Long-term valuation more relevant than ever as industry change continues
Fund Manager, North America Team
Co-manager, North America Team
Compared to the past few years, we think very different, broader factors will influence North American equities, not just over the next year but the next few years.
For instance, the past few years have been influenced either by fear of a deep recession or by experiencing the deepest one we have seen in our lifetimes as the COVID-19 pandemic stalled so much economic activity. The next few years will likely be influenced by a strong recovery from this deep recession while also seeing normalisation in demand of many industries particularly impacted by COVID-19, such as travel.
In addition, following a period of disinflation, the unprecedented monetary and fiscal response to the COVID-19 crisis and a stalling in globalisation raise the prospect that reflationary forces could be a factor over the next few years. Disinflation and a strong dollar have been headwinds for profit growth for many businesses in recent years. If reversed, we could see tailwinds to growth for a broader swathe of companies in the market and a resultant re-appraisal of their prospects and valuations.
The past few years have been influenced by valuation spreads widening with a noteworthy thirst for some specific characteristics. For example, the premium valuation awarded to the top decile of companies in terms of earnings growth in the US market this year versus the rest of the market reached the highest level seen in the past 70 years according to the research firm, Empirical Research Partners. The next few years are highly unlikely to see this spread continuing to widen and much more likely see it narrow towards more normal levels.
It is not unreasonable to think there could be some change in the nature and distribution of growth across the market over the coming years and hence a change in the landscape of extreme valuations. We are perhaps at a turning point in terms of how many companies’ future prospects and valuations are viewed.
A narrow process focused solely on near-term valuations and mean reversion without regard to a company’s long-term positioning will unlikely reward investors over the long term.
Having said that, we continue to think industry change is one constant that will transcend some of the potential changes highlighted above. We continue to believe that this necessitates a long-term mindset when assessing sustainable value creation. We feel this is a vital part of our investment process and will continue to contribute positively in years to come. A narrow process focused solely on near-term valuations and mean reversion without regard to a company’s long-term positioning will unlikely reward investors over the long term.
With so many investors on one side of the proverbial boat we think it is extremely dangerous to extrapolate the trends of recent years when allocating capital. At the core of our process is the simple idea that whatever we invest in should constitute good value for our investors’ capital. We appraise value in a disciplined yet pragmatic way. Of late, market conditions have not been favourable to this kind of strategy, but we think this approach remains more relevant than ever and that rather than being a headwind, our valuation discipline will become much more of a tailwind in the future.
Andrew started his career in 1997 at Baillie Gifford, before spending seven years at Threadneedle where he managed the Threadneedle American Fund. He left to set up Polar Capital's North American team in 2011.
Richard Wilson, CFA
Richard started his career in 1999 at Mercury Asset Management, before working at Threadneedle for nine years managing institutional mandates on the North American equities team. He left to set up Polar Capital's North American team in 2011