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Why "Growth" stocks have, and will continue to, outperform "Value":
Three structural market dynamics will continue to cause Growth stocks to outperform Value:
1) ZIRP (low rates)
2) Fed Put
3) Business Cycles
My take may not be as obvious as you think.
Time for a thread
Three structural market dynamics will continue to cause Growth stocks to outperform Value:
1) ZIRP (low rates)
2) Fed Put
3) Business Cycles
My take may not be as obvious as you think.
Time for a thread
1a) ZIRP
This dynamic is well-discussed and not unique, but it's still a meaningful factor.
The Fed has committed to rates near the lower bound until 2023. To simplify, this has two implications that benefit Growth more than Value:
This dynamic is well-discussed and not unique, but it's still a meaningful factor.
The Fed has committed to rates near the lower bound until 2023. To simplify, this has two implications that benefit Growth more than Value:
1b) ZIRP - Impact
Debt Financing: Companies have easier access to debt capital, with lower borrowing costs, to fund growth.
Valuation: A corollary to the above, utilizing a lower discount rate in traditional valuation models significantly increases company value.
Debt Financing: Companies have easier access to debt capital, with lower borrowing costs, to fund growth.
Valuation: A corollary to the above, utilizing a lower discount rate in traditional valuation models significantly increases company value.
1c) ZIRP - Valuation
Specifically, lower discount rates makes future CFs more valuable (higher PV). These future CFs reflect high expected growth, more benefit is captured.
Importantly, Terminal Value = largest component of a company's value, which has a higher PV w/ ZIRP.
Specifically, lower discount rates makes future CFs more valuable (higher PV). These future CFs reflect high expected growth, more benefit is captured.
Importantly, Terminal Value = largest component of a company's value, which has a higher PV w/ ZIRP.
2a) Fed Put
The Fed Put is the widespread belief that the Fed can always rescue the economy and markets in times of financial stress.
Younger "Growth" companies are more likely than established "Value" to require this assistance.
See this thread: https://twitter.com/SahilBloom/status/1285945300687876097
The Fed Put is the widespread belief that the Fed can always rescue the economy and markets in times of financial stress.
Younger "Growth" companies are more likely than established "Value" to require this assistance.
See this thread: https://twitter.com/SahilBloom/status/1285945300687876097
2b) Fed Put - Impact
Higher Growth co's have a wider dispersion of potential outcomes vs. Value (i.e. fatter tails). Envision the curves for each.
A Fed Put cuts off the left tail of a distribution curve, making a bet on Growth companies more asymmetric than Value (+ skew).
Higher Growth co's have a wider dispersion of potential outcomes vs. Value (i.e. fatter tails). Envision the curves for each.
A Fed Put cuts off the left tail of a distribution curve, making a bet on Growth companies more asymmetric than Value (+ skew).
2c) Fed Put - Option Value
The Fed Put makes Growth a better "bet" - I also want to elaborate on the impact of a company's real options.
Think about a high growth company's valuation as follows: Mkt Value = DCF Value + Real Options Value (can be used to est. mkt assumptions)
The Fed Put makes Growth a better "bet" - I also want to elaborate on the impact of a company's real options.
Think about a high growth company's valuation as follows: Mkt Value = DCF Value + Real Options Value (can be used to est. mkt assumptions)
2d) Fed Put - Option Value
Controlling for DCF value, Growth co value is based on how the mkt values its real options (future opportunities).
Just as a lower Rf rate increases DCF values, it does the same for options. The higher volatility of Growth also increases option value.
Controlling for DCF value, Growth co value is based on how the mkt values its real options (future opportunities).
Just as a lower Rf rate increases DCF values, it does the same for options. The higher volatility of Growth also increases option value.
2e) Fed Put - Option Value
When potential negative outcomes of option values are cut off (Fed Put), it yields a higher avg probability outcome than it would otherwise.
A simple example - w/ the Fed Put, the probability of a Very Bad outcome is 0%. Notice the value difference.
When potential negative outcomes of option values are cut off (Fed Put), it yields a higher avg probability outcome than it would otherwise.
A simple example - w/ the Fed Put, the probability of a Very Bad outcome is 0%. Notice the value difference.
3a) Compressing Business Cycles
The advantage that Value investors have had is the ability to hold companies over long periods of time and let earnings compound. Due to the exponential nature of compounding, the majority of the benefits came at the end of the holding pd.
The advantage that Value investors have had is the ability to hold companies over long periods of time and let earnings compound. Due to the exponential nature of compounding, the majority of the benefits came at the end of the holding pd.
3b) Compressing Business Cycles
But what happens when an investment never reaches those later years? The majority of the potential value can't materialize.
The outcome of a McKinsey study is below. Note that 75% of current S&P 500 is expected to disappear by 2027.
But what happens when an investment never reaches those later years? The majority of the potential value can't materialize.
The outcome of a McKinsey study is below. Note that 75% of current S&P 500 is expected to disappear by 2027.
3c) Compressing Business Cycles
A simple example below shows the magnitude of this dynamic (i.e. 3.6x difference).
Buffett's biggest advantage has been the ability to hold companies for a long time and let earnings compound. This is A LOT harder for today's Value managers.
A simple example below shows the magnitude of this dynamic (i.e. 3.6x difference).
Buffett's biggest advantage has been the ability to hold companies for a long time and let earnings compound. This is A LOT harder for today's Value managers.
12/ Conclusion
Markets, as in nature, are cyclical. That won't change, Value will outperform again one day.
But having a clear understanding of the present is the best way to generate alpha.
Present dynamics tell me Growth will continue to outperform.
Best of luck!
Markets, as in nature, are cyclical. That won't change, Value will outperform again one day.
But having a clear understanding of the present is the best way to generate alpha.
Present dynamics tell me Growth will continue to outperform.
Best of luck!
