While the AIM market is a great hunting ground for growth companies, many of these ‘AIM darlings’ have become very expensive. Judith MacKenzie, Head of Downing Public Equity, discusses the virtues of value investing and her focus on unearthing value companies with distinct growth characteristics.
Current market valuations look vulnerable to us in the face of higher interest rates and other economic pressures, reigniting the traditional ‘growth versus value’ debate. Rather than discuss the attributes of one style over another, it may be more helpful and enlightening to our investors to determine what constitutes a ‘good’ company in 2018. We have a strong value bias, seeking to buy intrinsically good quality businesses at bargain prices. However, we do love growth – we just don’t want to overpay for it.
In the AIM market, the divergence in valuations between companies considered growth and those considered value can be significant – stocks with a market cap of more than £1 billion are trading on an average P/E multiple of 27.9x, while the smaller sub £150 million market cap companies at the value end are trading on a multiple of just 8.3x. This is due in some part to tax reasons – IHT qualifying stocks are popular with investors seeking to reduce their IHT liabilities – but we think it is predominantly due to investors piling into companies on a sharp growth trajectory. Obvious recent examples are Fever Tree, the upmarket soft drinks manufacturer, and Purple Bricks, the online estate agent. Both have been heavily bought by momentum investors and growth stocks like these are becoming very expensive. Our focus is on unearthing the ‘hidden gems’, those good value stocks that sit beneath most investors’ radar, despite exhibiting classic growth characteristics.
Another consideration is that advances in technology have had a massive impact on the fortunes of companies in recent years, so working out which companies will thrive on digital disruption and those which will falter could be a more meaningful indicator of future success than merely putting stocks into either a growth or a value bucket.
A case in point is one of our holdings, AdEPT Technology Group, which was once just a fixed line telecoms company. However, CEO Ian Fishwick has driven an ambitious acquisition strategy and AdEPT has developed into a much broader managed services provider, adopting new IP including Voice Over Internet Protocol (VOIP), and embracing cyber solutions. It was also recently named as one of the top 25 quoted technology companies in the UK. AdEPT has a tremendous quality of earnings and earnings growth, and recent results demonstrate a track record of delivering nine consecutive years of EPS growth, a feat only matched or bettered by three in over 700 companies listed on AIM. Adept has all the attributes of a growth company, but it is considered a value stock by the market because it is sitting at a discount to its peer group.
Synectics is another of our portfolio companies that demonstrates the irrelevance of the value or growth label and instead the importance of backing successful digital strategies. Synectics is a designer of end-to-end integrated security and surveillance solutions specifically for gaming, oil and gas, marine, transport, infrastructure and public space applications. In its latest interim results for the six months to 31 May 2018, it reported revenue was up 3%, order book growth up 18%, and underlying profits up 12%. Synectics is building on its 30 years’ experience of customer-driven innovation and continuing to adjust its product and business development activities towards the emerging needs and opportunities in both established and developing market segments. We think that this is a great company delivering double digit growth and quality of earnings, and another we consider a value company despite showing distinct growth characteristics.
A respected fellow investor, James Sullivan of MitonOptimal UK, recently highlighted the ‘Death by Amazon Index’, which was created in 2014 by a US-based advisory group, Bespoke Investment Group. It is home to about 50 stocks that haven’t embraced technology and were therefore obvious victims of the Amazon and wider technological revolution. Unsurprisingly, the index in question has performed poorly versus the broader market.
I agree with James that this doesn’t simply mean all tech companies are good and traditional ones bad, but it does possibly provide a more relevant framework for assessing how and why companies will succeed. Some companies are embracing technology and can disrupt markets, while those that do not may be disrupted.
Possibly, more important than casting aside an arguably outdated debate is our primary focus of providing a solution for what our investors want rather than back ourselves into a rigid style straightjacket. First and foremost, we are active managers employing a private equity investment process that aims to manage risk and drive strong returns for our investors over the long term.
Partner and Head of Public Equity
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