Revaluation, dislocation and recession: why it’s not over for growth stocks
- Growth stocks have sold off indiscriminately, not based on operational performance or prospects
- Against a difficult backdrop, investors favour short-term certainties over long-term opportunity
- The future is brighter for growth stocks as innovation accelerates and there are more opportunities to own businesses with outlier potential
The value of an investment, and any income from it, can fall as well as rise and investors may not get back the amount invested.
After sky-high gains during the pandemic, growth stocks have come crashing down to earth over the last eight months or so. This year, the Nasdaq has given up around 25 per cent, putting it among the bears.
Tech stocks have sold off indiscriminately, regardless of reputation. Any slight disappointment in quarterly results has triggered a dramatic drawdown.
The volatility of share prices of growth stocks has been both staggering and sobering. It has been a humbling experience for managers such as Baillie Gifford and more so for our clients. Indeed, we are acutely aware that 2022 has been very uncomfortable for those that invest with us.
As a result, we have revisited the investment case for every stock we hold. We are gauging their long-term prospects in the prevailing environment and beyond. We are more than happy to continue holding most; some are in the waiting room and a few have been shown the door.
More importantly, our philosophy and process remain unchanged. We continue to seek exceptional companies that offer significant returns to investors on five-to-ten-year horizons.
Some clients may be wrestling with more immediate concerns:
- Have growth stocks been justifiably revalued?
- Is there a possible dislocation between their share prices and prospects?
- Or are we facing recession and the potential for more widespread market negativity?
Embracing the future
As we know, lockdown threw up a series of big winners. Share prices rose exponentially for those companies catering for the stay-at-home lifestyle. Netflix and Zoom became bywords in entertainment and communication. Amazon and Ocado flourished by bringing necessities to the door.
In addition to shopping, education and medicine went online. Biotech went to work on vaccines with speedy results. Greater digitalisation increased interest in the cloud and demand for computing power.
The future was embraced with both arms. The share prices of alternative energy companies and electric vehicle providers rose on a wave of tech fervour. With market momentum behind the winners, valuations become stretched, while asset managers considered whether this growth was long term or brought forward by circumstance.
The clouds gather
As we emerged from Covid-19 Mr Market provided an answer. Those stocks that stood to benefit from the resumption of economic activity became immediately popular, such as energy, financials, commodities and property.
At the same time, the clouds gathered for growth:
- Easy money, pent-up demand and supply chain issues stoked vicious inflation;
- China first cracked down on tech platforms then re-engaged battle with Covid-19;
- and, most destructive of all, President Putin invaded Ukraine with tragic consequences.
This cocktail of concerns has had serious short-term consequences for growth managers such as Baillie Gifford. While many investors have seen drawdowns of 30 per cent or more over the past few months, this does not necessarily make us villains. In the same way that we were not heroes in 2020, when some portfolios rose by over 100 per cent.
Caught in the crossfire
Our style of investing will inevitably see periods of share price volatility. Tesla, for example, has endured 11 sharp declines ranging from -60 to -17 per cent on the way to an almost 2,000 per cent gain for investors in many of our portfolios.
Unsurprisingly, investors are now finding it difficult to digest long-term uncertainty. They prefer to embrace what they believe are short-term certainties.
The market has revalued growth in a way last seen in the tech bust and the Great Financial Crisis. But this may not be fair. Many of these revalued growth stocks are in significantly better shape than those damaged during earlier crises. Indeed, there is a strong chance that quality growth has become dislocated in share price terms from corporate fundamentals and prospects.
Market inefficiency creates opportunity
If this is the case, then we could be on the cusp of a great opportunity. Netflix and Zoom have seen share prices fall back below 2019 levels. This is despite revenues and margins doubling in the case of the former and revenues multiplying by five for the latter. The much-maligned China tech giants Alibaba and Tencent are priced at 2016 and 2017 levels. Again, despite revenues increasing five times and doubling respectively. Significant operational progress and savage ratings creates market inefficiency and therefore opportunity.
Even more striking are the graphs of Shopify and Moderna below. In both cases share price is back to pre-Covid levels while revenues have grown strongly. The former has been revalued on slowed growth, which has some logic post-pandemic. But the company has abundant scope to grow its business many times over.
Shopify is building the digital infrastructure to make commerce better for everyone. Its platform helps merchants of all sizes manage their businesses across every channel and any device. It is forging lasting relationships with high-quality products. With less than 2 per cent of US sales, Shopify has a long runway of potential success ahead.
The market is treating Moderna and its Covid-19 vaccine as a one-trick pony. It has failed to price in that the mRNA technology platform is highly scalable. Unlike existing technologies, mRNA delivers its intracellular and membrane proteins directly into cells. And it can target multiple areas of disease from flu to cancer too. Moderna already has big pharma scale revenues, but if it succeeds in developing this new class of medicine, it could become the first trillion-dollar biotech business.
Investing in the future
Another key difference between the growth of today and yesterday is its resilience, especially in the face of reinvigorated inflation. In many cases, the stocks held in our portfolios are growing sales faster than before Covid-19. This suggests customers value their products and they have pricing power. These growth companies have net cash on their balance sheets, or at least positive free cash flow. They are busy investing in their future, not maximising profits in the present. Delivery Hero, for example, last year spent £632m on marketing while making £492m in profits. The table below shows just how companies owned within the US Equity Growth portfolio are growing their revenues year on year. It is an improving picture.
|Annual sales growth||2021||2020||2019|
We can’t tell you when or how share prices will bounce back. Nobody can with accuracy. Stock markets are unpredictable and in the short run are affected by all sorts of human behaviours. Panic, excitement and herding, to name a few.
Our investment process deliberately invests through that noise. We know that over five years and longer, market sentiment becomes much less important to investment returns. Company fundamentals dominate over these longer time frames. Therefore, we search for those rare businesses with exceptional and underappreciated growth potential.
In contrast to current market sentiment, we believe that the opportunities to own businesses with outlier potential are expanding as innovation accelerates in almost every industry. In times like these, it becomes harder to exercise patience, but that’s exactly when our investment edge is at its most important.
The recession threat
A key influence on any potential for recovery is the threat of recession. There has been talk that a tech correction may extend into a wider recession. This is on the back of a global slowdown in business growth and consumer confidence, amplified by higher interest rates to combat inflation, as well as continuing issues in China and conflict in Europe.
Should the world slide into recession, then company revenues and profits will dissipate, and valuations deteriorate. Investors will no doubt seek traditional safe havens such as gold, fixed interest and companies with strong balance sheets and resilient franchises.
The last category may encompass today’s great growth companies, with growth being more highly prized in a no-growth world. Recent recessions have lasted as much as two years. Our horizons are longer than that so we will remain optimistic.
There’s no going back
Current market sentiment favours a return to how it was before. Put another way, it thinks fossil fuels can trump alternative energy and that the rise of electric vehicles may be illusory. It says we will return to the high street rather than shop more online and that health will remain impersonal, reactive and driven by trial and error.
There are plenty of other such examples. Looking out three, five or ten years, today’s market view seems myopic. The opportunity offered by growth companies looms large in front of us all. Those who are patient can reap the rewards.
The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in June 2022 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
This communication contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.
Representative Global Composite
|Representative Global Composite||
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this communication are for illustrative purposes only.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
This communication is suitable for use of financial intermediaries. Financial intermediaries are solely responsible for any further distribution and Baillie Gifford takes no responsibility for the reliance on this document by any other person who did not receive this document directly from Baillie Gifford.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018. Baillie Gifford Investment Management (Europe) Limited is authorised by the Central Bank of Ireland as an AIFM under the AIFM Regulations and as a UCITS management company under the UCITS Regulation. Baillie Gifford Investment Management (Europe) Limited is also authorised in accordance with Regulation 7 of the AIFM Regulations, to provide management of portfolios of investments, including Individual Portfolio Management (‘IPM’) and Non-Core Services. Baillie Gifford Investment Management (Europe) Limited has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. Through passporting it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (‘FinIA’). The representative office is authorised by the Swiss Financial Market Supervisory Authority (FINMA). The representative office does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited and Baillie Gifford & Co are authorised and regulated in the UK by the Financial Conduct Authority.
Baillie Gifford Investment Management (Shanghai) Limited
柏基投资管理(上海)有限公司(‘BGIMS’) is wholly owned by Baillie Gifford Overseas Limited and may provide investment research to the Baillie Gifford Group pursuant to applicable laws. BGIMS is incorporated in Shanghai in the People’s Republic of China (‘PRC’) as a wholly foreign-owned limited liability company with a unified social credit code of 91310000MA1FL6KQ30. BGIMS is a registered Private Fund Manager with the Asset Management Association of China (‘AMAC’) and manages private security investment fund in the PRC, with a registration code of P1071226.
Baillie Gifford Overseas Investment Fund Management (Shanghai) Limited
柏基海外投资基金管理(上海)有限公司(‘BGQS’) is a wholly owned subsidiary of BGIMS incorporated in Shanghai as a limited liability company with its unified social credit code of 91310000MA1FL7JFXQ. BGQS is a registered Private Fund Manager with AMAC with a registration code of P1071708. BGQS has been approved by Shanghai Municipal Financial Regulatory Bureau for the Qualified Domestic Limited Partners (QDLP) Pilot Program, under which it may raise funds from PRC investors for making overseas investments.
Baillie Gifford Asia (Hong Kong) Limited
柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 license from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited
柏基亞洲(香港)有限公司 can be contacted at Suites 2713-2715, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone +852 3756 5700.
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth) and holds Foreign Australian Financial Services Licence No 528911. This material is provided to you on the basis that you are a ‘wholesale client’ within the meaning of section 761G of the Corporations Act 2001 (Cth) (‘Corporations Act’). Please advise Baillie Gifford Overseas Limited immediately if you are not a wholesale client. In no circumstances may this material be made available to a ‘retail client’ within the meaning of section 761G of the Corporations Act.
This material contains general information only. It does not take into account any person’s objectives, financial situation or needs.
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.
The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission (‘OSC’). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.
Baillie Gifford Overseas is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755-1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This material is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.
Ref: 23204 10011653