Transcript: Crowding effect means some great stocks are being ignored
Ryan Fitzgerald of Beutel Goodman Investment Counsel says stretched valuations are opening up a wealth of opportunities
- Featuring: Ryan Fitzgerald
- June 25, 2024 June 18, 2024
- 13:01
iStockphoto/da-kuk
Ryan Fitzgerald
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’re talking about bottom-up investing with Ryan Fitzgerald, vice-president, U.S. and international equities, with Beutel Goodman Investment Counsel. We talked about finding quality companies in the current moment, battling biases, and we started by asking about limitations to top-down investment strategies.
Ryan Fitzgerald (RF): Even though at Beutel, we’re bottom-up, long-term, buy-and-hold quality value investors, we acknowledge that our way of approaching the stock market is not the only way. There’s different philosophies and different approaches, and there are successful examples. including macro. However, calling a big macro variable is difficult. And no matter who you are, you’re going to be wrong a significant amount of time. Even if you’re right on one big macro variable on one day, you could be completely incorrect the next day. And so the successful macro investors tend to have a little bit more of a trading mentality. There’s absolutely a flexibility that has to be built into their process. A lot of the most successful macro investors are trend followers. There’s almost a momentum. Now, if you contrast that to many bottom-up, buy-and-hold investors, you’re really talking about a completely different thing. And so I think that many strategists suffer from being a ‘permabear.’ And I think there are opportunity costs to that. Very often as stock markets are going up, they go up in a fairly low-drama, fairly gradual way. If you contrast that to some of the big drawdowns that we’ve experienced over the years —the Great Financial Crisis, the Covid stock market hit — there’s nothing low drama about that. There will always be a select few investors that seemingly saw the whole thing coming. The rewards for calling the downside are immense. Meanwhile, being wrong about it, nobody really minds or notices. And so I think there’s absolutely a temptation to call the downturn, whether or not one is going to happen. Because when one eventually does happen, you can be one of the few people that can point yourself out as having called it.
The valuation gap between growth and value stocks
RF: There absolutely is a large discrepancy between the valuation of growth and value stocks. There’s a big crowding effect that’s happening in the U.S. stock market. And so if you look at the S&P 500, the top five largest companies make up approximately 27% of the overall index. So this is extreme concentration. These companies are very good companies. We’re talking about the likes of [Redmond, Wash.-based] Microsoft and [Cupertino, Calif.-based] Apple and [Seattle, Wash.-based] Amazon. However, there’s a price to pay for everything. And we think that the market has become quite thematic. Valuations can get stretched and we do think a significant amount of valuation risk has built up at the top of the S&P 500. So I think investors have to be quite cautious. On the opportunity side, we think because the market is so thematic and there’s such a crowding effect, we think that there’s large swathes of the stock market that are being completely ignored, and valuations are excellent. And so we’re finding high-quality companies in sectors such as big pharma and biotech, consumer — on both the staples and the discretionary side. We’re finding tremendous value. And it all makes us very excited for the long-term opportunities that we’re able to uncover.
Ignoring the headwinds
RF: I think that identifiable headwinds are the reason that you can invest in good companies at very good prices. And so we don’t look at near-term problems that a company is experiencing negatively. That’s actually our opportunity to invest in various companies. We’re very conscious of investing in companies with solid balance sheets that manage their debt very conservatively. We look for good quality businesses with good returns on capital, good management teams, good margins and with end markets that grow over time. And then the one other area that an investor can hurt themselves [in] is overpaying, even for a good business. And so that’s where our strict criteria on valuation comes in. And I think that combination of quality and a reasonable price is a recipe to mitigate that downside. And then your winners take care of themselves and I think you can have a good experience over the long term.
And finally, what’s the bottom line on equity investing in the current environment?
RF: My message is, be wary of valuation. We are in a market that has become very thematic and very enamored with growth. And it’s these types of markets where valuations get stretched, and you really don’t want to be caught chasing some of these popular themes in the eighth inning. And so I think that it would be prudent to pay attention to the quality of the businesses that you’re investing in. I think in the current environment, for any investor, it’s even more important today.
Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Ryan Fitzgerald of Beutel Goodman Investment Counsel. Visit us 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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