Comgest: value and growth are not incompatible

Pierre Lamelin, manager of the Comgest Growth Europe fund, has made finding value in growth companies the cornerstone of his strategy. These companies, with their unique combination of value and growth characteristics, are invariably labelled quality. The manager is convinced that these companies, given their higher and predictable earnings growth, will outperform the market in the longer term. 

Inflation fears exaggerated

In 2021, the debate about inflation has come to the fore, with both companies and investors talking about it, said Lamelin. “There are indeed some inflationary forces at work, including the post-covid demand recovery, huge fiscal stimulus and unprecedented money creation, and a shrinking labour supply. It is therefore understandable that investors are wondering how this development will affect our investment portfolio, which is grafted onto growth values. In theory, inflation and the higher interest rates it normally brings are not good for growth stocks.”

Lamelin said he believes these fears are exaggerated. “Although we are not macroeconomists at Comgest, we expect less dynamic economic growth and inflation to slow down.” The Comgest manager points to several persistent forces weighing on inflation, including technical progress and productivity gains, the ongoing digitalisation of the economy and the rise in the savings rate. “And I would also add the presence of zombie companies. These companies are helped by government intervention and the low interest rate environment. But they are not innovative and only through working with cheap prices, which works deflationary, do they stay alive.” 

Quality comes first

But what if inflation and higher interest rates do occur? The Comgest Growth Europe fund will be well armed, said Pierre Lamelin, because it is focused on finding high-quality growth values and Value of Growth. “We describe our investment philosophy as quality of growth. And quality gives us the confidence that growth can be achieved. We also believe that in the long run the fundamental value of a company always comes out on top. So quality comes first and gives us predictability in terms of profit, then comes growth and finally we look at the valuation/price component. It is not the other way round.”

As an example of Value of Growth, with a strong view on profit development and earnings growth, he gives the Dutch company ASML. “We bought the share in 2018 at EUR 160 against a price/earnings ratio (based on 2017 earnings per share) of 32. This could not be called value. But if you look at how profitability has developed over the years, the share at the time was only trading at 19 times 2020 earnings. And at the expected profit for 2025, it will have been at 7 times.”

But to find quality, it is not only the hard financial ratios that play a role. Lamelin pointed to a whole series of elements that can give a company the quality label. Companies with competitive advantages, with business models we understand, growth from their own resources, respect for the various stakeholders with an eye for ESG, quality of the management team, and so on.

Buy and hold

Lamelin also underlined that his fund has a “buy and hold” approach. “We hold our positions for the long term and we take a Darwinian approach with a strict selection process. We like to take our time when looking at new ideas. Companies with too much uncertainty or too much dependence on an external factor, that cannot be predicted, are definitely dropped.” 

On valuation grounds, according to the Comgest manager, adjustments are made. “We take full or partial profits if certain companies have become relatively too expensive or if the investment conditions are no longer met. If, for example, a company has made a major takeover, the overall risk has risen sharply.”

Two important factors

For Lamelin, two factors are important in the quality analysis: a strong balance sheet with low financial leverage and pricing power. “The debt burden of companies in our portfolio, with a net debt/EBITDA ratio of 1, is fairly limited compared to the MSCI Europe average of 1.8. Even if interest rates or the cost of debt were to rise, the impact on our portfolio would be limited.” And in addition, a large proportion of the companies in the manager’s portfolio have pricing power. “This is very clear in the luxury goods sector but also some industrial companies can easily pass on the higher costs. It is noteworthy that innovation is increasingly playing a role in the pricing power component. If a new product or service creates extra added value for the customer, it is easier to pass on a higher price. The market is currently taking too little account of such innovation-driven pricing power, which is more valuable than ordinary price increases. We see this particularly in the healthcare and tech sectors.” 

K-shaped recovery

And how does he find that growth today? “Well, we find that the Covid pandemic has acted as an accelerator of a number of trends, such as digitalisation and climate transition, from which some companies or sectors benefit more than others. So we see an economic recovery in the form of a K. A good example is the boom in e-commerce, while shops were struggling due to lockdowns. And within certain sectors we also see shifts, with one player taking market share from the other due to the acceleration of these trends. In the illustration below, the K-shape that Comgest puts forward is easy to see.”

And that growth is visible, as companies in Comgest’s European equity portfolio saw organic sales growth increase by 13 per cent between July 2019 and July 2021 while nominal GDP was unchanged over the period. “In other words, our companies have gained market share within European GDP,” Lamelin concluded.

Comgest Growth Europe fund