As growth managers, we at Baillie Gifford search for companies that have the potential to generate superior long-term growth in revenues, earnings and cash flow in the belief that this will be reflected in long-term share price outperformance.
We are not operating in a static environment however. For example, technological progress is so relentless and all pervasive, affecting countless aspects of our lives and providing forward thinking and entrepreneurial management teams with huge growth platforms. This is creating a new set of opportunities, but also threats to the old order. Whilst it is old news that Amazon, and others, have decimated traditional high street retailing, the vulnerabilities are now much more broadly based than just shops. How do the large pharmaceutical companies react when advances in genetic knowledge are giving rise to the emergence of a whole range of young, innovative companies that are threatening the incumbents by developing better and more accurate treatments for diseases? Will ever-falling alternative energy costs spell the end for the oil and gas behemoths? What is the value of the billions of dollars invested in the internal combustion engine when Tesla’s Model 3 electric vehicle can receive 325,000 reservations as rapidly as one week after its unveiling?
In good part as a result of the above factors, the portfolios managed by Baillie Gifford have been migrating to a greater or lesser extent towards younger companies with very impressive revenue growth but relatively immature profit profiles. Over recent years, we have sold out of a range of stocks that, although previously successful, possess increasingly compromised growth prospects, and reinvested the proceeds in some of the less mature and faster moving companies that are challenging the old order. Five years ago it wasn’t unusual to find a decent proportion of stocks such as travel agents, bricks and mortar retailers and cigarette manufacturers in portfolios. Since then, however, a number of those holdings have been sold and the proceeds reinvested in companies such as those at the forefront of the e-commerce revolution, chip designers, online retailers and biotech stocks.
A defining characteristic of many of these younger disruptive companies is that they possess a seductive mix of growth and profitability, owing to the relatively capital light nature of their business models. The ubiquity of cheap computing power and the availability of the cloud allow growth to be achieved at much lower cost than previously, while for certain online businesses ‘network effects’ can drive up revenues rapidly. And, importantly, many of these companies are happy to use their cash flows to invest in the business for the long term, even if it means sacrificing margins in the short term.
Patience is the key. As a shareholder you can only capture the real benefits of growth if you are prepared to hold stocks for multi-year periods and to accept that there will be times when you will look wrong. We need to give companies time to develop their plans, engage with them where appropriate and support them through difficult times. Of course this is much easier to say than do, but the asymmetry of stock market investing, where you can make many multiples of your initial investment on the upside but lose only as much as you put in on the downside, means that the benefit of as few as one or two big long-term winners can more than compensate for the inevitable mistakes that all investment managers make.
We can help ourselves find these big winners by thinking about stocks in the context of their broad long-term potential rather than getting bogged down in overly precise and inevitably flawed short-term financial projections, by specifically incorporating ‘blue sky’ upside scenarios into our analysis, and by trying not to worry or engage in blame when stocks don’t work out.
Asymmetry also means running your winners – fund managers are sometimes tempted to take profits in stocks that have been performing well (the old market cliché being “it’s never wrong to take a profit”). Similarly, investors in a portfolio may be tempted to take their money away from outperforming managers, typically on the basis of mean reversion, but if you adopt this approach then you are of course giving up some of the benefits of asymmetry. If you find a stock, or an investment manager, that has generated good returns and that you think has the structures in place to continue to do so, why would you want to dilute your portfolio by reducing your exposure?
At Baillie Gifford, we are clear in our belief that growth investing provides the best platform to generate superior returns and we believe that there is a strong correlation between a company’s long-term economic performance and its long-term share price performance. The real value lies, however, in the quest to successfully identify growth before it is recognised in share prices, and key to this is to think broadly about how the world may look in the future and what investment opportunities that might create. Doing so successfully should yield better returns over the long term.
Please remember that the value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. Investing in emerging markets is only suitable for those investors prepared to accept a higher level of risk. This is because difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment.
The views and opinions contained herein are third party and may not necessarily represent views expressed or reflected by Willis Owen.
Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.