By Phillip Weiss | CFA, CPA Chief Investment Analyst
Whether an investor calls himself a value or a growth investor, both the business’ growth potential and its valuation are always relevant. When seeking appropriate investments for client portfolios, the valuation of the applicable security is always assessed. However, the company’s potential for growth factors into the determination of an investment’s underlying value. Investment legend Warren Buffett is best known of as a value investor; however, he does not dismiss the importance of growth in the investment equation. In fact, Buffett has said the following:
Most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.
We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
INVESTING FOR INCOME
Because retiree portfolios, in particular, need to generate current income, some of the companies held in client portfolios are expected to deliver modest growth and pay a generous dividend.We typically classify such businesses as Growth & Income (G&I) holdings within client portfolios. Johnson & Johnson and PepsiCo fall into this category1. These companies are growing, albeit at a slow pace. They are most likely mature companies. Of course, for companies like J&J and Pepsi, the maturity phase can last for a considerable period. Our goal is also to avoid those that are on a decline that is unlikely to reverse (typically referred to as “value traps.”)
INVESTING FOR GROWTH
However, average lifespans are increasing, which means that a retiree’s assets need to last longer than they used to. This increases the need for investors to generate more than just income from their portfolios. Growth, too, is needed to help ensure they do not outlive their assets. In addition, investors who are still funding their retirements are less interested in meeting current income needs and more concerned with the appreciation of their capital so they may be better prepared for retirement. These factors make it more important to find companies we believe can deliver above-average growth. One good source of such companies is those that look to be well-positioned to benefit from key demographic trends. Millennials make up the largest generation in U.S. history, so companies are paying considerable attention as they enter their peak spending years. It is reasonable to believe that over the next two decades, stocks will likely rise and fall based largely on the spending power of the millennial generation. It is important to consider that spending power while investing in the stock market.
THE IMPACT OF MILLENNIALS
In many ways, millennials are different than the generations that came before them. They favor experiences over things. (Earlier this year we initiated positions in Priceline and Walt Disney to try to take advantage of this trend.2) They are less interested in living in large homes. They believe strongly in having a good work/life balance. When compared to previous generations, millennials are believed to try to direct their consumption trends to companies in whose missions they believe. This heightens the importance of corporate culture. Corporate culture is important when these individuals are looking for jobs. They are also relevant when looking at potential investments.
Google (now called Alphabet)3 is a company whose culture is highly regarded. It is known to treat its employees extraordinarily well and its management team is very focused on the long term. Google also has a strong global brand that commands significant customer loyalty. The company has also been building machine learning tools for years; those investments are playing an increasingly important role in Google’s business. In 2014, Google acquired DeepMind, a leading start-up in what is known as “deep learning.” While much of what DeepMind does is still a mystery, readers may be aware of Google’s most significant public breakthrough in the field of artificial intelligence (AI). Earlier this year, DeepMind’s AlphaGo program defeated the world’s best Go player, Lee Sedol. Go is a challenging board game; so beating the world’s best player is not an easy task, making this an important step forward for AI.
There is more to the Google’s AI story. AI now drives Google’s core internet search business. Each and every time someone searches using Google, the platform learns and gets smarter for all subsequent searches. Over time, we should be able to tell that Google is doing a better job of pulling information based not on the words we type but rather the true intention behind those words. Over time, AI is expected to play an even larger role in other Google features.
For example, during its first quarter 2016earnings conference call, Google’s CEO Sundar Pichai said, “In the long run, I think we will evolve in computing from a mobile first to an AI first world.” Google is also at the forefront of driverless car technology, which could potentially have a positive societal impact.
Mobile payment company PayPal4 is another company that could benefit from preferences of the millennial generation. PayPal was spun off from eBay in 2015. The company’s technology platform enables digital and mobile payments on behalf of consumers and merchants. Millennials are not as willing to go to their local bank branches as were previous generations. Using PayPal can help reduce the number of times consumers go to the bank. The company also has an app called Venmo. Venmo allows individuals to send money instantly from their phones. They can even sign up through Facebook. One of the favorite uses of Venmo happens when a group of friends goes out to dinner and splits the check. One person can pay the bill and then have her friends transfer their share to her bank account using Venmo before they leave the restaurant.
Ideally, a well-diversified portfolio will have a mix of stocks operating in different industries with different growth prospects. Some will be expected to provide a stream of income via dividends. Others will be expected to add more growth and share price appreciation. Our goal is to construct portfolios holding companies that provide a mixture of capital appreciation and current income with the potential to deliver solid, long-term growth. Whether the primary purpose of holding a stock is to add current income or to provide capital appreciation, valuation is always a consideration.