Friday Morning Coffee Nr. 91: From GARP to GAAP

130220 Friday Morning Coffee

Friday Morning Coffee Nr. 91: From GARP to GAAP

We are scratching our heads as valuation of the so-called growth stocks has now reached what we think are unsustainable extremes while at the same time the value stocks continue to trade at affordable valuations. While Mr Market, what we value investors call the average investor, can be frenetic at times and has a tendency to go to extremes, he cannot escape the reality that the value of every company is at the end of the day the present value of its discounted cash flows. In the long run a stock price trading above its fair value will be arbitraged and see its stock price fall back towards its fair value.

 

This may not happen overnight or to use another quote this time from Keynes : “Markets can stay irrational longer than you can stay solvent.”. However, we believe that in the long run, valuations are to the stock market what gravity is to physics.

 

The graph below shows the difference in valuation as measured by forward price / earnings ratio between value and growth stocks over the last 15 years.

Source : Bloomberg

Historically value stocks traded at a discount to growth, however over the last 2 years this discount or spread reached unseen extremes. We believe the higher this valuation spread between value and growth becomes, the more brutal the return to earth of growth stocks will become as their valuations are unsustainable considering the earnings they produce. And it is not only the valuation of Tesla that skyrocketed: in Europe the average growth company trades currently at 21 times forward earnings. This is a 30% premium to the 15-year average historical valuation of growth stocks. Growth at a reasonable price (GARP) has become growth at any price (GAAP) in a zero-interest world!

 

On the value side however, valuations remain down to realistic. The average value stock currently trades at 11 times forward earnings, exactly in line with its long-term average.

 

Our European portfolio stays attractively valued with the average company trading at 36% compared to our estimated fair value. The companies we are invested in have solid balance sheets, generate solid cash flows and, for most of them, pay juicy dividends.

I wish you a nice weekend,

Léon

 

European Capital Partners (Luxembourg) SA ("ECP") is responsible for the publication of this promotional document.  ECP is an asset management company based in Luxembourg, registered at JF Kennedy avenue 35a, L-1855 Luxembourg (RCS Luxembourg, B 134.746) authorized as an Alternative Investment Fund Manager ("AIFM") of the Luxembourg law of 12 July 2013 and supervised by the Commission de Surveillance du Secteur Financier (CSSF). This document is published for information purposes only and gives the opinion of the Investment team at the time of the publication. It does not constitute an offer to buy or sell financial instruments or investment advice and does not confirm any transaction unless expressly agreed otherwise. Although ECP carefully selects the data and sources used, errors or omissions cannot be excluded a priori. ECP cannot be held liable for any direct or indirect damage resulting from the use of this document. The intellectual property rights of ECP must be respected at all times; The contents of this document may not be reproduced without prior written consent. Any investment involves risks, such as the risk of loss of initial capital. Please read the Prospectus of Selected Funds, their Key Investor Information Documents (KIIDs) and financial reports before making an investment decision to understand their specific risks, costs and conditions. Those documents are available on www.ecp.lu.  Past performance does not guarantee future performance. Please refer to an independent tax advisor for country tax information that can change at any time and analyze the tax impacts of any investment on your personal situation.