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Market View

Long-term equity investors may be wise to augment their traditional growth beta with an allocation to “high growth” stocks, providing the potential for an additional source of excess returns.

In a recent Market View, we highlighted the merits of a high-growth approach to equity investing. We noted that the stocks of the fastest-growing U.S. large-cap companies historically have generated strong outperformance relative to the rest of the market.

 

Table 1: Historically, U.S. High-Growth Companies Have Been Worth Their Premium
Three-year rolling averages (12/31/2006-12/31/2016)

Source: FactSet and Lord Abbett. Based on annual reported earnings. Data most recent available. The average top 10% of high-revenue growth stocks were chosen by screening all companies with a market capitalization greater than $10 billion at the end of each three-year time period and then stacking the companies according to their revenue growth over a three-year period. The historical data shown are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment. Performance quoted represents past performance. Past performance is not a reliable indicator or a guarantee of future results. Indexes are unmanaged and are not available for direct investment.

 

These high-growth companies tend to be driven by innovative business models and/or products and services that have the potential to disrupt markets, allowing these dynamic organizations the opportunity to rapidly grow market share within their industries. Given the unique opportunity presented by these high-growth companies, and the notable historical outperformance of their stocks, investors may want to consider an approach that focuses on this distinct subset of the market in order to potentially generate excess returns over and above traditional growth beta.

As Table 2 reveals, large-cap growth funds with a Morningstar Value-Growth Score1 in the top decile of the category historically have generated considerable long-term outperformance relative to the remainder of the category and the group’s most common benchmark, the Russell 1000 Growth Index.

 

Table 2: Historically, U.S. High-Growth Stocks Have Offered Competitive Long-Term Outperformance

Source: Morningstar Direct. The historical data shown are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment. Performance quoted represents past performance. Past performance is not a reliable indicator or a guarantee of future results. Indexes are unmanaged and are not available for direct investment.

 

Over the past 20 years, this select subset of managers has added more than 167% of cumulative excess return above the Russell 1000 Growth Index, and has done so with a high level of consistency. During this 20-year period, high-growth strategies outperformed the Russell 1000 Growth Index and traditional growth peers in more than 75% of rolling 10-year periods.

 

Table 3: U.S. High-Growth Managers Historically Have Outperformed the Index

Source: Morningstar Direct. The historical data shown are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment. Performance quoted represents past performance. Past performance is not a reliable indicator or a guarantee of future results. Indexes are unmanaged and are not available for direct investment.

 

The magnitude and consistency of high-growth outperformance highlight why long-term investors may be well served by treating this segment of the market independently from their growth beta and as a distinct source of potential excess return. However, as we have discussed in previous articles, we believe that managing high-growth stocks requires an active, specialized, and flexible approach due to the higher volatility observed in these names.

Managers able to harness the power of these dynamic stocks have rewarded investors exceptionally well over time. Yet despite the long-term appeal, high-growth stocks appear to be a relatively untapped segment of the market—as of October 31, 2017, just 7% of assets allocated to large-cap growth funds were placed with high-growth strategies.

 

1 Morningstar’s score for a stock’s value and growth characteristics, which determine its horizontal placement in the Morningstar style box. A higher score indicates a greater orientation towards the “Growth” style box. There are five value factors and five growth factors: Value factors: Forward looking: Price/projected earnings: 50.0%. Price/book: 12.5%; price/sales: 12.5%; price/cash flow: 12.5%; dividend yield: 12.5%.  Growth factors: Forward looking: Long-term projected earnings growth: 50.0%. Historical-based measures: Book value growth: 12.5%; sales growth: 12.5%; cash flow growth: 12.5%.

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. Historically speaking, growth and value investments tend to react differently during the economic cycle. Since value stocks are often cyclical in nature, they may benefit from the increased spending that usually occurs during an economic expansion. Growth stocks may also perform well during an expansion, but they may also be out of favor during market downturns, when investors pay more attention to price ratios. 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. Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market. No investing strategy can overcome all market volatility or guarantee future results.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article 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.

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 guarantee or a reliable indicator of future results.

Glossary of Terms

Annualized Return: A measure of investment performance that allows comparisons between different time periods. The cumulative return is converted into an annual return that would, if repeated each year during the period, produce the same cumulative result.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. A stock with a beta higher than one is considered more volatile—and therefore more risky—than the market. A stock with a beta lower than one is considered less risky.

Cumulative Return: The total change in the value of an asset or a portfolio over a given period of time, expressed in percentage terms. It is often displayed as the growth of a given sum of money over the time period.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation.

Total Return: The change in the value of an asset or portfolio due to both capital appreciation or depreciation and/or dividends, interest payments or other income.

The Russell 1000 Index® measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index.

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

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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