Capitec is the epitome of an SA Inc success story. says the writer. Picture: SUPPLIED
Capitec is the epitome of an SA Inc success story. says the writer. Picture: SUPPLIED

Growth stocks have consistently outperformed value stocks for the past 12 consecutive years. Investors holding mostly growth stocks over this period have had significantly better outcomes than those holding mostly value stocks. How has this affected value investors?

There are clear distinctions as well as similarities between the MSCI world growth and MSCI world value indices. Growth stocks are companies that are growing their sales and earnings the fastest. Value stocks are those that are the cheapest when measured by traditional valuation metrics (price-to-book ratio, price-earnings ratio and dividend yield). These definitions are used by MSCI to construct its world growth and world value indices. A closer look at the geographic and sector compositions of the indices reveals further distinctions, as well as interesting similarities.

The geographic compositions of the two indices are largely aligned. Both have relatively high exposures to the US, and similar exposures to Japan, France, the UK and a basket of other developed countries. As such, both indices only consider developed markets.

Where the indices noticeably differ is at the sector level, with several market sectors falling clearly into either growth or value territory. Information technology and consumer discretionary are clearly growth sectors. Financials and high-yielding sectors such as real estate, energy and utilities are value sectors.

There are often anomalies within sectors. For example, in the consumer discretionary sector, a growth sector, there is a wide divergence between the valuations of growth stocks and value stocks. In health care (about equally split between growth and value), there is a wide divergence between biotechnology companies and all others, such as hospitals and insurers.

We started selling when the share reached our appraisal of fair value in December 2017. It has gone on to achieve record high valuation ratings

Value asset managers following a bottom-up approach — those who buy and sell equities based on their intrinsic value — rotate out of stocks when their price exceeds the manager’s assessment of its worth, and buy when they identify mispriced quality. Using this method the distinction between growth and value often blurs.

In May 2016 our funds’ global holdings contained many stocks now classified as growth. However, a few years earlier we’d identified them as value stocks as they’d become cheap. By 2018 the stocks were reaching valuation levels we considered expensive. Pockets of value were also starting to emerge elsewhere in the market. We therefore started selling the expensive stocks and buying cheap ones. Examples of stocks we sold include Union Pacific and Microsoft, both great companies but neither of which continue to offer the margin of safety we require.

Union Pacific, a railroad owner and operator in the US, is a good leading indicator of US GDP and global trade. We bought Union Pacific when it sold off in 2015 due to concerns about the lower oil price, the “death of coal” and a sharp reduction in agricultural exports. We started selling when the share reached our appraisal of fair value in December 2017. It has gone on to achieve record high valuation ratings.

A similar story emerges regarding Microsoft. Our process identified the company as a good investment opportunity when it traded below its average valuation multiple in 2011. As its share price increased and its valuation level normalised, we started selling. However, the share has since rerated to levels above those seen before the global financial crisis.

Unmatched growth

SA growth and value stocks have shown similar trends to their global counterparts. As the local economy isn’t growing, it’s difficult for domestic-facing (SA Inc) companies to produce growth. Therefore, local stocks can be regarded as growth stocks if they’re taking market share. While SA companies aren’t included in either the MSCI world growth or MSCI world value indices, similar market dynamics have been at play: the divergence between those that are exhibiting fast growth and those that aren’t is extreme. The divergence between the share prices of Capitec and its competitors, and between Clicks and Shoprite are good illustrations.

Capitec is the epitome of an SA Inc success story. Since its inception it has produced unmatched growth relative to other SA Inc companies and has continued to take market share from the big four banks (Nedbank, Standard Bank, FirstRand and Absa) and informal lenders. Investors have seized the opportunity to benefit from this growth, driving the Capitec share price to record highs in recent years, in absolute terms and relative to peers. Comparing its valuation with Nedbank reveals the extent of the valuation divergence. At end-December 2019 Capitec’s share price traded at a 384% premium to Nedbank’s, compared with a long-term average of 192%.

While Clicks and Shoprite have historically traded at similar multiples, they’re now displaying a wide divergence in valuations. Both companies sell everyday goods, in many cases to the same consumers. Yet the recent experience of investors in the two companies has been vastly different, again due to growth.

As Clicks continues to take market share away from independent pharmacies, its growth has exceeded that of the average SA Inc company. But as with Capitec, investors have driven its valuation to record highs. In fact, the valuation premium of Clicks over Shoprite is 133%, after a history of trading on average at similar multiples. We believe the discount embedded in the Shoprite share price is unwarranted. As a result, this appears to be an attractive opportunity and we’ve invested accordingly.

Labels such as “growth” and “value”, while convenient, are insufficient and imperfect guides for investors. What matters more than anything in producing long-term outperformance is the price you pay for a stock relative to its intrinsic worth.

• Motala is assistant fund manager at PSG Asset Management.