With the tech stocks that have driven much of the growth in world markets over the past decade looking incredibly expensive on most conventional measures, it is no surprise that value investors are steering clear of much of this sector.
However, Legal & General Investment Management’s Gavin Launder (pictured) warns that growth investors may also be missing out on some of the best opportunities in tech if they use a GARP (growth at a reasonable price) approach, as the screens used in this strategy are too limited in their scope for spotting long-term potential
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While the manager’s strategy involves screening for valuations – as well as other metrics such as earnings growth, balance-sheet strength and cash generation – he claimed it is this part of the process that many of his peers seem to get wrong.
“If you have a very strict value approach, there are a lot of [tech] names that you wouldn’t have. But I know a lot of people say they are GARP, but then still baulk at ASOS or Ocado,” he said.
Launder, who runs the L&G Growth Trust, said the problem with this is that when analysts make forecasts which often then fuel the market, they are made for the next two-to-three years, and will always assume that growth will fade in the third year.
However, he warned this isn’t appropriate for companies that are causing huge market disruption – and said that applying a more open-minded approach to valuation provides a more accurate assessment of potential upside.
“So if you look at companies and go, ASOS isn’t going to fade at all for five years and then it does fade over 10 – which I also think is unrealistic as it will go on beyond that – but suddenly you get over 100 per cent upside to the share price and those small changes make a massive difference,” he explained.
“I’m not going to go to ASOS and assume it is going to carry on at that growth rate for 15 years or something, but I do think it is going to be longer than five. But five is good enough for now.”
Launder said that this is where “the objective becomes a bit more subjective”. To work out the sustainability of a disruptive company’s growth trajectory, he will consider the major threats to its business model, which often involves talking with management teams – of both the company he intends to invest in and its competitors.
For example, in ASOS’s case, he weighed up the threat from changing fashions and from competitors harnessing new technology – but found them limited in both cases.
“Because ASOS is so fast, has so many items and because it can see the trends with its data, if it gets one summer dress wrong, it can kill that one quite quickly and there are lots of other ones it can push instead,” he continued.
“And with the technology companies, when you talk to them about who is going to disrupt them in the way they are disrupting others, they say ‘well we are always looking over our shoulder, we are trying new things, we don’t see anyone yet’.
“You have to believe them up to a certain extent, but the fact is that they are looking over their shoulder, they are not complacently going ‘nah, we will be fine’. That they do worry about it is encouraging.”
While many funds use a bottom-up GARP strategy, Launder said that what is unique about the L&G Growth Trust is that it only has 25 holdings, which are equally weighted at 4 per cent of the fund. These numbers are fairly rigid, which forces a discipline on the manager – if the fund ever has 26 holdings, it will be because one stock is coming in and one is going out and the process is taking longer than a day.
Equally, there is a maximum limit per holding of 6 per cent, so if a stock becomes a “real winner” – usually if it gets to 5 per cent of assets – the manager will trim it down to 4 per cent.
Launder said one stock he has frequently trimmed down for this reason in the past few months – and one he expects to trim down again in the near future – is Ocado. He said that again, this is another tech stock that became mis-priced after it was misunderstood by analysts.
Performance of stock over 5yrs
Source: FE Analytics
“Ocado isn’t a long-held one, but I hope it will be, because we only bought it in September last year,” he continued.
“The debate is always fascinating because in my mind it was always followed by the wrong analysts. It was followed by food retail analysts who then thought of it as an expensive food retailer rather than as a tech stock.
“You could see why they would do that. And all the time the company was saying ‘we are going to sign deals internationally, people are going to use our technology’, but it kept failing to land those deals.”
As a result, investors began to lose confidence in the stock and traders began to short it aggressively. Data from FE Analytics shows Ocado fell by 50 per cent between the start of 2014 and last September – at which point Launder decided that it looked inexpensive for a food retailer, never mind a tech stock, so he bought in.
“Then within a month or so, it landed the first of a series of deals,” he added. “So, it has been off to the races and someone actually increased their price target on it recently from £6.30, which is admittedly below the £10 where it already is, to £17. And who knows where it goes from there? So that was a surprising one.”
Data from FE Analytics shows the L&G Growth Trust has made 51.12 per cent since Launder took charge in April 2015, compared with 27.71 per cent from the IA UK All Companies sector and 27.48 per cent from its FTSE All Share benchmark.
Performance of fund under manager tenure vs sector and benchmark
Source: FE Analytics
L&G Growth Trust is £212.3m in size and has ongoing charges of 0.78 per cent.