Portfolio Analyst Brandon Smith, CFA, CAIA, highlights the importance of adhering to a valuation discipline and the risks associated with investing in statistically expensive companies.
Catalysts in Play: Are today’s highly valued growth stocks vulnerable?
We have just emerged from a decade in which investors enjoyed historically high rates of return with low inflation. We believe these returns were primarily driven by multiple expansion as central banks experimented with zero interest-rate policies. Growth equities, in particular, saw multiples rise to valuation levels not seen since the dotcom era of the early 2000s.
Today, we are in a dramatically different market environment.
Entry Points: Inflation, though it may have peaked, remains uncomfortably high. Central banks have rapidly tightened their monetary policies, and risk is seemingly being priced once again by the open market instead of the U.S. Federal Reserve.
Multiple Compression | We believe we are in the early innings of multiple compression across a wide swath of equities. Therefore, it may be an important time to remind investors that a great company does not necessarily equal a great investment.
- One such example is Microsoft Corp. during the dotcom era of the early 2000s. This is a period that has many similarities to today’s market environment.
- From January 2000 through December 2011, Microsoft sales more than tripled, and operating income, or EBIT (earnings before income and tax), more than doubled. But, the market capitalization of the stock was reduced by more than half, dropping to $218 billion from $476 billion.
- Microsoft’s price-to-earnings (PE) multiple went from 53 times earnings to nine times earnings over this 12-year period, and the cumulative stock price return for Microsoft was negative 55.5 percent.
- Why did the stock perform so poorly? We believe this is because investors paid too much for it in 2000. While Microsoft was a great company that continued to grow, investors experienced a poor return because they overpaid for it.
Today’s Environment | We hold that market indices are populated with many similarly expensive stocks. That is why we firmly adhere to the valuation discipline outlined in our three-circle stock selection process. And by doing so, we remain optimistic about the prospects for continued outperformance of low-valuation stocks in the coming years.
Active Strategy: Boston Partners’ strategies offer specialized actively managed value equity investing across a variety of geographies, market capitalizations, and long/short approaches. The construction of our portfolios is guided by a sensible set of fundamental truths that have been tested over time and various market cycles.
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