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‘Valuation matters again’: Growth after ‘growth’

Growth is not a dirty word, but it didn’t cover itself in glory through the market upheaval of 2022. Managers now find themselves in a paradigm where what they pay is important again.

‘Growth’ almost became a pejorative term as the money-fueled tech bubble popped in 2022, with plenty of managers finding out that they’d paid too much for what turned out to be too little. And over the last decade, those who’d cast a stern eye over financials were often left in the dust. For US-based growth manager DSM Capital, valuation discipline “worked really well” from its inception in 2002 to the point in 2015 when rates went almost to zero – or beyond – in some countries. Covid only made things worse.

“In the US post-Covid valuation simply didn’t matter,” says Eric Woodworth, DSM’s deputy chief investment officer. “If you were a fast growing company you traded at 200-300 times earnings. Didn’t matter if you made a profit. If you were involved in Bitcoin or NFTs, even better.

“But now that we’re back to sticky inflation of three or four per cent and interest rates at four or five per cent, valuation matters again. We think we’re back to a more normal operating environment as far as investing goes, and valuation is an integral part of the investment process. For the last six years or so it really didn’t matter. That was a headwind to our philosophy and strategy, but now we think we’re back to the good old days.”

After “sticking to their knitting” – and lagging their benchmark – through the growth bubble, DSM and other growth managers are casting a fresh eye over the digital transformation space.

“Everything moves online and everything’s being digitized,” Woodworth says. “There are a lot of companies that help them make that transformation. The key ones are in cloud, analytics, artificial intelligence, security and online advertising and online payment. You can find companies that leverage a bunch of those segments that aren’t at obscene valuations. Most of our companies trade between 20-35x – you’re getting great exposure to multi-decade secular growth without having to take on valuation risk.”

Still, some storm clouds loom over what – at least, for the last several months – has been a relatively calm market landscape, with fundies fretting over the prospect of a Fed-enforced hard landing and the US winding up back in the economic doldrums.

“The biggest debate is whether we’re going to go into a recession; people have been calling one for a while, we haven’t really seen it yet,” Woodworth says. “Six to eight months ago I would have told you that Europe is definitely going into a recession but it looks like it might skirt by now. What I’m watching in the US is the jobs market, which remains incredibly strong.

“We’re seeing all these tech layoffs, but other companies are now hiring those workers. Two years ago Walmart, Target, Coke couldn’t hire them because the market was so hot. If everybody still has a job you can’t really have a recession.”

And while high growth companies are usually fond of pie in the sky projections, Woodworth believes that many of those made during the Covid boom ultimately won’t pan out.

“A number of companies did suffer what we think of as a Covid overhang – PayPal and Snap came out with these 25 or 50 per cent growth rates forever and 9-12 months later they didn’t work out,” Woodworth says. “What might not play out is the idea that everything will move online. While online will continue to take market share, I do think people still want to go into a store and try on clothes and do things in person.”

“I think that online only thought is a bit of a misnomer, and we’re seeing as countries reopen that people are going back to stores. There was that thought that Covid changed everything forever; there was that forecast that business travel was never going to come back, and now it’s 70-80 per cent of the way back and headed for 90.”

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