Growth characteristics can be found in established as well as early-stage companies. Therefore it is...
Growth characteristics can be found in established as well as early-stage companies. Therefore it is essential that research is continued throughout a company's lifecycle. This analysis will give the investor a competitive advantage in identifying those stocks which will provide superior growth relative to the market.
Three broad strategic themes form the backbone of our analysis for growth companies:
n Companies with competitive advantages, such as a technological lead or barriers to entry, can lead to sustainable returns relative to competitors and market expectations.
n A management team that is proven in anticipating and responding to change and, in young companies, owns a significant stake in the business.
n The need for a financial structure to fund future growth prospects without constant recourse to shareholders.
You must also overlay onto company analysis two other factors: changes in economies in the medium term and a long-term view of structural changes in markets. From their analysis you can identify which are the biggest market opportunities. Recent examples include, opportunities apparent in genomics, data over mobile communications (rather than voice services) and e-commerce security.
Many start-up growth companies lack current earnings and revenues, so much of the perceived value is contained in future prospects. So taking into account the macro-economic outlook will help with investment timing. Interest rate, inflation and discount rate expectations are key in driving short-term sentiment and valuation levels for these companies. By understanding the macroeconomic environment investors will be able to spot changes in economic cycles and rate expectations, thereby avoiding poor market timing.
Two structural themes currently stand out when looking for growth: the existence of excess capacity and the rapid growth of e-commerce.
Perhaps the most important structural change in the last decade has been the growth in global productivity, particularly in the US. We believe that this growth is sustainable and can increase further, due primarily to ongoing technological change, deregulation and globalisation. In essence, all these are due to the increased use of information.
The move to a more service-based economy has profound implications. In particular, one of the principle impacts of the internet is that it helps companies allocate resources more efficiently, allowing many businesses to be more open to international trade, and therefore competition.
Through this, barriers to entry are falling, distribution methods changing and, in many industries, prices are set to fall. The absence of pricing power is apparent in many sectors. This is likely to be an extremely harsh environment for the majority of industries and companies. When looking for growth opportunities there will be fewer winners, and a narrowly-based stock market performance.
Global industrial structures will continue to change as technological change accelerates. The boundaries between industries will dissolve as more companies seek necessary consolidation to achieve the critical mass and economies of scale necessary to survive in a low inflation world with non-existent pricing power. Portfolios will need to contain a mixture of the mega-firms that will be able to cut costs and invest in product development and the micro-firms that are nimble enough to operate in added-value niches partly insulated from harsh competition.
Alan Greenspan has said: "Knowledge-based goods and services use relatively few physical resources to generate value".
This is reducing one key scarcity constraint on growth the physical availability of labour and resources. We should, therefore, expect further substantial improvements in the trade-off between growth and inflation due to productivity.
Markets are now less surprised by GDP growth in excess of 30%, combined with negligible inflation. The long-term outlook remains disinflationary due to technological investment and productivity growth. This fundamentally remains bullish for equity markets.
In essence, therefore, successful investment in the next few years will involve tearing up traditional attitudes and the acknowledgement that conventional rules of thumb have lost their validity.
This is, perhaps, unsurprising in the revolutionary economic shift we are in the midst of. The information revolution is, in its own way, as significant as the agricultural and industrial revolutions were in their time. All involve technological breakthroughs but investors have to deal with two key differences.
Firstly, the intellectual capital generated by companies in a knowledge-based economy is unpatentable and software can be disseminated far more quickly than physical capital. Therefore, it is very difficult to protect technological leads. Excess margins become more visible and can be competed away quickly.
Secondly, our traditional accounting systems built up to deal with trade in physical resources are unable to deal adequately with changes on the scale being witnessed. As the source of value-creation increasingly becomes intangible capital, the current accounting systems are less able to reflect the economic reality.
Conventional investment analysis has difficulty in capturing the value contained in the prospects of many technology growth companies. Successful investment becomes as much about the 'vision' as the absolute 'valuation' and the holding period for successful stocks may shorten, as company lifecycles contract and franchises become more vulnerable.
It has often been said that
Follows McVey's resignation
Schroders and Aviva Investors
LightTower Partners, Seneca Partners and Unicorn AM
Integration with Money Dashboard
View from the front row