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July 14, 2016 at 08:00 PM
It seems that by now we are all in agreement that the global economy has slowed and is possibly still slowing. China is no longer growing by double digits. Europe’s economy is still struggling and the U.S. appears to offer the only glimmer of hope. And if all that weren’t bad enough: emerging markets (excluding China) continue to suffer in the aftermath of collapsing commodity prices.
This begs a question—is it still possible for investors to find good growth companies at reasonable prices in such a low nominal GDP regime? Some of the stocks we select for our portfolios have become expensive. And the data suggest that both “quality” and “growth” are very expensive today as a result of this scarcity of growth.
As long-term growth investors, we tend to stick to the companies we like for an extended period—five or sometimes 10 years or more. The problem is that valuations can be way ahead of fundamentals at any given time—which may be a sell sign for short-term investors, but also present buying opportunities for long-term investors after some meaningful correction. Of course, there is no guarantee that a stock’s growth potential still exists after correcting.
Our goal is to find growth companies at a reasonable (or discounted) price and to monitor their rise to a compelling “potential” market capitalization size. This is why I tend to focus more on today’s market capitalization, rather than traditional valuation metrics, such as price-to-earnings ratio or the price-to-book ratio for companies. What I ideally want to identify are companies that can grow from something less than US$1 billion to above US$10 billion, within a foreseeable timeframe—so called “10 baggers.” While it is true that large-cap growth companies that have market valuations of US$10 billion can see their value increase to US$100 billion over time, it can be much more difficult to spot one.
How difficult? Our posed one question to test the theory: how many companies, with a US$100 billion market cap or larger anywhere in the world, were under US$10 billion market cap 10 years ago? The answer is rather astonishing (and note that it requires roughly a 26% annual compound growth rate to achieve this). Out of 68,000 listed companies in the world today, only one fit the bill, based on Bloomberg data. However, the number of companies that have grown to a market cap size over US$10 billion today, up from US$1 billion a decade ago, is dramatically higher at 40. Still, this is less than one-tenth of 1% of the universe. I believe more opportunities exist in smaller-cap growth names than in “mega” cap names.
What Growth Looks Like Today
Now, let us quickly reflect upon the current macro environment to assess what “growth” looks like today. When I think about a company’s growth, I typically focus on sales growth, rather than earnings per share (EPS) growth, which may be the industry standard. It seems to me that top-line growth is more appropriate in the context of Asia.
Research indicates that despite some past academic studies, sales growth appears to be fairly well correlated with “nominal” GDP growth. Global growth has slowed significantly over the past four years, compared to the decade prior. Surprisingly, nominal GDP in 2015 dipped into negative growth territory, which led to negative sales growth. One might imagine that sales growth for Asian companies was much higher than their global peers. Well, yes and no.
Yes, nominal GDP growth has certainly been higher in Asia compared to elsewhere. But Asia’s sales growth also declined by an even higher magnitude in 2015.
