The 'Growth' versus 'Value' debateDownload document (435 kB)
The printing presses of central banks have gone into overdrive this year in an attempt to ward off the greatest economic and social uncertainties most of us have ever encountered. One of the very early consequences of this unprecedented action has been the widening of various distortions in stock markets. One such distortion is the large difference between stocks wearing the label ‘value’ and those preferring to don ‘growth’G1. The discrepancy in performance between growth and value has rarely, if ever, been wider than it is currently. This is the case globally and emerging markets are no exception.
At the end of September the price to earnings ratio (or PE ratio)G2 of the MSCI Emerging Markets Index was 19x, the MSCI Emerging Markets Value Index was 12x and the MSCI Emerging Markets Growth Index was 32x.1
Unsurprisingly, therefore, we have increasingly been asked to self-identify as either ‘growth’ or ‘value’ investors. We have to reply, ‘neither’. The question is akin to asking whether we own t-shirts or jackets – we feel it prudent for your wardrobe to include a few well-made versions of both.
Growth’s Premium over Value2
Rather, the common thread that runs through all of our investments is that of ‘stewardship’. The companies in which we invest, we believe, are presided over by prudent and capable individuals with high levels of integrity and long-termism. Some have higher growth rates than others, some have higher dividend yieldsG3 than others, but we believe that all are well stewarded, and that minority shareholders will be able to benefit from their future successes as a result.
As an aside, it is true that no fund manager would claim to be uninterested in stewardship, but it is clear that, for many, other factors are far more important. Consider the two largest constituents of the emerging market indices. Both companies are known participants in, and beneficiaries of, China’s surveillance stateG4. This entails the general curtailment of human rights of the populace, with especially alarming treatment of certain groups – none more so than that of Xinjiang province’s Uighur population. The behaviour in question is well documented by the independent press; its links to large holdings in a typical investor savings account less so. It does not really seem important whether these two companies are labelled as growth or value.
Our investments for clients
Let us consider how the above relates to some specific investments we hold for clients.
Two ‘Growth’ Investments
Two examples of companies that might be categorised as ‘growth’ investments are Philippine Seven and IndiaMart. Philippine Seven operates 7-11 convenience stores across the Philippines, a format in which it has a 70% market share3 and four times as many stores as its closest competitor. It is a highly cash-generative model. The company has grown its revenues ten-fold since 2007 and still has a large opportunity ahead of it – convenience retail has just a 3% market share in total4, so it is hoped that growth can continue for many years to come.
IndiaMart is India’s largest (and the world’s second largest) business-to-business classifieds website, with a market share in excess of 60%5 and rising. About six million suppliers are listed on the website, having grown at over 30% per annum6 over the last three years, and there are nearly 100 million registered buyers. It is a highly cash-generative company.
For us, more important than the growth prospects of either company is the identification of their stewards. These must be individuals who possess high levels of integrity and who are well aligned with their shareholders for the long term, with the competency to grasp the opportunities ahead of them and to grapple with the inevitable challenges too. Philippine Seven is controlled by Taiwan’s President Chain Store, one of Asia’s finest retailers, itself owned by a group of families. The local founding family of the Filipino subsidiary remains involved with a significant shareholding themselves. Despite its growth, the company’s balance sheet is conservative.
IndiaMart is run and controlled by its founder, Dinesh Agarwal, who has an aversion to debt and a fondness for cashflows. These are two companies with conservative, long-term stewards who certainly do not lack ambition.
Two ‘Value’ Investments
Two examples of companies that would more readily be labelled as value investments are Consorcio ARA in Mexico, and Yue Yuen, a Hong Kong listed company. Consorcio ARA is a Mexican housebuilder that can be bought for less than a quarter of its net asset value (NAV) currentlyG5. NAV may be understated too, given that the land it owns is held at cost. The dividend yield is 9%7 and the company is net cash. It is unlikely that the company will grow significantly. It is our purest value investment, if such a label is required.
Yue Yuen is the world’s largest shoe manufacturer, producing over 300 million pairs per year.8 Nike and Adidas are its largest customers.9 This is a cash generative business that currently has a dividend yield of over 9%.10
It is probably most easily categorised as a value investment, but it also owns 62% of rapidly-growing Pou Sheng, China’s second largest sports retailer.11 Value investments, perhaps, but crucially these two companies are stewarded by families that we believe will act in the best interests of minority shareholders. Consorcio ARA has been run by German Ahumada Russek and his brother for over 40 years. Whatever his ultimate plans for the company may be, we are confident that minority shareholders will benefit as a result. He has a strong governance track record and is competent enough to do so in the most beneficial manner possible. If, in fact, it is ‘business as usual’, we have no doubt he will continue to share the company’s significant cash flows.
Yue Yuen is ultimately controlled by the Tsai family who have looked after shareholders well over the years and who have in recent years improved the company’s treatment of all stakeholders. Nike and Adidas are highly dependent on the company (nearly 10% of Nike’s total purchases are from Yue Yuen12) and should be motivated to see it succeed in the years ahead.
The year has been a difficult one so far for emerging markets companies. Indices have never been our starting point for portfolio construction, but when comparing performance with the MSCI Emerging Market Index, it may be useful to point out that it has a significant concentration by country and sector. Almost two thirds of its combined country exposure is to Taiwan, China and South Korea, and it has significant exposure to Information Technology.13 Most emerging markets have experienced large falls in 2020, although China and Taiwan are notable exceptions. There has been little differentiation between quality companies and less-good ones since the outbreak of the Covid-19 pandemic and the related sell-off. It is not unreasonable to expect that companies blessed with long-term stewardship, strong balance sheets and resilient cash flow generation are relatively well-placed to deal with the stresses and uncertainties ahead. Our portfolios invest in many such companies.
Two notable detractors that are owned across a number of our client portfolios have been particularly adversely impacted by the pandemic. Remgro, a South African holding company, has seen profits fall across the group as the country faced a particularly prolonged lockdown period, weighing heavily on the domestic economy. BBVA, a collection of conservatively managed emerging market focused banking franchises, has also been weak, as the bank has been forced to take significant provisionsG to its loan book in Mexico and elsewhere in Latin America, where it owns a number of leading banking franchises. These investments have been especially disappointing.
Others have been more positive. Dr Reddy’s, the Indian non-branded drug manufacturer supplying affordable quality medicines globally, has seen very resilient sales during the pandemic. Infosys has also been a positive contributor, as the Indian IT outsourcer continues to go from strength to strength, winning >USD500m contracts from global multinationals, such as Vanguard and Rolls Royce.14
‘Growth’ investments may have been relatively very popular so far this year, but it is unlikely that their divergence from sound, but less glamorous, investments will continue unabated forever. We feel it prudent to keep your wardrobe stocked with both well-made t-shirts and well-made jackets.
We are often asked to explain how we attempt to value companies and it makes sense to explain this here given our comments above about the term ‘value’. We follow some broad principles. Use of the word ‘principle’ here is deliberate because it reflects the fact that every analyst in our team will approach this differently and as a process it serves more as a source of debate than it does as a standalone exercise. The most important point is that for those companies which do not meet our strict quality criteria, there is no price we are prepared to pay, given that the downside risk is always 100%. Next, for those which do meet our quality criteria there is a sliding scale of risk associated with relative quality.
Our investment time horizon is long, we attempt therefore to think about valuation on a ten year basis. Valuation for us is an art rather than a science and is most valuable when identifying extremes of over or under-valuation. We don’t believe in decimal points and believe that the fewer assumptions made the better.
We don’t have any crystal balls used to predict the future but our ten year fair market values are largely based around examining corporate histories as far back as we can.
Chris Grey, September 2020
1 Source: FactSet. The MSCI Emerging Markets Value and MSCI Emerging Markets Growth indices are two subdivisions of the MSCI Emerging Markets Index categorised by MSCI according to the characteristics of the companies they hold.
2 Source: FactSet. The graph shows the difference between the MSCI Emerging Markets Growth and Value Indices’ PE ratios divided by the Value Index’s PE ratio, over the last 20 years to 30 September 2020. For example if the Value Index’s PE ratio was 10x and the Growth Index’s was 20x, the premium would be 100%.
Source for company information: Stewart Investors investment team.
G1 Growth stocks - those expected to grow earnings strongly in the future, while value stocks may not grow earnings but their share price does not reflect the value of all their assets and is expected to rise as a result.
G2 PE ratio - a company valuation measure which compares the market value of the company in the stock market with the earnings per share.
G3 Dividend yield - the amount of cash returned to shareholders relative to the company share price.
G4 Surveillance state - a government which exerts significant control over its people by monitoring them closely.
G5 Net Asset Value - a measure of the assets minus the liabilities of a company.
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