Tag Archives: income

‘Go For Growth’ Still A Sound Strategy In Today’s Market

Stocks perceived as mitigating the effects of market volatility were popular among investors in the first quarter. Big swings in equity markets drove a flight to quality that benefitted dividend-paying sectors such as Utilities and Telecommunication Services (which were the two best-performing sectors in both ACWI and the Russell 3000). We largely have avoided those sectors due to their elevated valuations and the fact that we don’t believe they offer the growth possibilities that are necessary to generate long-term returns. While some high-profile growth stocks trade at triple-digit P/E valuations today, the reality is that the vast majority of growth stocks do not, and we do not believe it is worthwhile to examine what is happening with the growth story. The case for growth stocks in a low-growth world is relatively straightforward. All else being equal, companies that are capable of delivering above-average growth in a low-growth world should be rewarded by investors over time. However, in investing, all else is rarely equal. A high-growth stock at an unsustainably high valuation can be just as risky as – or even more risky than – a company that is in secular decline. 2015 was the best year since 2009 for major U.S. growth indices (e.g., Russell 1000 Growth, S&P 500 Growth) versus their value counterparts (e.g., Russell 1000 Value, S&P 500 Value), so it makes sense to take a deeper dive. The median growth stock trades at a similar valuation (on both an absolute and relative basis versus non-growth stocks) to where it started 2015. For example, the median P/E of Russell 1000 Growth stocks that have no weight assigned to the Russell 1000 Value traded at a next 12-month P/E of 19.4 at the start of 2015. This group of stocks entered 2016 with a very similar next 12-month P/E of 19.5, and ended the first quarter at 19.7. Absolute valuations for this group as a whole are not cheap, and therefore, risks associated with coming up short of investor expectations can be high. However, the premium for these high-growth businesses versus the rest of the Russell 1000 is well within historical norms (see chart below). Against this backdrop, we continue to seek opportunities to own well-positioned, growth-oriented businesses with valuations that offer attractive compensation for the risks taken. The number of such opportunities might be fewer than earlier in the current market cycle, but we believe a selective and active approach to investing can maximize the likelihood of finding such companies today. Click to enlarge Investing in companies that can grow their earnings at rates above the trend in broad economic growth is particularly important in today’s slow-growth economy. As an illustration, we’ve taken returns in the U.S. equity market on a rolling 10-year basis and broken them down into how much came from earnings growth and how much came from changes in the P/E multiple (i.e., multiple expansion or contraction). Beginning in 1970, it has been earnings growth that has been more consistent and stable most of the time (see chart below). Historically, earnings growth has been a more reliable contributor to the returns we get as investors than multiple expansion. Click to enlarge While there certainly are periods in which multiple expansion drove or provided a boost to returns, changes in multiples have been quite volatile. In the 1980s and 1990s – when multiple growth helped returns – the market was coming off some attractive starting valuations and had a backdrop that was favorable for rising valuations. As a result, there was solid multiple expansion. But before that – and, more importantly, recently – not only could investors not rely on multiple expansion, they also had to deal with multiple contraction. This is one illustration of why we believe it is particularly important right now to focus on companies that are capable of growing their earnings on an individual basis, which, in our view, puts investors in a much better position to generate positive returns. Past performance does not guarantee future results.

The Story Of A Diversification Graph

How do you decide what stock or which sector to invest in? You rely on the media? You just invest in the latest hot stock? Or you setup a process to strategically help you out? When all is good, it seems easy to buy a stock but when the markets turn sour, it becomes more challenging and emotions start to make their way in. For example, did you ever sell a stock because you weren’t happy with the customer service you got? That would be an emotional transaction. Finding the Story… There are a number of ways to look at the graph… It’s important to put all the data points into context between your investments and the markets and economies impacting your investments. The graph below is a snapshot of my diversification by sector as of May 2016. First and foremost, the graph tells me that I should rebalance between my consumer defensive and technology sectors with the other deficient sectors. However, I do not like to sell that way, instead I just focus on those sectors when I add new money. The other story it tells when you take the markets into account is that the energy and basic materials sectors are out of favour. This is where the graph can start conflicting with emotions. You may not be happy about the performance of your current energy or basic material investments and the graph is telling you to pour more money in it. This is when you have a chance to buy low and sell high if you can pick a strong company that will bounce back. For me, that’s Suncor (NYSE: SU ), Enbridge (NYSE: ENB ), or TransCanada Corporation (NYSE: TRP ). As for the industrial and consumer cyclical sector, they have just fallen behind due to the movement of the others. When looking at my holdings, I only have 1 investment in each of those sectors and they have been doing fine over the past couple of years. McDondald’s (NYSE: MCD ) is doing remarkably well considering the lull it was in for a while. The sector deficiency isn’t based on performance but rather due to an increase in portfolio size. As it grows, so does the percentage of each sector. The same applies to Canadian National Railway ( TSX:CNR , NYSE:CNI ) Final Graph Reading As you can see, there has been 3 ways to read the graph each with its own story to tell. As I get ready to invest new money, I take into consideration the following: Any investment opportunity too good to pass on The stories of my diversification graph How much I have in a specific holding Readers: What’s your process?

Matthews Asia: Q&A With Robert Horrocks, PhD

Q&A With Robert Horrocks, PhD by Matthews Asia Chief Investment Officer and Lead Manager, Matthews Asia Dividend Fund Matthews Asia: How do you view the market environment for Asian economies? Robert Horrocks: The biggest negative in the short term is the U.S. Federal Reserve raising interest rates, meaning potential currency weakness and capital outflows for Asian markets. The main question is whether growth will pick up in an environment where markets are weak. In the short term, we are also seeing aggressive monetary stimulus across Asia: in China, India, Taiwan and Korea. The long-term outlook is, however, more upbeat. First, current accounts in Asia are generally positive: Asian countries are saving more domestically than they invest and are relatively less reliant on foreign capital. Asia has a higher share of manufacturing as a percentage of GDP and higher productivity growth, compared with the rest of the world. This started from a low base and has improved significantly over the past 20-30 years. Matthews Asia: How do you mitigate volatility? Robert Horrocks: The behavior of a dividend portfolio tends to be less volatile than the market: the security of receiving a dividend yield enables us to pursue a reasonable level of total return without chasing faster-growing, but more volatile investments. That is a double-edged sword, however: if the market goes up, we do not necessarily follow at the same pace. But in down times, we may have an element of protection. Matthews Asia: How is the Matthews Asia Dividend portfolio structured? Robert Horrocks: We take an all-cap approach, meaning we can invest in anything from small to mega caps. What is nice about Asia is that you see companies right down the market cap paying dividends. In small and mid-caps, you tend to find more entrepreneurial companies, family-owned commercial businesses, while large companies in Asia are often less commercially run and connected to governments. The market capitalisation of companies we invest in depends on the liquidity of underlying stocks in a particular market. For some markets, a liquid stock would have to be $1 billion, for others, only a few hundred million. But one thing this Fund will not do is morph into a blue-chip yield portfolio. Matthews Asia: What differentiates the Matthews Asia Dividend Fund from other Asia income funds? Robert Horrocks: We believe it is important to focus on the sustainability of the dividend stream. Many Asian equity income portfolios are built with a lot of emphasis on yield, containing stocks of Chinese and Australian banks and commodities, for example, which can be difficult underlying businesses. In our long-term total return approach, we use dividends as an indicator of core earnings growth and strength of the company. The companies we seek to invest in range from small and mid-caps that may be yielding 2% to solid businesses that may yield 4-5% but potentially growing their dividends at a 15% rate. This balanced approach seeks to create a portfolio that can benefit from an attractive dividend yield without giving up on growth. We have a lot of flexibility: If the market is hot, the natural thing for us is to take a step back and look in the other direction. If everyone is looking for yield, we would look for growth; if they start paying more for growth, we would move the portfolio back towards yield. We have a dedicated team of investment professionals that have 2,500 company meetings every year, looking at all businesses through the Asian dividends framework. We also meet with companies’ competitors and suppliers to gauge their outlook. Matthews Asia: Where are you currently wary of investing? Robert Horrocks: The Fund has currently no allocation in Australia. A lot of the time, the Australian banks or the material sectors are quite cyclical and exposed to shocks, both internally and externally. There are some countries that are more fertile ground than others. In India, for example, it is difficult to find high-quality companies, which are giving you a particularly high current yield. Now the reason for that is capital is quite scarce in India – after you have reinvested it into the business, there is less to pay out. Also, valuations there tend to be a little bit higher than in the rest of the region, so that is where the valuation discipline of the Fund comes in. In places like Korea, there is a lot of capital that can be shared with minority shareholders, but historically, the attitudes of management teams there has been less favorable to shareholders. That is where the corporate governance side of the discipline of our framework comes in. Matthews Asia: What are some of the most prevalent investment themes in Asia? Robert Horrocks: Looking at the past 30 years, inequality across the world has been decreasing (although it could be increasing within certain individual countries). This development has resulted in the rise of the middle class, so an opportunity for us is to find companies that will facilitate that middle-class life. This is an ongoing trend, likely to continue for the next 30 years. According to the Organization for Economic Co-operation and Development’s estimations, by 2060, Asia will account for two-thirds of middle-class spending in the world. Companies that should gain from that spending include businesses in industries as varied as retail, consumer staples and goods, consumer discretionaries, autos, media, leisure, entertainment, tourism, insurance and wealth management. Consumer and auto loan businesses of banks as well as healthcare are also expected to benefit – whether it is a high-street establishment or a more sophisticated business, such as a healthcare equipment manufacturer, a private hospital or a drugs company. Click to enlarge Robert Horrocks – Image source: Matthews Asia See full PDF below. Disclosure: None