Finding growth outside the Faangs

Asset Class in Focus

“Power compounding” growth stocks outperform peer companies on a five-year growth horizon, argues Julian Cook, London-based portfolio specialist at T Rowe Price.

Year-to-date, the Russell 1000 Growth Index performed 17.94%, which compares to the Russell 1000’s 15.3%, according to data from FE.

Annual calendar year performance (%)

YTD 2019

20182017

2016

Russell 1000 Growth

17.94

-1.5130.21

7.08

Russell 1000

15.3

-4.7821.69

12.05

Source: FE Analytics

Yet the companies in the index are highly volatile. Over the trailing three years, the growth index had annualised volatility of 13.82% vs the Russell 1000’s 12.66% and the S&P 500’s 12.65%.

Additionally, the Russell 1000 Growth plunged (-16.1%) in volatile Q4 2018.

In comparison, the S&P 500 (-13.83%) and the Russell 1000 (-14.06) fared better, FE data shows.

Nonetheless, growth stocks have been in favour since 2017, mostly driven by the Faang stocks, which include tech giants Facebook, Apple, Amazon, Netflix and Alphabet’s Google.

Cook believes that growth stocks will continue to outperform the market because he does not think the US economy is heading into recession in the near-to-medium term.

“If we believe that we are heading into a recession, then you could argue that we could rotate away from growth into the more value areas of the market,” he said at a media briefing in Hong Kong.

“But in the absence of that, I think there is still a constructive backdrop for growth equities.”

In terms of growth opportunities, investors mostly think of the Faang stocks. which contribute about 38% of alpha to the firm’s US Large Cap Growth Equity Fund, managed by Taymour Tamaddon.

Amazon, Alphabet and Facebook are included in the top 10 holdings of the firm’s US Large Cap Growth Equity Fund, accounting for 22.1% of the portfolio, according to the fund factsheet.

Top 10 holdings (%) as of 30 April 2019

Company

Exposure

Amazon

8.8

Alphabet

7.1

Microsoft

6.9

Facebook

6.2

Boeing

5.5

Visa

4.9

Tencent Holdings

2.6

Alibaba

2.2

Stryker

2.1

Intuit

2.1

Source: Fund factsheet

The power compounders 

Cook argues that there are better growth stocks outside of the Faang group. As an example, he cites “power compounders” — companies with an annualised earnings growth rate of around 12% over a five-year time horizon, according to Cook.

This group accounts for 15% of the large cap growth portfolio.

“These companies will never be among the top five or bottom five performing stocks in any particular quarter. But over a five-to-10 year time period, they can have compound growth at a double-digit rate, which make them extremely attractive alpha stories.”

These firms also provide “ballast” in volatile periods, as most of them have strong franchises, higher barriers to entry and generate high cash flows.

An example of a power compounder that the fund owns is American Water Works, which has been investing in water infrastructure, an area that is under-invested, he said.

“American Water Works is getting capital together and is buying assets to update the infrastructure and run them. We believe it can give a total return of 12% a year [9% earnings growth plus a 3% dividend].”

Another is energy infrastructure company Sempra Energy, according to Cook.

“Natural gas is a long-term duration growth area, which is not an obvious choice for a growth investor,” he said.

Facebook risk

The firm’s US large-cap growth product has 6% of assets in Facebook, a company which has attracted a lot of controversies, including the Facebook and Cambridge Analytica data harvesting scandal last year.

However, Cook believes that the negative headlines have made it an attractive stock.

“We love buying controversial stocks. That is where we find inefficiencies in the market,” he said, adding that the fund is now overweight Facebook relative to its benchmark index, the Russell 1000 Growth Index.

Facebook has been under strong political pressure to address privacy protection, pushing management to respond. Cook said the investment in the company is on the back of improving privacy measures and attractive fundamentals.

From a fundamental standpoint, Cook added that Facebook also rolled out last year the “stories” feature, which can potentially be an additional source of advertising revenue on top of its news feed ads.

Currently, the ad revenue split is 95% from news feeds and 5% from stories, according to Cook. “We think there is a long runway growth for stories to develop.”


The US Large Cap Growth Equity Fund versus its benchmark and category

Source: FE Analytics. In US dollars.

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