How we evaluate growth stocks - LGIM's Launder
Partner Insight: Gavin Launder, Lead Fund Manager of the Legal & General Growth Trust, on the four characteristics of a growth stock and how he identifies a mispriced equity
When seeking out the best growth companies from the UK universe, the Growth Trust team look for four common themes; the first being a disruptive quality, explains Gavin Launder.
"As a ‘disrupter' they will be a new entrant into the sector. They'll be doing something differently," he says.
A second growth characteristic, he continues, are companies who are market leaders in the space they've created. Another is scale-up potential. When a company is constantly improving its product offering and its marketing effort, it makes it really difficult for new market entrants to compete because you need to offer all of what they offer, and more.
"A final characteristic or ‘growth theme' is that we look for companies with extremely high margins and this is shown by gross margins. So although the company's operating margins may be lower because they're spending a lot on marketing and advertising to roll out the product and get new customers in, the core product itself is extremely profitable. That is something that makes their business model highly viable and highly profitable."
Looking ahead
If this is the process for identifying good growth opportunities, what signals are there that a company is overpriced?
"An indication of a mispriced company is when the market doesn't look far enough out when evaluating growth stocks. Typically analysts look to three years only. That then makes the near-term valuations appear to be expensive. But if that fade doesn't happen, if the company beats the fade, by even a couple of years really, that changes the valuation significantly.
"The example I would give is ASOS. They are growing at 30% top line in their 18th year of existence. Can they maintain good double digit growth? Maybe not but 20-something-% for the next 15 years is plausible. Yet the market has them fading after two or three years. So we do a lot of work around the longer term, and the sustainability of growth in these companies."
Ultimately, Launder adds, the further out you start looking into a company's future, the more likely you will move from being fairly objective to fairly subjective. So you do need to immerse yourself in the company, get to know the management, and get to know the competitors. "That's something we always stay on top of."
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