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American Fur Company at the top of the S&P?

Hamish Maxwell, Investment specialist

Key Points

  • A gloomy economic backdrop has led many investors to shorten their horizons, reducing support for growth companies
  • This anti-growth sentiment means quality businesses with a high chance of profiting can be overlooked
  • The unlimited upside of the most successful growth investments can outweigh the limited downside of the least

Following a recent period of unprecedentedly good performance, many Baillie Gifford growth funds are now underperforming worse than at any point in their history. If this market rollercoaster tells us anything, it’s that for growth investors, patience and imagination matter more than ever. Here’s a case for why.

There’s been plenty for investors to worry about lately, during an era of conflict. Trade tensions between the US and China, including the weaponisation of the semi-conductor trade, were followed by a planet-wide fight against the unseen quasi-life form Coronavirus, and more recently were the awful images of tanks rolling across a European border, a sight that ought to have been confined to history. 

Not only has the world experienced serious humanitarian issues lately, but restrictions of supply chains have been caused by some of these challenges and have contributed to rising prices, which in turn has reintroduced an idea to global markets that many younger investors won’t have experienced before, interest rate rises.

This gloomy backdrop has led many to seek more immediate certainty from their assets. Time horizons have come in drastically and shorter horizon stocks have been favoured over longer horizon growth companies, the type that need time to earn their potentially larger cash flows. Not to mention that their forecasted cash flows must travel backwards through time by way of the market’s imagination to become today’s share price, labouring through things like costly inflation and interest rate expectations on the way.

This process, known to practitioners simply as ‘discounting’, is particularly laborious for growth stocks when the market is more nervous about the future. It’s why traditional business models in areas such as energy, commodities and banks have done so well lately. Their cash flows are already mature and much more dependable in the near-term. 

The flip side is that portfolios of growth companies have had a tougher time. After all, growth requires patient investment now to realise greater profits later, not what the current market mood prefers.

However, the above immediate challenges bely three important facts. First, the market’s prevailing anti-growth sentiment can indiscriminately overlook a company’s financial quality, strength of management, and competitive advantages. Second, notwithstanding the current discount that the stock market is giving to future growth, the market is highly unlikely to discount actual profit growth when it accrues over time. In other words, businesses that grow their profits will be worth more as a result. Third, is that certain mature business models currently favoured by the market remain highly disruptable.

We further believe that the whole vast stock market consists mostly of companies that will be disrupted over time. This sort of ‘creative destruction’, as Schumpeter called it, is part of the natural order of things. It’s as old as industry itself. Otherwise, 19th century industrial titans like the American Fur Company would dominate the index today, with beaver pelts, instead of becoming obsolete 150 years ago.

To paraphrase George Bernard Shaw, unreasonable people drive change. George would perhaps nod knowingly at the small number of visionary business leaders who are right now refusing to accept the way things are done and are changing the world around them. It can be much to the delight of consumers whose heads will turn when something better comes along. Consider Ginkgo Bioworks harnessing 4 billion years of evolution to create living medicines, or ASML pushing the boundaries of physics to make the next generation of world-changing microchips. 

Not all growth investments will work out, but the unlimited upside of the most successful can greatly outweigh the limited downside of any losers.

There are short-term challenges for growth stocks. We can anticipate profit warnings as supply chains and consumer behaviour take time to settle down in light of recent events. Therefore, we must carefully consider financial resilience. After all, a company has to stay afloat to grow. Resilience comes from things like positive earnings per share or free cash flow, or a net cash balance. But the current market is retreating indiscriminately from even the more resilient growth stocks. This can be a costly mistake, when the opportunity for long-term disruption remains so profound. 

The profit and share price growth for the biggest winners can be so substantial that it demands proper use of patience and imagination now. For growth investors, patience and imagination are more than just virtues, they’re an absolute must.

 

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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.

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Author

Hamish Maxwell

Investment specialist

Hamish joined Baillie Gifford in 2017 and is an international equities investment specialist in our Clients Department. Just prior to joining Baillie Gifford, he achieved an MBA from Cass Business School and was recipient of the EU Award. Earlier in life, Hamish also completed post-graduate Law at the University of Sussex, but a well-known economic event in 2008 encouraged him to pursue a different interest professionally, i.e., join the Royal Navy as a Commissioned Officer. Hamish served in aircraft carriers, mine-hunters and trident nuclear submarines and was awarded top-of-class by HRH Prince Edward.

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