The “nifty 50” was a phenomenon in the US in the 1960s and 70s when earnings were scarce and investors were prepared to pay very high prices for growth stocks. Today, investors are also focusing on a generation of stocks, which are able to get through the storm of the COVID-19 lockdown while continuing to deliver capital growth and income to shareholders.
Don’t be afraid to pay for quality
US household growth stocks like Coca-Cola, McDonald’s and Polaroid soared during the 60s and 70s, becoming symbolic of the spirit of the times. Today, it is the FAANG stocks – Facebook, Apple, Amazon, Netflix and Google parent Alphabet – that are leading the US market.
The same phenomenon could come to the UK, where investors are increasingly prepared to pay up for the companies that are likely to deliver through the COVID crisis. Quality companies with good management and attractive earnings outlooks don’t come along often. But when investors do find these stocks, investors in the current growth drought shouldn’t be afraid to pay up for them.
This is the approach we’ve been taking in the JPMorgan Claverhouse Investment Trust in recent months , as COVID-19 began to grip the western world and spook stock markets, we removed the trust’s 9% gearing and tilted the portfolio even further towards quality companies with the brightest outlooks. Since then, as we’ve got better visibility on earnings, we’ve increased our exposure to these quality stocks and taken gearing back up to 8%*.
Of course, we continue to look out for cheaper companies that we believe will pay attractive dividends in the future, but at the moment we are maintaining a very prudent, quality first approach.
Competitive advantage
Housebuilders, life assurers and online retailers look to be among the most attractive sectors as we move through the current crisis.
Within broad financials we much prefer life assurers to banks—so we’ve been looking at Legal & General and Phoenix rather than for example Lloyds and Royal Bank of Scotland. While Britain’s largest banks have all cancelled their dividends, Legal & General pressed ahead in April with a final payment.
Housebuilders’ strong balance sheets will help them to survive the downturn. Their shares are good value, trading on single-digit multiples based on their earnings forecasts for next year, and they should resume dividend payments in the next six to 12 months. The JPMorgan Claverhouse portfolio includes holdings in Berkeley, Persimmon, Barratt, Bellway and Taylor Wimpey (as of 30 April 2020, positions can change).
Online retail is another sector that is likely to come through the crisis stronger. Next was an existing position in the JPMorgan Claverhouse portfolio, but one that has been added to recently. Even on chief executive Lord Wolfson’s worst-case scenario of a 40% drop in sales in the next 12 months, Next will still generate £200m of surplus cash. Next has one of the best management teams in the retail business, paving the way for it to emerge from the crisis even stronger.
While many retailers are asking landlords for rent cuts of up to 50% during lockdown, Lord Wolfson is paying in full. When the crisis is over, Next believes it will have generated a lot of goodwill with its landlords and be able to take any space on any high street in the UK, so putting it at a huge competitive advantage.
What the future holds
Although interest rates are likely to remain low for the foreseeable future, it is quite likely that one consequence of the current crisis is that many companies will carry much less debt in future. For example, one of the reasons housebuilders currently have such strong balance sheets is because most of their executives went through the fiery furnace of 2008 and learned about the perils of carrying too much debt. It is quite likely that many other boards in other industries will take similar lessons from this crisis and avoid having such high levels of debt in future.
We don’t know exactly what the new world will look like, but for many companies and sectors it is likely to look very different and only those that can quickly adapt to the new normal will be worth considering as an equity investment.
*source: J.P. Morgan as at 10/06/20
