Why some ‘growth’ companies now look like value opportunities

The qualities to look for in so-called ‘growth’ companies are changing as investment styles continue to rotate, says Dustin Haygood, client portfolio manager with Aristotle Capital Management.

Haygood says a holistic view that includes much more than just price-to-book valuation is critical in today’s turbulent market environment.

“There are value-oriented investors out there that dismiss some of the world’s greatest businesses because they trade at above-average price-to-earnings ratios,” he said. “We believe this can create opportunities for investors like us who look at valuation holistically.”

According to Haygood, investors should be asking about the predictability of cash flows, the range of potential outcomes and the long-term prospects for a business.

He said the recent shifts in style leadership from growth to value and now back to growth again have taken many by surprise. After outperforming value for over a decade, growth was overtaken by value in 2022, with the Russell 1000 value index outperforming its growth counterpart by more than 20%.

“It was the largest outperformance by value since the tech bubble burst in the early 2000s,” he said. “And now, in 2023, we’re seeing another large reversal back toward growth. So far this year, growth is up about 16%, while value is down 1%.”

The takeaway, he said, is to avoid trying to time the markets, and instead take a business owner’s perspective to assess true market potential.

“If I’d told you at the beginning of the year that the most expensive parts of the market would do the best, after last year when the lowest-priced parts did the best, you probably wouldn’t have believed me,” he said.

Haygood believes the line between value and growth has blurred, and companies can now fluctuate between classifications.

“Value style indices typically look for companies that have attributes like low price-to-book ratio. And if tech companies fall in price relative to their book value, it’s always possible style indices may no longer consider them ‘growth’ or [may] even reconstitute them as ‘value.’”

In fact, looking strictly at growth rates and price momentum, energy companies like Texas-based ExxonMobil Corp. and California-based Chevron Corp. are beginning to look like growth stocks, he pointed out.

Conversely, he has identified a few tech stocks that hold potential in the value category.

One of them is California-based Activision Blizzard Inc., one of the world’s largest video-game companies. “We think it is an optimal investment, regardless of whether or not the pending acquisition by Microsoft [Corp.] goes through,” he said.

He likes the company’s ability to develop popular games, such as World of Warcraft and Call of Duty, and monetize them over the long term through sequels and downloadable content. He also expects increased sales through “free-to-play” content that relies on in-game transactions and advertising, developing mobile versions of its top-selling games, and investing in esports — multiplayer video games often played live in stadiums packed with paying spectators.

Haygood also praised Microsoft Corp., which announced it wanted to acquire Activision Blizzard in January 2022 for US$69 million. The deal has faced regulatory scrutiny from the U.K. and the U.S. in particular.

Microsoft has high recurring revenues, free cash flow, healthy margins and enviable returns on invested capital, he said.

“It is successfully pivoting to a cloud-first, mobile-first strategy and uniquely positioned to benefit from digital transformation efforts with its enterprise customers that are increasingly looking to improve their technological capabilities,” he said.

He also owns Pennsylvania-based Ansys Inc., which develops simulation software that allows design engineers to crash-test products virtually before they are physically created.

“It’s an underpenetrated market with, we estimate, only 1 in 10 design engineers currently using simulation software, even though simulation significantly reduces development time and costs,” he said. “We think Ansys will benefit as simulation software becomes more widely used, products become more complex, and there’s a desire to speed up the time it takes to get products to market.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.