These Are Not the Growth Stocks You’re Looking For | Lord Abbett
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Market View

From a forthcoming Lord Abbett white paper: Many of the largest names in a popular equity growth benchmark display very un-growthlike characteristics.

Read time: 2 minutes

This Market View is excerpted, in part, from a new white paper, "Value and Growth: Moving Beyond the Old Formulas.” 

Finding those companies that are disrupting established business models and rapidly taking market share from entrenched competitors is part of the allure of growth investing. In the last few decades, we intuitively see that the pace of innovation is increasing in the world, and the prospect of owning a stock as its market value catches up to its disruption potential is enticing.

But how might investors best participate in this phenomenon? Some investors have opted for passive strategies tied to well-known growth benchmarks. However, there is a problem here: Growth indexes are not necessarily tasked with identifying those kinds of equities. True, they typically contain companies that fit that description, but they also harbor many other companies that simply do not fit the growth profile.

Here’s why. Growth index construction mechanisms rely on a blend of the following: “lack of value” metrics like a high price-to-book, historical growth, or consensus earnings growth. Figure 1 displays a recent roster of the top 20 weights in the Russell 1000 growth universe, and while many of these companies are disruptors with potential to be part of that elite, positive-skewed return group, many others *(as highlighted) simply do not possess this growth potential in our opinion.

 

Figure 1. Growth Indexes Fail to Represent Growth and Innovation
Characteristics of the top 20 stocks by market capitalization in the Russell 1000 Growth Index as of June 30, 2020

Source: FactSet. Data as of June 30, 2020. Top 20 companies in the Russell 1000 Growth Index, by market capitalization. *Historical 3-Year Sales Growth data as of 06/30/2020. **Alphabet, Inc. Class A and Class C shareholdings have been combined. Price-to-earnings FY1 ratio shown is an average of the two share classes.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. The securities and data are for information only. It does not constitute a recommendation or an offer for a particular security, nor should it be taken as a solicitation or recommendation to buy or sell securities or other investments, and should not be used as the basis for any investment decision. Due to market volatility, the market may not perform in a similar manner in the future.

 

Many of the names listed in the table have dividend yields of 1.5% or higher, while others have historical sales growth rates in the low single digits. This certainly does not sound like an effective way to access stocks offering high growth of sales and earnings. 

Given this problem, investors relying on such passive approaches may wind up owning many stocks that fail to offer the potential for high growth of sales and earnings. As we have written elsewhere, a more effective approach to growth may be be an actively managed strategy that identifies the innovative companies with the potential to disrupt entire industries (or even create new ones) and seize revenues, and market share, from entrenched competitors.

Read more of the authors’ insights on the long-term changes in the value-growth dynamic, and its potential implications for portfolio allocations, here

 

IMPORTANT INFORMATION

A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies.

The information provided is for general informational purposes only. References to any specific securities, sectors or investment themes are for illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a reliable indicator of future results.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Dividend Yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock.

The price-to-book [P/B] ratio is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. The ratio is  used to compare a stock's market value or price to its book value.

The price-to-earnings [P/E] ratio is a measure of valuation. It is a company's share price divided by its earnings per share. The P/E ratio can also be calculated for the companies in a stock index such as the S&P 500. It can be calculated using either historical earnings (trailing P/E) or estimated earnings (forward P/E).

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this Market View are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information.

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