27 February 2024

    Where to look for tomorrow's stock market winners

    Ashley Gardyne

    Chief Investment Officer

    Ashley Gardyne

    Chief Investment Officer

    As I write this article, silicon chip manufacturer Nvidia has just announced blockbuster earnings growth on the back of an AI driven demand surge. As a result, its market value has surged over $200bn in a single day. Beyond Nvidia, there has been a steady stream of news charting the meteoric share price gains of companies like Amazon, Tesla and Microsoft in recent years.

    The quest for high returns

    Seeing explosive market returns can lure investors into trying to find ‘the next Amazon’. Right now, investors are looking for ways to ‘play’ the surge in interest in artificial intelligence. But before the interest in AI, we had other similar bursts of enthusiasm about a range of growth industries – from electric vehicles to cryptocurrencies, genomics to digital payments.

    While this can be rewarding if done well (and we have had significant investments in companies like Amazon for many years), this strategy doesn’t come without its risks. The highest growth companies are often accompanied by high valuations. This leads to what some investors call a ‘growth trap’. When a company doesn’t deliver on high market growth expectations – its share price can get hit hard.

    Balancing the potential growth of a company, the certainty of management delivering, and the price you pay are all equally important.

    Boring can be beautiful

    There are other places to look for attractive returns, and tomorrow’s stock market winners don’t always come from the highest growth and most futuristic corners of the market.

    Some examples of companies with more moderate growth targets currently in our portfolios include US home improvement chain Home Depot, and Dublin-based clinical trials operator Icon plc. Both companies operate in industries that are relatively mature, but they have also materially outperformed the broader share market in the past decade or so – and both have multiplied in value 10-fold since the start of 2012.

    Home Depot is America’s version of Bunnings – and during the 1990s and early 2000s they were on a store roll-out spree, grabbing as much retail space as they could. After the Global Financial Crisis, Home Depot made a big change in their strategy. They decided to stop rolling out new stores, instead focusing on store efficiency, taking market share in existing catchments, and attracting pro customers. Many thought this was the end of Home Depot as a growth investment, questioning how it would work out for shareholders if they were no longer expanding and adding new stores.

    But the change in strategy ultimately proved to be hugely successful, with sales per square foot increasing from ~$334 in 2014 to ~$653 in 2023. Management have also been very disciplined on costs, and operating income margins have increased from 11% to 15%. Home Depot also supplemented their more modest growth with returns of capital to shareholders through dividends and share buybacks. The result? A 17% per annum return for Home Depot shareholders over the past 10 years. The same return delivered by internet search giant Alphabet.

    Get rich slowly

    Another good example of more moderate growth companies delivering exceptional returns is Icon plc, which we have invested in for over 15 years.

    Icon is an outsourced clinical trials provider to pharmaceutical companies globally. They help big pharma companies like Pfizer get their drugs through clinical trials and to market quickly and efficiently.

    The company has grown by continually improving their service offering and becoming more valuable for their customers. They have benefitted from more pharmaceutical companies deciding to outsource their clinical trials, but they have also taken market share from competitors as the industry has consolidated.

    By focusing on operating efficiently, tightly controlling costs, and being disciplined when making acquisitions, they have seen their profits grow from $110m to $610m over the last 10 years. Icon’s share price has followed suit and delivered a 20% annual return for shareholders over the last 10 years – broadly in-line with the return delivered by Meta (Facebook and Instagram parent) over the same period.

    Maintaining balance

    So, what’s the lesson? While there is nothing wrong with looking for high growth technology stocks that can deliver big long-term gains (we have owned Google and Amazon for many years), you don’t have to chase these sorts of stocks to do well as an investor. There are lots of moderately growing, but exceptionally run companies in more traditional industries that should continue to deliver good returns for clients in the years ahead. As is often the case, maintaining balance is a sensible strategy.

    Talk to us

    If you’d like to make sure you have the right investment strategy to help you reach your ambitions, get in touch with us – our team are always happy to help.