Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we discuss U.S. growth stocks with Greg McCullough, a portfolio manager with Putnam Investments. We talk about whether growth stocks are poised for a return to in-favour status, and how Fed policy has impacted that class. And we started by asking why there’s been some recent nervousness around growth stocks.

Greg McCullough (GM): Well, there’s certainly concern in the market around some combination of the Fed raising rates to combat inflation, supply chain disruptions, the war in the Ukraine and other market headwinds. We think a great deal of those concerns are priced into growth stocks today, given the year-to-date drawdown. And our expectation is that growth companies with pricing power will be able to largely offset cost pressures, including labour inflation and rising freight costs, and be able to differentiate themselves in periods such as these.

Prospects for in-favour status.

GM: We’ve seen a healthy de-rating for growth companies across the board, but particularly for those that are earlier in their development and are not yet profitable. Those stocks may continue to be out of favour as rates move higher, but quality growth stocks can certainly work going forward. High-return, growth companies with advantaged balance sheets in secular growth areas of the market are likely to be the growth stocks that return to favour the quickest and deliver sustainable returns.

Advice for those who have suspended activity in growth stocks.

GM: We’d suggest you have to be present in growth to win over in the long term. Trying to time changes in market leadership is very difficult, and often times market leadership can change rather quickly. We wouldn’t want investors to miss big moves higher in growth stocks, particularly now, given the high degree of pessimism currently reflected in the market.

Buying on the dip

GM: Every stock has its own growth algorithm and differing degrees of economic sensitivity. Companies with contractual, recurring revenues, such as American Tower [Boston, Mass.-based American Tower Corporation], [Woodlands, Texas-based] Waste Connections, and UnitedHealth [Minnetonka, Minn.-based UnitedHealth Group Incorporated] should not necessarily pull back when other growth stocks do. This increases our appetite to buy the dip on these stocks. We see similar opportunities across the growth universe.

Names he likes.

GM: I’d highlight Dexcom [San Diego, Calif.-based Dexcom, Inc.] and Intuitive Surgical [Sunnyvale, Calif.-based Intuitive Surgical, Inc.] — respective leaders in the continuous glucose monitoring and robotic surgery markets — as two innovation leaders with growth potential that should prove resilient regardless of the macro backdrop. We anticipate double-digit growth for both of these businesses for at least the next half decade, given low levels of penetration in large, secularly growing end-markets. Other holdings in the healthcare with attractive valuations today include Danaher [Washington, D.C.-based Danaher, Inc.], ICON [Dublin, Ireland-based ICON plc], and UnitedHealth Group. All of these businesses should be able to compound growth at above market rates with an attractive return profile over the next several years. Danaher is an example of a business that we have added recently to take advantage of what we view as unwarranted year-to-date price declines. Life sciences and diagnostics represent 85% of Danaher’s revenues. And this exposure is not typically cyclical and possesses clear secular growth tailwinds. We would expect Danaher’s businesses to fare far better than the broader market in the event of an economic slowdown. We also currently own two foreign-listed securities — Lonza Group [Basel, Switzerland-based Lonza Group AG] and Universal Music Group [Hilversum, Netherlands-based Universal Music Group NV] — both of which provide attractive exposure to secular growth trends that we could not easily replicate in the U.S.

And, finally, what’s the bottom line on investing in growth stocks?

GM: I’ll circle back to something that I mentioned earlier. The bulk of the innovation in the economy is driven by growth companies and over the course of a cycle, these businesses compound growth at attractive returns to drive higher intrinsic value in stocks. We place a heavy emphasis on the duration and the durability of growth, as well as the absolute level of growth. We want to own businesses with high levels of recurring revenue, long-term contracts, an ability to price their product, a lack of customer concentration, and an ability to gain market share. These are the attributes that allow these businesses to grow at above market rates for a long period of time, largely independent of macroeconomic fluctuations. As economic growth becomes more scarce over the next 18 months, we would expect growth businesses with secular tailwinds to perform well relative to the broader market.

Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Greg McCullough of Putnam Investments. Join us every Wednesday at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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