For the last ten year or so, global markets have been dominated by one thing: growth. I don’t mean growth as in rising stock prices – although that has been happening and is a factor – I mean growth as in high-growth companies.
Companies like Amazon and Facebook kicked off the trend by delivering almost unbelievable annual rates of revenue growth and – in the cases of platforms like Facebook and Google at least – unbelievably juicy margins. Early investors in these current giants often came in when profits were low or non-existent, and benefitted from a rapid and prolonged rise in the share price that mirrored growth in revenues and margins.
Understandably enough, this got investors excited. Everyone was on the lookout for the next big thing, the next growth stock that would achieve a similar run. Investor focus shifted from the bottom line to the top line – instead of worrying about profitability, the key metric became growth, especially how fast a company was growing its user base and revenues. Being a “tech” company helped.
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Money flooded into growth stocks and momentum investing – whereby an investor puts money into stocks that have risen the most in the last twelve months or something similar – became the only game in town. Value investing, in which investors look for companies with stable revenues, attractive profits, and low valuations (basically, the Warren Buffett approach) fell out of favour.
This was a glorious time for venture capital types. They all headed to Silicon Valley and started looking around for any vaguely tech-like company that could demonstrate double-digit sales or customer growth. They then poured money into these businesses and bided their time, waiting until the companies in question were ready for a triumphant and lucrative IPO.
The plan worked very well, especially since returns on traditional instruments like bonds were at rock bottom and the world’s central banks were basically handing out money in large sacks. Public market investors, desperate for yield, were only too happy to pay top dollar for unicorns – private companies with valuations in excess of $1 billion – and from China to the US, venture capital funds were printing money on public markets.
But then, things started to change, beginning with the Uber listing.
Uber is a poster child for the growth craze. It has grown revenues very rapidly and expanded its market share aggressively, plus it is a “tech” company with a sleek app to boot. But despite all this, the Uber listing didn’t go as planned. It’s $45 listing price was below expectations and today it is trading at around $30 – down around a third.
Investors in public markets, it seemed, were more concerned with Uber’s sizeable losses and the fact that it seemed to have no clear path to profitability than its rapid revenue growth. Uber sells its services at a loss and seems to be hoping for one of two things to make it profitable: 1) It achieves a market monopoly on rides and is able to raise prices or 2) Self-driving cars come online soon and Uber is able to work out a way to deliver self-driving rides at a profit.
Despite Uber’s struggles, the momentum investing trend kept growth stocks buoyant and a number of unicorns prepared to list. Then came the debacle at WeWork. After that failed IPO, markets made a definitive turn against growth and value stocks boomed. In particular, markets seemed concerned that momentum strategies had pushed valuations up beyond where even the most optimistic growth prospects could sustain them.
This is all very good news. There is evidence that the momentum/growth craze of the last few years has gone further than the fundamentals really warrant. The result has been that a whole lot of capital has been allocated to companies like Uber and WeWork that don’t necessarily offer a solid case of economic value-add. Genuine growth, the kind that drives higher incomes and living standards, comes from figuring out how to do something more rapidly and cheaply – using a steam-powered loom to weave fabric instead of a handloom, for example, or using science to increase crop yields per acre.
Many of the companies that have driven the markets in the last few years haven’t done much in terms of genuine economic value-add. In fact, a lot of their profitability comes from achieving monopolies. That makes them vulnerable to legislative action, as the growing clamour for a crackdown on Big Tech illustrates.
All of this is not to tar all growth companies with the same brush. Many wonderful and profitable businesses wear the label growth but promise to deliver real-world value. However, it seems increasingly clear that the days when anything with fast sales growth and “tech” label would sell for top dollar are behind us. Hopefully, from here on out, investors will look more sceptically at businesses and pay a fair price for a good company.
