Will you profit from the stock mar­ket’s ‘seis­mic shift’?

It’s a force tipped to trans­form the stock mar­ket this year and be­yond. What is it, and what does it mean for your in­vest­ments, asks Richard Dyson

The Daily Telegraph - Your Money - - YOUR MONEY -

The mar­ket is ar­riv­ing at a turn­ing point that is as sig­nif­i­cant as the col­lapse in share prices fol­low­ing the dot­com boom in the early 2000s – or so say a grow­ing num­ber of ex­pe­ri­enced pro­fes­sional in­vestors. A seis­mic shift is un­der way, they ar­gue, in which cer­tain types of shares are about to plunge out of favour. In their place a raft of new stocks will come to the fore.

In­vestors stand to gain or lose ac­cord­ing to how their port­fo­lios are po­si­tioned – and the stakes could be very high in­deed.

Shares that in the past decade have risen to dizzy­ing valu­a­tions, pro­pelled by ul­tra-low in­ter­est rates and a hunt for low-risk, solid re­turns, might now cor­rect vi­o­lently. This would bring their share prices back down to­wards their long-term re­la­tion­ship with the com­pany’s earn­ings.

Other shares, which have been shunned in the decade since the credit crunch, will now be reap­praised as an ap­petite for risk re­turns. Their low cur­rent valu­a­tions, rel­a­tive to their earn­ings and prospects, will cor­rect in the op­po­site di­rec­tion: their share prices will rise.

This tec­tonic move­ment, if it comes to pass as pre­dicted, would be a huge shift from “growth stocks” to “value stocks”. While that may sound tech­ni­cal, it’s be­ing viewed by some as a once-in-a-gen­er­a­tion force set to trans­form mar­kets through this year and be­yond.

Here, in the answers to five ques­tions, is ev­ery­thing you need to know in order to un­der­stand how your in­vest­ments could ben­e­fit – and how they are at risk.

What are ‘growth’ stocks and what are ‘value’ stocks?

Quoted com­pa­nies are val­ued by their shares. HSBC, for ex­am­ple, is priced at £135bn, which is the to­tal worth of all its shares in is­sue at the cur­rent share price of 680p. But is that cheap or ex­pen­sive? To find out, an­a­lysts ap­ply nu­mer­ous mea­sures in an at­tempt to gauge a com­pany’s true value. These in­clude look­ing at the ra­tio of a busi­ness’s share price to its earn­ings (the price to earn­ings ra­tio or p/e), for in­stance, to see whether it is out of kil­ter with the long-term norm. The div­i­dend paid rel­a­tive to share price (div­i­dend yield) is an­other mea­sure of value.

“Value” stocks tend to be those that the mar­ket has, for one rea­son or other, un­der­priced rel­a­tive to their likely prospects or the value of their as­sets. “Value in­vestors” seek these shares con­sis­tently.

The long tra­di­tion of value in­vest­ing stretches back to Ben­jamin Gra­ham, author of the hugely in­flu­en­tial book The In­tel­li­gent In­vestor. His ap­proach was later fol­lowed by other in­vestors, in­clud­ing War­ren Buf­fett.

“Growth” stocks have dif­fer­ent char­ac­ter­is­tics. When mea­sured against the same cri­te­ria as “value” stocks, they may seem ex­pen­sive.

But their ap­peal is that they prom­ise solid earn­ings growth. They may, for ex­am­ple, be man­u­fac­tur­ers of sta­ple goods or cig­a­rettes. And they may have a mo­nop­oly in their mar­ket area. De­mand for these prod­ucts – and thus the firm’s earn­ings – should hold up or grow, even when, for in­stance, the wider econ­omy is fal­ter­ing.

Ac­cord­ing to the ex­perts we spoke to, ex­am­ples of growth stocks in to­day’s mar­ket in­clude Unilever, the maker of Mar­mite, and ri­val Reckitt Benckiser, but could even ex­tend to tra­di­tion­ally “de­fen­sive”, slow-but­steady firms such as Na­tional Grid and Bri­tish Amer­i­can Tobacco.

Robert Bur­dett, who chooses funds for F&C In­vest­ments, said one def­i­ni­tion of a value stock was one trad­ing on a p/e ra­tio be­low the mar­ket av­er­age, while growth stocks were some­times seen as those grow­ing faster than the mar­ket av­er­age.

Why does this growth/value dis­tinc­tion mat­ter?

At the root of the dis­tinc­tion is whether a com­pany’s share price re­flects the busi­ness’s real value. Dur­ing pe­ri­ods of fear and cau­tion, as in the past decade, the tra­di­tional meth­ods of valu­ing com­pa­nies are partly put aside. In­stead, the mar­kets cher­ish busi­nesses that seem able to grow their earn­ings, come what may. Ni­cholas Kir­rage of fund group Schroders is one of those who be­lieve that a gi­gan­tic switch from growth to value is un­der way.

Ac­cord­ing to his anal­y­sis (see graph), “value stocks are more out of favour now than at any point in the past 40 years”. The whole mar­ket has drifted to the po­si­tion where growth is favoured above all else, he said.

His anal­y­sis of all ma­jor unit trusts in­vest­ing in Bri­tish shares shows that 91pc have a “growth” bias. Just 9pc are tilted to­wards “value” stocks. This shift has arisen as fund man­agers, act­ing in con­cert, have chased the same stocks and types of stock.

In turn, this has ex­ag­ger­ated the di­vide be­tween “value” stocks and larger swathes of the mar­ket (“growth”) where prices are too high.

Why now? What’s trig­ger­ing the change?

One an­swer lies in eco­nomic fac­tors. These in­clude ris­ing in­ter­est rates and higher-than-ex­pected growth.

Guy Mon­son of Sarasin, a firm that spe­cialises in man­ag­ing char­i­ties’ money, is an­other sea­soned in­vestor who said a dra­matic shift was tak­ing place.

For him a com­bi­na­tion of Don­ald Trump’s elec­tion – the “Trumpfla­tion ef­fect” – and bet­ter-than-hoped-for eco­nomic growth from Europe and China is steer­ing the change. He be­lieves the dom­i­na­tion of growth stocks, with their per­ceived low risk and “bond-like” char­ac­ter­is­tics, is over. “Can these big, de­fen­sive growth

‘When the econ­omy im­proves, it boosts value more than growth’

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