Portfolio Analyst Brandon Smith, CFA, CAIA, highlights the importance of adhering to a valuation discipline and the risks associated with investing in statistically expensive companies.
Catalysts in Play: Are today’s highly valued growth stocks vulnerable?
We have just emerged from a decade in which investors enjoyed historically high rates of return with low inflation. We believe these returns were primarily driven by multiple expansion as central banks experimented with zero interest-rate policies. Growth equities, in particular, saw multiples rise to valuation levels not seen since the dotcom era of the early 2000s.
Today, we are in a dramatically different market environment.
Entry Points: Inflation, though it may have peaked, remains uncomfortably high. Central banks have rapidly tightened their monetary policies, and risk is seemingly being priced once again by the open market instead of the U.S. Federal Reserve.
Multiple Compression | We believe we are in the early innings of multiple compression across a wide swath of equities. Therefore, it may be an important time to remind investors that a great company does not necessarily equal a great investment.
- One such example is Microsoft Corp. during the dotcom era of the early 2000s. This is a period that has many similarities to today’s market environment.
- From January 2000 through December 2011, Microsoft sales more than tripled, and operating income, or EBIT (earnings before income and tax), more than doubled. But, the market capitalization of the stock was reduced by more than half, dropping to $218 billion from $476 billion.
- Microsoft’s price-to-earnings (PE) multiple went from 53 times earnings to nine times earnings over this 12-year period, and the cumulative stock price return for Microsoft was negative 55.5 percent.
- Why did the stock perform so poorly? We believe this is because investors paid too much for it in 2000. While Microsoft was a great company that continued to grow, investors experienced a poor return because they overpaid for it.
Today’s Environment | We hold that market indices are populated with many similarly expensive stocks. That is why we firmly adhere to the valuation discipline outlined in our three-circle stock selection process. And by doing so, we remain optimistic about the prospects for continued outperformance of low-valuation stocks in the coming years.
Active Strategy: Boston Partners’ strategies offer specialized actively managed value equity investing across a variety of geographies, market capitalizations, and long/short approaches. The construction of our portfolios is guided by a sensible set of fundamental truths that have been tested over time and various market cycles.
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Disclosures:
Boston Partners Global Investors, Inc. (“Boston Partners”) is an Investment Adviser registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Registration does not imply a certain level of skill or training. Boston Partners is an indirect, wholly owned subsidiary of ORIX Corporation of Japan (“ORIX”). Boston Partners updated its firm description as of November 2018 to reflect changes in its divisional structure. Boston Partners is comprised of two divisions, Boston Partners and Weiss, Peck & Greer Partners (“WPG”).
The views expressed reflect those of Boston Partners as of November 2, 2022. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Discussions of market returns and trends are not intended to be a forecast of future events or returns.
Estimates reflect subjective judgments and assumptions. There can be no assurance that developments will transpire as forecasted and that the estimates are accurate.
Risk:
Foreign investors may have taxes withheld. Investing involves risk including the risk of loss of principal. Value investing involves buying the stocks of companies that are out of favor or are undervalued. This may adversely affect an account’s value and return. Stock values fluctuate in response to issuer, political, regulatory, market or economic developments. The value of small and mid-capitalization securities may be more volatile than those of larger issuers, but larger issuers could fall out of favor. Investments in foreign issuers may be more volatile than in the U.S. market, and international investing is subject to special risks including, but not limited to, currency risk associated with non – U.S. dollar denominated securities, which may be affected by fluctuations in currency exchange rates, political, social or economic instability, and differences in taxation, auditing and other financial practices. Investments in emerging markets may increase risks.
