Solid growth companies will continue to live up to high expectations by showing strong profit growth. This offers the prospect of an attractive total return after inflation of 7-10% per annum on average over the long term, according to manager George Dent of the BNY Mellon Long-Term Global Equity Fund.
Dent’s fund focuses on global quality stocks with good growth prospects with the MSCI World as its benchmark. This index recently reached another record level and is historically on the expensive side, with a price/earnings ratio of 21 based on expected profits over the next twelve months.
‘We are certainly worried about the valuations and have been doing a lot on this lately. Surely the stock market is not an accurate reflection of the economy. Because the earnings recovery has already been priced in, risks are skewed to the downside in the short term. Company profits will now have to catch up with prices first,’ says Dent.
Double-digit profit growth
The rapid recovery after the corona shock in March surprised him. ‘The pandemic is not over and still has a major impact on the economy and business. The stock market is supported by a limited number of large, mainly technology companies that continue to perform well despite the coronavirus crisis.’
If you correct for this the performance of the world index is less impressive. For example, until the end of August this year the equal-weighted version of the MSCI World is down around 4%, compared to a gain of 5.7% for the market-weighted index. Dent’s fund, which is part of the boutique Walter Scott & Partners, is up 4.8%.
Dent sees the stock market polarisation continue for the time being. Due to the coronavirus crisis, cyclical companies and some consumer-related sectors continue to face headwinds. The team therefore still prefers quality companies that thrive under the current circumstances and is willing to pay a little more for this. ‘The best-performing stocks in our portfolio are also the most expensive, and in fact this applies to the whole market. Nevertheless, the portfolio only trades at a small premium compared to the broad market.’
The low valuations of many value stocks are no reason for Dent to rotate to value, he says. ‘We remain true to our investment philosophy and will always look for financially sound, innovative companies that have proven to be able to grow through economic cycles. Ideally, we aim for potential earnings growth of 10-20% per annum. However, we do not exclude companies with somewhat lower but predictable growth.’
Nevertheless, Dent does invest in outspoken corona victims, such as the British corporate catering company Compass Group. ‘The corona outbreak has hit them hard because employees have started working from home in numbers. This trend will continue for the time being. However, thanks to its strong balance sheet, Compass Group is well-positioned to benefit from a recovery and we expect good returns over the next three to five years.’
Emerging markets via Finland
The investment strategy has proved itself over time: over the last five years, the fund has achieved an annual average total return of 10.8% in euros, compared to 9.0% for the benchmark. The fund manager points to the advantage of a global universe. There are always places where investors get more value for money.
Because corporate governance in emerging countries often leaves much to be desired, Dent is still reluctant to invest directly in emerging markets though. He prefers companies that indirectly benefit from growth opportunities in China, such as the Finnish lift manufacturer Kone. ‘The Finns are the market leader in China and benefit enormously from urbanisation in the country. In addition, Kone is a rock-solid brand name and has its corporate governance in order.’
Despite some scepticism about the valuations, Dent remains positive about the stock market. For the long term, we are very optimistic about the outlook for the stock market. Over the past hundred years, global equities have yielded a real return of 5 to 6% per annum on average. We are trying to do a little better and are aiming for a real return of 7 to 10% per annum. Based on the above-average profit growth in our portfolio, we expect to achieve this target over the next ten years.’