Tim Garratt, Partner, Baillie Gifford
It’s been a tough couple of years for growth investors. A nasty cocktail of rising rates and extreme risk aversion following the global pandemic drove huge market swings, leading to a drop in share prices for companies with longer term potential.
Understandably, people have been asking whether growth investing can still generate attractive returns from here, but history suggests that this would be the wrong time to throw in the towel.
Previous market shocks and sharp drawdowns in growth equity funds have been followed by huge returns over the ensuing decade. We saw this after the inflationary crisis of the mid 1970s and the financial crisis of 2008, with subsequent ten-year cumulative returns of around 1000 per cent and 500 per cent respectively.
There is every reason to believe that this time will be no different. Although there is an extra dynamic at play because we are seeing rapid technological and societal change.
In recent decades, the business backdrop has been relatively benign. There’s been cheap funding for business ventures; natural resources have been extracted and mined for business progress; and all within a free trade environment.
But it’s changing fast. We’re shifting to a new era of limitations.
Money is no longer free - rates aren’t returning to zero. Natural resources are dwindling - businesses can no longer treat the environment as a cash machine. And international trust is in short supply, with trade policies that restrict imports, protect domestic industries, and prioritise national interests.
But amidst these growing constraints, one force is heading in the opposite direction. Computer intelligence is accelerating, reducing in cost and spreading fast. In the next decade, machine learning seems likely to turn every single industry on its head.
Some businesses are better placed than others to cope with these shifts. As with every major transition, there will be big winners and big losers. Here lies the opportunity for stock pickers - a chance to find the champions that will emerge.
So, what are the characteristics of companies that will thrive in this new environment?
- They solve real-world challenges
Some companies are turning headwinds into opportunities, providing innovative solutions in areas such as e-commerce, healthcare and banking.
Samsara is putting telematic systems in trucks and warehouses to improve productivity and cut pollution within the logistics industry; Mercado Libre is using technology to lower the costs of banking, payments and savings across Latin America where 70% of people don’t have a bank account; Dexcom has transformed how people manage diabetes at home, reducing the burden on hospitals.
2. Execution discipline and financial strength
With higher interest rates, the benefits of strong balance sheets come to the fore. The stock market associates growth companies with dubious financials but this stereotype is misplaced. We see many growth companies with disciplined leaders using financial strength and competitive edge to push through price increases, grow revenue and continue to invest for the long-term
Adyen, which provides a platform that simplifies local and worldwide payment methods, stood firm with its pricing, even when competitors lowered fees in the USA. The management team had confidence in the business model and kept staffing at a sensible level.
Dominant music streaming app Spotify rolled out price increases last year. Netflix has also increased monthly subscription rates several times over the last few years and is generating new revenue from advertising.
3. Adaptability
History is full of sorry tales of businesses that disappeared because they failed to adapt – Kodak, Nokia and Blockbuster video. And stock markets are full of investors trying to eke out a few ‘last cigar puffs’ from dying business models.
With big shifts to navigate, companies need an adaptable mindset and evolving business approach. Take tractor company, John Deere, founded in 1837 but now integrating technology into agriculture. It uses computers, cameras and machine learning for high-precision crop spraying, which massively reduces the volume of herbicide required - great news for the environment and a farmer’s costs.
Another examples is Shopify, which provides all the tools to set up a shop on the internet, and has created a new suite of machine learning capabilities to transform online retail. Shopify merchants can now use their AI tools to automate repetitive processing tasks, write product descriptions and analyse sales - saving them time and money.
There is no neat way of modelling corporate adaptability in a spreadsheet, but companies will pull ahead of the competition if they continue to experiment in order to adapt.
Rewarding patience
Humility and reflection are essential aspects of investing, and any period of extreme returns brings lessons. But it’s equally important for investment managers to stick to their style and approach. For growth investors, that means unearthing companies that can navigate a new world of rapid change and deep shifts.
Despite the loneliness of focussing on long-term potential amidst short-term sentiment, history suggests the rewards for patient, strategic investment should be substantial in the coming decade. Amidst the blinding success of a few superstar companies, termed ‘the magnificent seven’, a large cohort of companies is being overlooked. It feels like a once-in-a-generation opportunity to be a growth investor.
Tim Garratt, Partner
Tim joined Baillie Gifford in 2007 and is an investment specialist, overseeing the institutional client base that invests in Long Term Global Growth. Tim became a Partner of the firm in 2016. Prior to Baillie Gifford, Tim worked at AT Kearney where he managed a number of private equity projects. Tim graduated MEng in Aeronautical Engineering from the University of Bristol in 1999.
This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.
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