By: Lawrence Kemp & Philip H. Ruvinsky
Growth stocks have led the market this year despite an economic slowdown. Fundamental equity investors Lawrence Kemp and Phil Ruvinsky look ahead and offer their view: Growth has staying power.
As growth investors, we are always attuned to disruption and the risks and opportunities it can present. A hallmark of our approach is to identify growth prospects arising from structural change and disruption before it is fully priced by the market.
There has been no shortage of these opportunities in 2020.
Charging into change
The COVID-19 crisis has been a forceful accelerant of many trends that were already in play pre-pandemic. The quarantine incited a seismic shift in corporate and consumer behavior, fast-tracking the digital transformation across multiple industries.
E-commerce, telemedicine and entertainment & data usage in the media space were some of the most obvious beneficiaries of a stay-at-home world. Yet these trends were seeded well before the pandemic. We knew, for example, that shopping malls were in danger. We knew that streaming services have been unrelenting opponents of traditional cable companies. Telemedicine, despite slower adoption in recent years, gained momentum for its ease of use in pediatrics and routine care in 2020.
We also saw less obvious beneficiaries. Among them: digital tours and leasing within real estate, contactless payments and electronic trading within financials, and shifts toward online and away from physical dealerships in the auto space.
Here to stay
Some question whether the changes seen this year are enduring – or was demand simply pulled forward. Can the types of growth companies that prospered during this unique time continue to prevail, or is a slowdown inevitable?
It’s true that many companies experienced a surge in demand for their products and services amid the pandemic and digital revolution tied to remote working. This will inevitably settle some, but we don’t see it stealing from the future.
We believe this year brought a sort of forced adoption necessary for future business survival a dynamic likely to continue for companies that want to be competitive in a post-COVID world. That means demand could continue to edge higher for providers of these products and services. One example: Many consumers swapped gym memberships for connected home fitness equipment. The initial demand spike may recede, but many of these consumers will be multi-year subscription payers and likely to become more firmly entrenched in an ecosystem of products offered by a certain company.
Many of the trends that were supercharged during the pandemic had been solidly in place for years. We believe this gives them staying power. In many ways, the COVID-induced acceleration could be viewed as a way to clear the market of companies that may have been unprepared, unable or unwilling to adapt, thereby creating greater shelf space for ‘survivors’ within these industries.
Beyond the big names
Growth has been a standout performer during three key market phases in recent years: the multi-year bull market, the pandemic-driven recession earlier this year and the subsequent snapback and market rally. We believe this potency can continue.
While the pandemic has helped propel many growth firms, some of the best companies in our portfolios have been everyday businesses that have put low-cost technology to work to gain market share against competitors. Child daycare companies, salvage auto, pest control, landscaping supplies — companies in these industries have been important drivers of return for us in recent years.
To be sure, the market for growth stocks is much broader and more robust than the FAAMG companies (Facebook, Apple, Amazon, Microsoft, Google) that dominate headlines. These large companies have driven the lion’s share of return in recent years, but the benefits of innovation and disruption have not accrued only to the big names. While market leadership may be narrow, as shown in the chart below, the opportunity is not. We see a much more fertile hunting ground outside of these names than we have in years past – and we believe sourcing the best opportunities will require the skill of an active manager, who can look through top-heavy indexes to the vast opportunity within.
Market leadership is narrow; opportunity is not
Index leaders’ contribution to five-year return, Sept. 2020
Source: BlackRock, with data from FactSet as of Sept. 30, 2020. Returns shown are five-year annualized returns. Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Originally Posted on November 7, 2020 – The Outlook for Growth Stocks
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