For the past 13 years, growth investing has handily outperformed value, and with COVID pouring fuel on the fire of change, that divergence has never been greater than it was in 2020. There are lots of commentaries swirling within the investment community posing questions such as “is value investing dead?” or “are growth stocks in a bubble?” I think that we are asking the wrong questions, but before we get there, what exactly is value versus growth investing.

According to the definitions on www.investopedia.com, “Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value” whereas growth investing “is an investment style and strategy that is focused on increasing an investor’s capital. Investing in companies whose earnings are expected to increase at an above-average rate compared to their industry sector or overall market.”

In a very simplistic view, the value investor looks for cheap companies by analyzing future cash flows and discounting them back to present value. One of the key components to value investing is that everything will eventually revert to its mean. So when a company is either expensive or cheap compared to its historical values then it will eventually fall back or rise up to it’s historical norms. With growth investing you are looking simply at how much growth that company will achieve over the years to come and you are typically willing to pay more for that growth then you would for a value company. In other words, how big is their total addressable market and how much market share can they garner.

I would venture to guess that everyone reading this would like to own companies that are growing at an above average rate but would prefer to buy them when they are cheap, after all everyone loves a sale. So by that definition most people would want to own companies that are cheap but that are also growing faster then the norm. Unfortunately with our the investment industry is created we typically have to pick an investment strategy causing us to ask the age old question of “do we invest in value vs growth?” I would like to pose a different question, and that is “do we have to choose one over the other?”

I still remember one of the very first institutional meetings I had in 2004. We were trying to get the fund research team of a major Canadian bank to recommend some of our funds. On our side of the table there was the Chief Investment Officer for one of our management teams, who had and continues to win numerous accolades for his long term performance, my boss who was the Sr. VP of Institutional Sales and 25 year old recently hired me. On the other side was the head of the banks fund research team and three members of her team. I still recall having to call up the head of the bank research team the next day to apologize on behalf of the manager. What had happened in that fateful meeting is that the Manager and the Analyst got into it when discussing his teams investment style. The research analysts were trying to figure out if this team was “Value”, “Growth” or the catch all “GARP – growth at a reasonable price”. Our Portfolio Manager’s response is that they invest money with the goal of creating an above average long term risk adjusted return and that they don’t care if a company is “growth” or “value” because their job is to go out and buy the best companies possible at the right price. The conversation got a little more colourful from there, hence my call the next day. That meeting was certainly an eye opener for me, but more importantly it did resonate.

For the 25 year old me, that was an interesting launch into my institutional career to say the least, but it also helped to create the mindset that I employ today as a Portfolio Manager. Is it not our goal as investors to create the best risk adjusted return that we can and if so why should we care if we are buying value vs growth? Or better yet, do they have to be mutually exclusive? If we view investing as buying and selling of businesses and that the stock price is just the price at which the market is willing to pay at any given moment, then shouldn’t we be focused on buying the absolute highest quality businesses we can but also making sure that we are paying the right price for them? Shouldn’t the value of that business be the present value of all of their future cash flows?

If that’s the case then value investing is the right call as you’re looking for companies that look cheap compared to their future earnings. But then why has growth investing outperformed by huge margins over the past 13 years?

I believe that the biggest mistake traditional value investors make is not understanding growth in the age of technology. What I mean by this is that if a company is the value of all their future cash flows then we have to look at what is the total addressable market for a company and also recognize how quickly a company can pivot into new revenue streams. This is extremely hard and more complex than analyzing how many widgets can be made and figuring out what that company is worth. It becomes even more difficult when you realize that companies are given leeway to grow at the expense of profits as the end prize could be so massive. For most of us how do we even value a company, understand their potential market or differentiate the company from it’s competitors when we have a hard time understanding the actual technology? Most of us can understand what a utility company is providing and compare one utility to another, but it takes a different skill set to understand the difference between the LIDAR (light detection and ranging devices) of two different companies and thus who has the higher probability of winning?

The classic example is Amazon which has always looked expensive by traditional metrics, but here is a company that started off selling books online and now owns Zoox, an autonomous ride-hailing service. These growth companies use the strength of their core businesses, low cost of capital, an investor base who allows them to lose money in certain areas, technical know-how and strong management vision to pivot into new revenue streams. In other words they have optionality to grow that many traditional businesses don’t have. The value of the business can’t be easily derived by analyzing how many widgets they can produce but more so on the intangibles and unknowns of the future. This is also what causes the “winner takes most” reality of the current market environment and allows the winners to continue to compound at double digit rates for longer than most people have ever thought imaginable.

So back to the question of value versus growth and where do we go from here. Like the manager from the meeting back in 2004, we don’t believe in the differentiation between value and growth. We believe our job is to try and create the best risk adjusted returns that we can for our clients. Looking to 2021 and beyond, perhaps another comparison will help us integrate the two. We suggest that you consider this split from another perspective – The Old Economy with lots of value companies, where we get our cash flow from dividends and some growth, and the New Economy driven by high growth technology across a broad spectrum of industries such as health, energy, cloud computing, that has and will continue to drive growth in the years ahead.

Our job is to marry the old and the new to achieve superior risk adjusted returns over a number of years and by marrying the two we believe we are giving our clients the best approach to achieve those results.