Financial Mail - Investors Monthly
Mind the investment gap
Let’s ignore the social media noise and focus instead on the numbers, writes The Finance Ghost
Rotation, rotation, rotation. One might be forgiven for thinking that real estate agents have moved into asset management, carrying through their favourite saying with a twist.
The narrative this year in the markets has clearly been around dollar weakness and a rotation by investors from growth stocks to value stocks.
As a quick refresher: growth stocks have higher valuation multiples and growth rates, promising great things in the future but not currently paying dividends and often not generating positive free cash flows yet either. Through tapping investors regularly for cash, growth stocks reinvest heavily in their businesses and so carry substantial operating costs.
By contrast, value stocks trade at more modest valuation multiples and have steady growth rates, paying dividends at a stable payout ratio. Investors receive cash rather than having to put more in. The net earnings are more predictable than for growth stocks and this makes value stocks a favourite for institutions managing retirement savings.
Importantly, the upside potential of the underlying businesses held by value stocks is typically much lower than for growth stocks (consider a local industrial business vs Facebook as an example), yet investors can do well in both types of companies. An investment return is not measured by the growth in underlying earnings, but by the growth in the share price and the payment of dividends.
At the right entry price, either growth or value can be a strong investment. Of course, overpaying for anything is always a bad idea, regardless of how exciting the underlying business may be.
Going into 2021, many believed tech stocks were running too hot. Unfortunately, as is too often the case, this is an oversimplification of a complicated market. Within the umbrella term of “tech stocks” we find everything from Tesla to Microsoft. It’s hard to imagine how those companies could have any fundamental relationship to each other.
Social media can be dangerous here. One might be forgiven for thinking that the markets blew up entirely this year, based on the “meme stocks” (which generate huge interest on social media) taking pain.
For example, Tesla is down 4% year to date, which doesn’t sound too bad at first blush. However, if you had invested on January 8 2021 instead of the first trading day of the year, you would be down around 23% instead.
As previously written in IM, the Germans have turned out to be the far better investment in 2021, with Volkswagen depository receipts in the US up 68% YTD.
If we take a more macro view based on broad market indices, the tech-heavy Nasdaq-100 comes in at 7.4% YTD. The traditional industries, measured in this case by the Dow
Jones industrial index, outperformed by 300BPS with gains of 10.4% YTD. While the rotation trade is clearly visible here, nobody is going to cry into their pillow about a 7.4% return in less than four months.
The JSE has also been a winner this year thanks to the rotation, achieving 13.1% YTD. The dollar weakness this year improves the JSE relative to the US indices by another 100BPS or so. It’s great to see the JSE having its day in the sun, but the Nasdaq isn’t exactly cowering under a tree.
An annualised view on 300BPS outperformance of Dow Jones industrial vs Nasdaq in under four months tells a different story. Admittedly, we are hardly operating in a stable market here. Annualising anything is a brave move.
A short-term view on the markets must consider the realities of dollar weakness (which doesn’t look set to change under US President Joe Biden this year) and the impact of ongoing stimulus on the economy. As vaccines are rolled out and the economy recovers, the growth rate gap between the “stay at home” stocks (like Zoom) and traditional industries is likely to narrow from where it has been over the past 12 months.
That doesn’t mean outperformance can’t continue. It just means the gap might be smaller. As an investor, I’m still more excited about Twitter over the next 10 years than I am about value unlock plays. My 12-month view might differ.
Let’s ignore the noise and the social media narrative, focusing instead on the numbers. There are some important trends within the Nasdaq and the tech stocks in general (as
“Overpaying for anything is always a bad idea, regardless of how exciting the underlying business may be