New companies vs old companies: a more interesting concept than “value” vs “growth”
Many investors divide companies into “value” stocks and “growth” stocks. But a more useful distinction might be between old companies and new companies. Max King explains why.
In mid-November, the Financial Times reported that Rivian, an electric-vehicle maker which has yet to record any meaningful revenue, had surged on its Nasdaq debut to a valuation of over $100bn, more than the valuation of Ford and General Motors.
On the same day, the FT also reported a 15% jump in the share price of ITV and 20% for Marks & Spencer.
It seems that “growth” stocks are continuing to attract investors while “value” stocks are bouncing back too.
But the contrast between new and old provides a more interesting perspective.
Sometimes faith in the new is absolutely justified
It’s human nature to be optimistic about the new and cynical about the old, and this serves a very useful economic purpose. Over-enthusiasm about railways in the 19th century and broadband around the millennium financed over-investment which eventually crushed investment returns. Investor enthusiasm for Tesla, now valued at $1trn – a hundred times annual cash-flow – has undoubtedly helped its phenomenal growth.
The optimism of early investors can turn out to be justified. In the late 1990s, investment legend Bill Miller asked the rhetorical question of whether it was rational to value Amazon at four times the combined value of Borders and Barnes & Noble, the two biggest American bookstores. He was right, but in the wrong direction; Borders has not survived and Amazon’s share price has multiplied at least 50-fold.
There was no shortage of sceptics when Google (now Alphabet) floated in 2004, but its share price has multiplied more than 50-fold, too. Facebook had a rockier start with its share price, over-hyped at issue in 2012 and halving in the first few months, but now at nine times its issue price. Salesforce, Netflix and Nvidia, among others, have also met with stellar – if volatile – success.
All these businesses had phenomenal and unique business plans, a massive competitive advantage and were not afraid to take risks, but that doesn’t apply to all tech-related investments. Half of the companies that raised more than $1bn at flotation this year, the Financial Times reports, are trading below their issue price. The Hut Group, described in MoneyWeek as “an online Woolworths” has fallen 80% since its January peak.
Investment fund flotations in 2021 have performed well, while those from recent years have been able to grow through equity issuance. These have been “value” rather than “growth” funds, mostly categorised as “alternatives” promising healthy yields. Renewable energy, energy efficiency and specialist property have been popular, though “old” companies may offer better value than “new.” For example, Jean Hugues de Lamaze, investment manager at Ecofin, argues that there is better value in energy utilities transitioning to renewables than in renewable start-ups.
The arch-disciple of established companies is Nick Train, manager of Finsbury Growth Trust, whose proud boast it is that “the average age of our portfolio companies is 148 years.” He is not completely averse to newer companies, hence a relatively recent investment in drink mixers specialist FeverTree, yet believes that companies with strong brand names and market positions should be able to evolve to meet changing market conditions.
Brands have value – but not all find it easy to adapt
Not that this applies to Pearson, which started as a global construction business, discovering oil in Mexico when the company built the Vera Cruz railway. Diversification led the group into a conglomerate phase which took it into publishing and hence online education. RXL, formerly Reed International, was a scientific and legal publisher which had to tear up its business model and switch online.
This transition was not easy (nor was it for music publisher EMI) which explains why many companies shrink from the challenge. For many, that is simply not an option; face-to-face trading at the London Stock Exchange (LSE) disappeared in 1986. Before long, the LSE and other financial businesses such as Experian discovered that the application of technology offered them a huge opportunity.
For branded goods companies, such as Diageo, disintermediation of the supply chain brought an avalanche of new competition, but it also brought strong market growth. Since the new competition was focused on niche, up-market brands, this actually helped established names.
Not all businesses adapt; some just give up. Woolworths disappeared from the UK High St, but prospers in Australia. The success of retailing chains such as B&M and Action (owned by 3i) shows that some management teams gave up too easily.
For some businesses, though, there may be no escape. Tobacco companies have been diversifying for well over 50 years but ended up spinning off or selling their diversifications in order to focus on maximising cash-flow from a declining business. For 20 years, that made them a very good investment.
The energy majors are trying desperately to transition to “zero-carbon” renewable energy businesses, but that deserves a great deal of scepticism: not only do they lack the home-grown expertise for such a radical change of strategy but it is highly doubtful that they have the culture to attract the innovators and risk-takers that they need.
High Street banks, too, are under threat. They have massively cut their branch networks and their costs, but without those how do they sustain a competitive advantage? Admittedly, start-up banks have had a rocky ride, but that just implies that banking in the future will be a much smaller sector than in the past.
There is probably now a bit more of a tendency to see new businesses through rose-tinted spectacles than in the past and to dismiss too easily the ability of existing businesses to adapt and prosper. Adaptation is not always easy and investors are often right to be sceptical, while the sheer number of companies that have come from nowhere to global domination in one or two generations should warn all investors against an excess of scepticism.