Last updated: 06:15 / Wednesday, 22 June 2022
Insights by New Capital at EFG Asset Management

Long Term Investing - Secular Growth Explained

Image
  • The Covid-19 pandemic accelerated some secular growth trends. One example is e-commerce. E-commerce penetrations (as a percentage of the total US retail sales) rose from 12.2% in 2009 to 20.8% by 2019, or roughly 0.9% increase per year. In 2020, e-commerce penetrations soared due to lockdowns: from 20.9% in December 2019 to 26.8% in April 2020 – pulling forward four years of e-commerce growth in just four months.
  • Higher rates hurt “growth” stocks more than “value” stocks. This is because when we value equities using Discount Cashflows, “growth” stocks’ cashflows are further in the future and therefore more sensitive to changes in discount rates
  • the underperformance of secular growth stocks since November 2021 can be attributed to a combination of 1) secular growth taking a pause to digest covid gains; and 2) rising bond yields compressing equity valuations.

Why do we invest in equities? A key reason is that equity investments compound over time. By investing $100 in a company that grows 10-15% per year for 20 years, that $100 turns into $673 at a 10% compound rate, or $1637 at a 15% compound rate. In comparison, a 3% bond would return $181 for the same period.

These 10-15% “compounders” are not as difficult to find as one might think, with many being household names: Google, Mastercard, and Louis Vuitton. We call them “secular growers” – high quality companies with favourable secular trends (digital advertising, cashless payment, and luxury democratisation respectively).

Gráfico 1

This strategy has served many investors well over the decades. However, as “growth” stocks have underperformed the broader equity market more recently, one question emerges: is it the end of secular growth investing?

To answer this question, we examine the two main causes for the recent “growth” stocks’ underperformance:

1. Secular growth: paused or broken?

The Covid-19 pandemic accelerated some secular growth trends. One example is e-commerce. Before the pandemic, US e-commerce sales had been growing at over 9% per annum between 2009 and 2019. E-commerce penetrations (as a percentage of the total US retail sales) rose from 12.2% in 2009 to 20.8% by 2019, or roughly 0.9% increase per year. In 2020, e-commerce penetrations soared due to lockdowns: from 20.9% in December 2019 to 26.8% in April 2020 – pulling forward four years of e-commerce growth in just four months (Figure 2).

Gráfico 2

Some of the pull-forward effect will stick – for example an octogenarian who learnt how to shop online in 2020 might continue to shop online in future. But in 2022 there is some normalisation between online and off-line shopping, as the world reopens.

This “pull-forward and pause” effect was evident in Amazon’s financial results. Amazon’s online stores sales year-on-year growth rate jumped from 24.3% in Q1 2020 to 47.8% in Q2 2020. The growth rate stayed around 40% for four quarters, before starting to moderate in 2021. Since Q3 2021, Amazon’s online sales have barely been growing at all.

We try to look through the Covid boost, by examining the 3-year period between 2019 and 2022. The annualised growth rate between 2019 and 2022 is around 20% - suggesting that secular growth remains healthy (Figure 3, red line). Indeed, Amazon’s year-on-year growth rate should recover to 15% by late 2022, according to FactSet consensus estimates, in-line with the long-term secular growth trend.

Gráfico 3

Similar patterns also occurred in connected TV (Netflix and Roku), social media (Facebook and Snapchat) and some software applications (Adobe and Asana). Almost anything with a screen attached.

2. Rising bond yields compress equity valuations

Not all secular growth stocks experienced the same Covid impact. For example, we look at Adyen, a modern merchant payment service provider.

Adyen’s revenue grew 28% in 2020. Despite a strong 2021 when its revenue grew 46%, Adyen is still expected to grow 39% in 2022. Further, consensus 2022 expectations, for revenue and profits (EBITDA), had not changed in the last six months between November 2021 and April 2022. Yet, Adyen’s share price dropped over -40% over the same period (Figure 4).

Gráfico 4

What happened? Valuation. Adyen’s valuation, in terms of the EV/EBITDA ratio, shrunk -46%, driving down the share price despite no changes to business fundamentals (Figure 5).

Gráfico 5

Inflation concern is the main reason for the valuation compression. Higher than expected inflation triggered fears that central banks would have to raise rates more aggressively than previously anticipated.

Higher rates hurt “growth” stocks more than “value” stocks. This is because when we value equities using Discount Cashflows, “growth” stocks’ cashflows are further in the future and therefore more sensitive to changes in discount rates. As illustrated in Figure 6, as the 30-year Treasury yield rose from 2.0% in November 2021 to 3.0% in April 2022, a “growth” stock’s valuation drops -30%, while a “value” stock’s valuation drops -15%.

Gráfico 6

In short, the combination of secular growth trends taking a pause and the valuation compression from rising rates, both occurred in late 2021, caused “growth” stocks to underperform.

Now, is this the end of secular growth investing? It is down to two factors:

1. Is the secular growth trend broken?

We must assess each individual secular trend carefully. Some growth trends could sustain (digital cloud adoption), some are taking a pause (e-commerce and connected TV), while some might revert back to 2019 (in-house fitness?).

Staying with our e-commerce example, the US e-commerce penetration was 24.5% in February 2022. In comparison, the Chinese e-commence penetration already reached 34.1% in 2019 and jumped to 52% in 2021, according to eMarketer. The US e-commerce penetration had been rising by 0.9% per year in 2009-2019. If a similar adoption trend continues from 2022, the US e-commerce could continue to grow for at least 10 more years, before reaching China’s 2019 levels (Figure 7).

Gráfico 7

2. Is valuation sensible?

It’s difficult to be definitive in absolute terms, but relative valuations are certainly becoming interesting.

Which of the following companies would you prefer to own for 5 years: A or B, and C or D?

Gráfico 8

Solely looking at the numbers, most would prefer Company A to Company B, and Company C to Company D. A and C have far superior financial metrics, despite trading at similar valuations to B and D.

Company A is Google, B is Duke Energy (electric utilities), Company C is Microsoft and Company D is General Mills (food staples). In a volatile environment, “value” stocks, such as Duke Energy and General Mills, are in favour due to safe-haven status. These stocks may deserve some capital allocation currently. But over a longer time-horizon, it’s secular growers like Google and Microsoft that deliver strong returns to patient investors.

To conclude, the underperformance of secular growth stocks since November 2021 can be attributed to a combination of 1) secular growth taking a pause to digest covid gains; and 2) rising bond yields compressing equity valuations. Now, the questions for secular growth investors to figure out are: 1) are long-term secular growth trends intact or broken; and 2) is the valuation reasonable? If both answers are yes, then secular growth investing should continue to deliver long-term gains.

 

 

 

Past performance is not a guide to the future. The value of your investments and the income from them may fall as well as rise as a result of market as well as currency fluctuations and you may not get back the full amount invested. Benchmarks are shown for performance comparison purposes only.

 

This marketing document does not constitute an offer to sell, solicit or buy any investment product or service, and is not intended to be a final representation of the terms and conditions of any product or service. The investments mentioned in this document may not be suitable for all recipients and you should seek professional advice if you are in doubt. Clients should obtain legal/taxation advice suitable to their particular circumstances. Investors should carefully read the Prospectus and the Key Investor Information Document (KIID) before investing. This information is only directed at persons residing in jurisdictions where the Fund is authorised for distribution. This document may not be reproduced or disclosed (in whole or in part) to any other person without our prior written permission. Although information in this document has been obtained from sources believed to be reliable, EFGAM does not represent or warrant its accuracy, and such information may be incomplete or condensed. All estimates and opinions in this document constitute our judgment as of the date of the document and may be subject to change without notice. EFGAM will not be responsible for the consequences of reliance upon any opinion or statement contained herein, and expressly disclaims any liability, including incidental or consequential damages, arising from any errors or omissions. Issued in the UK by EFG Asset Management (UK) Limited which is authorised and regulated by the Financial Conduct Authority (FCA Registration No. 536771). Registered No: 7389746. Registered address: Park House, 116 Park Street, London W1K 6AP. Telephone: +44 (0)20 7491 9111.

 

Investment products may be subject to investment risks, involving but not limited to, currency exchange and market risks, fluctuations in value, liquidity risk and, where applicable, possible loss of principal invested. The information contained is merely a brief summary of key aspects of the New Capital UCITS Fund plc (the “Fund”). More complete information on the Fund can be found in the prospectus or key investor information document, and the most recent audited annual report and the most recent semi-annual report. Some funds may have high volatility owing to portfolio composition or the portfolio management techniques utilised or be subject to various other risk factors. Such risks are set out in the Prospectus and KIID. These documents constitute the sole binding basis for the purchase of Fund units. Not all sub-funds will necessarily be registered or authorised for sales in all jurisdictions or be available to all investors.

 

These documents constitute the sole binding basis for the purchase of fund units. Copies of these documents are available free of charge in the United Kingdom at EFG Asset Management (UK) Limited (“EFGAM”), Park House, 116 Park Street, London W1K 6AP, United Kingdom. Copies of these documents are available free of charge in Germany at the offices of the German information agent, HSBC Trinkaus & Burkhardt AG, Königsallee 21/23, 40212 Düsseldorf, Germany. Copies of these documents are available free of charge in France from the French centralizing agent, Societe Generale, 29, boulevard Haussmann – 75009 Paris, France. Copies of these documents are available free of charge from the Swiss Representative: CACEIS (Switzerland) SA, Route de Signy 35, CH-1260 Nyon, Switzerland. Paying Agent:  EFG Bank SA. 24 Quai du Seujet, CH-1211, Geneva 2, Switzerland.

 

Copies of these documents are available free of charge in Luxembourg at the offices of the Luxembourg paying agent, HSBC Securities Services (Luxembourg) S.A., 16 boulevard d’Avranches, L-1160 Luxembourg, R.C.S. Luxembourg, B28531. Copies of these documents are available in the local languages as per the above and from www.newcapitalfunds.com.  A summary of investor rights is available at: https://www.efgam.com/newcapitalfunds/Summary-Investor-Rights.html

 

In the European Union, this Document is issued by KBA Investments Limited (“KBA”). KBA Investments Limited is licensed in terms of the Investment Services Act (Cap 370) as an Investment Firm and is regulated by the Malta Financial Services Authority (Authorisation ID KIL2-IF-16174). In the European Union, this Document is available to Professional Investors only (as defined under Annex II to Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU).

 

KBA Investments Limited

Licensed in terms of the Investment Services Act (Cap 370) as an Investment Firm and is regulated by the Malta Financial Services Authority (Authorisation ID KIL2-IF-16174). KBA Investments Limited is a sub-distributor in certain countries in the European Union for EFG Asset Management (UK) Limited. For the full list of EU countries, please visit the MFSA Financial Services Register https://www.mfsa.mt/financial-services-register/  . Registered Office: Trident Park, Notabile Gardens, No 2 - Level 3, Zone 2, Central Business District, Birkirkara, Malta. Registered in Malta No. C97015

United States: EFG Asset Management (Americas) Corp. (“EFGAM Americas”) is a U.S. Securities and Exchange Commission (SEC) Registered Investment Adviser and an affiliate of EFG Capital International Corporation
(“EFG Capital”), an SEC registered broker-dealer, member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). None of the SEC, FINRA or SIPC, have endorsed this document or the services and products provided by EFG Capital or its U.S. based affiliate, EFGAM Americas. Securities products and brokerage services are provided by EFG Capital, and asset management services are provided by EFGAM Americas. EFG Capital, and EFGAM Americas are affiliated by common ownership and may maintain mutually associated personnel. This document is not intended for distribution to U.S. persons or for the accounts of U.S. persons except to persons who are “qualified purchasers” (as defined in the United States Investment Company Act of 1940, as amended (the “Investment Company Act”)) and “accredited investors” (as defined in Rule 501(a) under the Securities Act). Any securities referred to in this document will not be registered under the Securities Act or qualified under any applicable state securities statutes. Any funds referred to in this document will not be registered as investment companies under the Investment Company Act.

Notice to Residents of Argentina: These shares may not be offered or sold to the public in Argentina. Accordingly, the offering of the shares has not been submitted to the Comisión Nacional de Valores (CNV) for approval. Documents relating to this offering (as well as information contained herein) may not be supplied to the general public for purposes of a public off ring in Argentina or be used in connection with any off error subscription for sale to the public in Argentina.

Notice to Residents of Bermuda: The securities being offered hereby are being offered on a private placement basis to investors who satisfy the criteria outlined in the prospectus. The prospectus is not subject to
and has not received approval from either the Bermuda Monetary Authority or the Registrar of Companies in Bermuda and no statement to the contrary, explicit or implicit, is authorised to be made in this regard. The securities being offered may be offered or sold in Bermuda only in compliance with the provisions of the Investment Business Act 2003 of Bermuda. Additionally, non-Bermudian persons may not carry on or engage
in any trade or business in Bermuda unless such persons are authorized to do so under applicable Bermuda legislation.  Engage in the activity of offering or marketing the securities being offered in Bermuda to persons in Bermuda may be deemed to be carrying on business in Bermuda.

Notice to Residents of Brazil: These shares may not be offered or sold to the public in Brazil. Accordingly, the offering of the shares has not been nor will be submitted to the Brazilian Securities Commission - CVM for approval nor has it been submitted to the foregoing agency for approval. Documents relating to such offering, as well as the information contained herein and therein may not be supplied to the public, as a public offering in Brazil or be used in connection with any offer for subscription or sale to the public in Brazil.

Notice to Residents of Chile: Fecha de inicio de la oferta: [11.10.2013]

(i) La presente oferta se acoge a la Norma de Carácter General N° 336 de la Superintendencia de Valores y Seguros de Chile.

(ii) La presente oferta versa sobre valores no inscritos en el Registro de Valores o en el Registro de Valores Extranjeros que lleva la Superintendencia de Valores y Seguros, por lo

que los valores sobre los cuales ésta versa, no están sujetos a su fiscalización;

(iii) Que por tratarse de valores no inscritos, no existe la obligación por parte del emisor de entregar en Chile información pública respecto de estos valores; y

(iv) Estos valores no podrán ser objeto de oferta pública mientras no sean inscritos en el Registro de Valores correspondiente.

(i) The commencement date of the off er and the fact that the relevant offer is made pursuant to this SVS Rule 336;

(ii) That the offer deals with securities that are not registered in the Securities Registry (Registro de Valores) or in the Foreign Securities Registry (Registro de Valores Extranjeros) kept by the SVS, which are, therefore, not subject to the supervision of the SVS. It is not sufficient to include disclaimers stating that the securities are registered in a specific jurisdiction other than Chile and supervised by the correspondent regulator; the SVS requires including in the communications and material used to offer the securities to potential investors the disclaimer provided by the NCG 336 and in Spanish;

(iii) That, given that the securities are not registered, there is no obligation for the issuer to disclose in Chile public information about said securities; and

(iv) That the securities may not be publicly offered as long as they are not registered in the corresponding Securities Registry.

 

Notice to Residents of Colombia: This presentation does not have the purpose or the effect of initiating, directly or indirectly, the purchase of a product or the rendering of a service by the company to Colombian residents. The company’s products and/or services may not be promoted or marketed in Colombia or to Colombian residents unless such promotion and marketing is made in compliance with decree 2555 of 2010
and other applicable rules and regulations related to the promotion of foreign financial and/or securities related products or services in Colombia. Colombian residents acknowledge that the receipt of this message constitutes a solicitation from the company’s products and/or services. Colombian residents acknowledge and represent that they are not receiving from the company any direct or indirect promotion or marketing
of financial products and/or services.

Notice to Residents of Costa Rica: This is an individual and private off er which is made in Costa Rica in reliance on an exemption from registration before the General Superintendence of Securities (“SUGEVAL”), pursuant to articles 7 and 8 of the Regulations on the Public Offering of Securities (“Reglamento sobre Oferta Pública de Valores”).

This information is confidential, and is not to be reproduced or distributed to third parties as this is not a public offering of securities in Costa Rica.  The product being offered is not intended for the Costa Rican public
or market and neither is registered or will be registered before the SUGEVAL, nor can be traded in the secondary market.

Notice to Residents of the Dominican Republic: This presentation does not constitute an offer or solicitation to the public in the Dominican Republic to subscribe for the shares discussed herein,

and any transaction contemplated hereby will take place on a private placement basis only. The shares have not been and will not be registered with the Dominican Securities Superintendence, and are not regulated
by any law of any specific sector. Any public offering, as defined under the laws and regulations of the Dominican Republic, of the shares in the Dominican Republic is not legal without such prior registration.

Notice to Residents of El Salvador: The recipient of this documentation hereby acknowledges that the same has been provided by EFG Capital International Corp. upon the recipient’s express request and instructions,
and on a private placement basis.

Notice to Residents of Guatemala: This communication and any accompanying information (the “Materials”) are intended solely for informational purposes and do not constitute (and should not be interpreted to constitute) the offering, selling, or conducting of business with respect to such securities, products or services in the

jurisdiction of the addressee (this “Jurisdiction”), or the conducting of any brokerage, banking or other similarly regulated activities (“Financial Activities”) in this Jurisdiction.  Neither the Fund, nor the securities,
products and services described herein, are registered (or intended to be registered) in this Jurisdiction. Furthermore, neither the Fund, nor the securities, products, services or activities described herein, are regulated
or supervised by any governmental or similar authority in this Jurisdiction. The Materials are private, confidential and are sent by the Fund only for the exclusive use of the addressee. The Materials must not be publicly distributed and any use of the Materials by anyone other than the addressee is not authorized. The addressee is required to comply with all applicable laws in this Jurisdiction, including, without limitation, tax laws and exchange control regulations, if any.

Notice to Residents of Honduras: The shares described herein are not securities regulated by the National Banking and Insurance Commission or a Securities Brokerage Firm in Honduras. The shares may not be offered or sold in Honduras except in circumstances which do not constitute a public offer. Any investment in shares of the Fund is done at the investor’s own risk.

Notice to Residents of Mexico: The shares have not been, and will not be, registered under the Mexican Securities Market Law (Ley del Mercado de Valores) and may not be offered or sold in the United Mexican States. The Prospectus relating to the Securities Offering may not be distributed publicly in Mexico and the shares may not be traded in Mexico.

Notice to Residents of Panama: Neither these securities, nor their off er, sale or transfer, have been registered with the Superintendence of the Securities Market (before named National Securities Commission). The exemption from registration is based on numeral 3 of Article 129 of Decree Law 1 of July 8, 1999 (Institutional Investors), as amended. In consequence, the tax treatment established in Articles 334 to 336 of Decree Law
1 of July 8, 1999, as amended, does not apply to them. These securities are not under the supervision of the Superintendence of the Securities Market (before named National Securities Commission).

Notice to Residents of Uruguay: Shares of the Fund are not available publicly in Uruguay and are offered only on a basis which constitutes a private placement in Uruguay.  As such, the Shares are not required to be,
and will not be, registered with the Central Bank of Uruguay. The Shares correspond to an investment fund that is not an investment fund regulated by Uruguayan law 16,774 dated September 27, 1996, as amended.

About Jonathan Rawicz

Jonathan joined EFGAM in March 2017 as an Equity Analyst, and is the portfolio manager for the New Capital Global Equity Conviction Fund. Prior to joining he worked as an Equity Analyst at AA-Capital, a family office, where he helped manage a long/short fund. Prior to that, he spent five years as an Equity Analyst at Morgan Stanley Quilter.

menu