ADGM Financial Services Regulatory Authority. T: +971 2 245 9000. Australia: State Street Global Advisors, Australia, Limited (ABN 42 003 914 225) is the holder of an Australian Financial Services License (AFSL Number 238276). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia. T: +612 9240-7600. F: +612 9240-7611. Belgium: State Street Global Advisors Belgium, Chaussée de La Hulpe 185, 1170 Brussels, Belgium. T: +32 2 663 2036. State Street Global Advisors Belgium is a branch office of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. Canada: State Street Global Advisors, Ltd., 1981 McGill College Avenue, Suite 500, Montreal, Qc, H3A 3A8, T: +514 282 2400 and 30 Adelaide Street East Suite 800, Toronto, Ontario M5C 3G6. T: +647 775 5900. France: State Street Global Advisors Europe Limited, France Branch (“State Street Global Advisors France”) is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors France is registered in France with company number RCS Nanterre 899 183 289, and its office is located at Coeur Défense — Tour A — La Défense 4, 33e étage, 100, Esplanade du Général de Gaulle, 92 931 Paris La Défense Cedex, France. T: +33 1 44 45 40 00. F: +33 1 44 45 41 92. Germany: State Street Global Advisors Europe Limited, Branch in Germany, Brienner Strasse 59, D-80333 Munich, Germany (“State Street Global Advisors Germany”). T: +49 (0)89 55878 400. State Street Global Advisors Germany is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. Hong Kong: State Street Global Advisors Asia Limited, 68/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. T: +852 2103-0288. F: +852 2103-0200. Ireland: State Street Global Advisors Europe Limited is regulated by the Central Bank of Ireland. Registered office address 78 Sir John Rogerson’s Quay, Dublin 2. Registered Number: 49934. T: +353 (0)1 776 3000. F: +353 (0)1 776 3300. Italy: State Street Global Advisors Europe Limited, Italy Branch (“State Street Global Advisors Italy”) is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors Italy is registered in Italy with company number 11871450968 — REA: 2628603 and VAT number 11871450968, and its office is located at Via Ferrante Aporti, 10 - 20125 Milan, Italy. T: +39 02 32066 100. F: +39 02 32066 155. Japan: State Street Global Advisors (Japan) Co., Ltd., Toranomon Hills Mori Tower 25F 1-23-1 Toranomon, Minato-ku, Tokyo 105-6325 Japan. T: +81-3-4530-7380. Financial Instruments Business Operator, Kanto Local Financial Bureau (Kinsho #345), Membership: Japan Investment Advisers Association, The Investment Trust Association, Japan, Japan Securities Dealers’ Association. Netherlands: State Street Global Advisors Netherlands, Apollo Building 7th floor, Herikerbergweg 29, 1101 CN Amsterdam, Netherlands. T: +31 20 7181 000. State Street Global Advisors Netherlands is a branch office of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. Singapore: State Street Global Advisors Singapore Limited, 168, Robinson Road, #33-01 Capital Tower, Singapore 068912 (Company Reg. No: 200002719D, regulated by the Monetary Authority of Singapore). T: +65 6826-7555. F: +65 6826-7501. Switzerland: State Street Global Advisors AG, Beethovenstr. 19, CH-8027 Zurich. Registered with the Register of Commerce Zurich CHE-105.078.458. T: +41 (0)44 245 70 00. F: +41 (0)44 245 70 16. United Kingdom: State Street Global Advisors Limited. Authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 2509928. VAT No. 5776591 81. Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. T: 020 3395 6000. F: 020 3395 6350. United States: State Street Global Advisors, 1 Iron Street, Boston, MA 02210-1641. T: +1 617 786 3000.
The views expressed in this material are the views of the Fundamental Growth and Core Equity Team through the period ended 31 October 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Past performance is not a guarantee of future results.
Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions. The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
This information is for informational purposes only, not to be construed as investment advice or a recommendation or offer to buy or sell any security. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. There are no guarantees regarding the achievement of investment objectives, target returns, portfolio construction, allocations or measurements such as alpha, tracking error, stock weightings and other information ratios. The views and strategies described may not be suitable for all investors. SSGA does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision. Investing entails risks and there can be no assurance that SSGA will achieve profits or avoid incurring losses.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.
Images of NYSE Group, Inc. are used with permission of NYSE Group, Inc. Neither NYSE Group, Inc. nor its affiliated companies sponsor, approve of or endorse the contents of this program. Neither NYSE Group, Inc. nor its affiliated companies recommend or make any representation as to possible benefits from any securities or investments.