By Alistair Wittet
The global economy is slowing, and finding sustainable quality growth remains a challenge for investors. However, a slowing economy does not condemn all those companies operating within it to underwhelming performance. Quite the contrary: there are many parts of the economy for which growth remains solid, or, in many instances, is even accelerating.
GDP is the average of many moving parts and the stock picker’s luxury is the ability to selectively focus on the growing areas while ignoring the rest.
One sector that has demonstrated rapid growth is online retail. The shift from bricks and mortar to online retail has driven strong growth in online-only businesses such as ASOS and Amazon, which now account for over 15% of purchases in the UK, 12% in the US and 11% in Germany. These companies continue to enjoy revenue growth in excess of 20%, set against the enduring travails of high street chains.
Another notable trend is that large scale demographic shifts such as the developed world’s ageing population, allied with changes in our lifestyle, mean the proportion of people suffering from impaired vision continues to grow. This drives demand for corrective glasses, benefitting the entire supply chain from lens manufacturers (such as Essilor) to frame designers (Luxottica) and opticians (Fielmann).
Not all growth companies are lucky enough to enjoy a structural tailwind. For some, growth is about gaining share in a static market; what analysts at Goldman Sachs call “pie-shift” stocks. For example, Aldi and Lidl’s disruptive business model has enabled them to more than double revenue in the UK since the recession. Meanwhile the “Big 4” supermarkets (Tesco, Sainsbury’s, Morrisons and Asda) have all lost share. Another example can be found in clothing retail, where Spanish giant Inditex, owner of Zara and Massimo Dutti, continues to expand its global retail network while driving same store sales growth (in excess of 7% in 2015) at a time when many other high-street retailers, e.g., Ben Sherman, are filing for administration.
While growth is a prerequisite for many long-term investors, it is not synonymous with an ability to generate shareholder value. The airline market, for example, has been growing for more than two decades and yet most airline companies have barely turned a profit in that time. On a macro level the same can be said of China, as evidenced by the lacklustre stock market returns over the past two decades despite significant and recurring GDP growth.
The missing link, and the final piece in the jigsaw for investors, is quality. Often defined as a high return on capital employed, or solid cash generation, quality is about the business model: the barriers to entry, the franchise, the corporate culture and the strength of management. Quality is what ensures growth translates into shareholder value.
Take the structurally growing mobile phone market as an example, driven in the early years by the feature phone and more recently by smartphones. In its relatively short history this “attractive” market can count more casualties than years of existence. These include Nokia, Blackberry, Motorola, Ericsson, LG and more recently, HTC. But while many suffered, others have thrived. Apple and Samsung have managed to defend and grow their leading positions in the sector in part thanks to their vertically integrated business models and focus on innovation.
A lesser-known winner is ARM, the UK-based semiconductor company, whose architectures are present in over 90% of phones in the world. Their low power chip design gave them a dominant position in the early years which they subsequently cemented as the software ecosystem developed around their architecture. Much like Intel in the PC space, ARM’s position as the industry standard acts as a formidable barrier to entry for competitors, even Intel itself.
Even against the backdrop of a slowing economy, talented stock pickers will be able to identify companies that buck the trend and offer sustainable, quality growth and deliver consistent shareholder value over the long term.
Alistair Wittet is European portfolio manager at Comgest
