“Hope and hype” replacing fundamentals?

  • Tweet
  • Share on LinkedIn
  • Share via email
  • Print
  • Download

March 2022
 

Walter Scott client investment manager George Dent argues that while the growth sell-off might appear indiscriminate, it pays to look beyond the noise for quality companies.

Rising inflation, higher interest rates and escalating global political tension have driven a shift away from growth, but not all such stocks should be tarred with the same brush, says Walter Scott client investment manager George Dent.

Dent says the recent sell-off in growth stocks may appear indiscriminate, but it is important to distinguish between “quality growth” and other companies to which a broad growth label is often applied.

“For some companies, growth can be fleeting, reflective of business models that are not durable, rely on too much debt, or that have weak competitive moats with products or services that are insufficiently differentiated,” he says.

According to Dent, some companies may be benefiting from the recent economic recovery, but their profitability could come under pressure against a backdrop of surging costs and the prospect of rising interest rates.

He says: “In some cases low interest rates have led to irrational exuberance where hope and hype have, to varying degrees, replaced fundamentals as an investment metric, with hefty valuations applied to companies with distant prospects of idea monetization and profitability.

“A reset in monetary policy will remind investors of the importance of the cost of capital and sustainable profit growth.”

Dent thinks the recent appetite for value stocks “speaks of investor interest in cheapness and laggards.” Using banks as an example, he notes that while some of these companies are “having their day in the sun” few of them have ever met Walter Scott’s investment criteria on the basis they employ “massive leverage and are financially and operationally opaque.”

Dent says Walter Scott defines ‘quality growth’ companies as innovators, with long growth prospects, a product or service that gives a competitive advantage and high profit margins. He adds these are often market leaders, willing to invest in their business and with an ability to create trends that should drive earnings into the future.

Such companies can rise to the recent spike in inflation, Dent adds, due to their “healthy balance sheets, good management, pricing power and robust cost control.”

He says: “As the world retreats from a period of extreme monetary stimulus, the importance of financial strength and good cash generation has all the more resonance.

“Having a strong balance sheet and high profit margins can cushion the blow from rising costs, while conservative levels of debt mean that companies are less impacted by rising interest rates.

“It is our belief that over the long term, whatever the short-term twists and turns in stock markets, earnings drive share prices. Indeed, for the patient investor, the present market volatility is providing opportunities.

All investments involve some level of risk, including loss of principal. Certain investments have specific or unique risks. Any views and opinions are those of the investment manager, unless otherwise noted and is not investment advice.

Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others.

This material has been provided for informational purposes only and should not be construed as tax advice, investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change.

This information contains projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

BNY Mellon Investment Management is one of the world’s leading investment management organizations, encompassing BNY Mellon’s affiliated investment management firms, and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally.

Walter Scott & Partners Limited (“Walter Scott”) is an investment management firm authorized and regulated in the United Kingdom by the Financial Conduct Authority in the conduct of investment business. Walter Scott is a subsidiary of The Bank of New York Mellon Corporation. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. BNY Mellon Securities Corporation is a subsidiary of BNY Mellon.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

© 2022 BNY Mellon Securities Corporation, distributor, 240 Greenwich Street, 9th Floor, New York NY, 10286

MARK-257919-2022-03-28