Josh Passmore at Artemis highlights a turning point for US “quality growth” stocks. With many of the famed Magnificent Seven struggling to deliver growth, history suggests investors may be better served looking elsewhere—diversifying globally and seeking undervalued, high-quality companies with strong cashflow and dividends.
After an extraordinary period that coincided with the low-inflation, low-interest-rate era of QE, the tide appears to be turning for ‘quality growth’ companies. Beyond the increasingly narrow subset of the market sustained by AI, many of these businesses – including some of the fabled ‘Magnificent Seven’ – are struggling to live up to the ‘growth’ part of their label. Maybe it is time to revisit the lessons of history.
Despite producing outstanding gains over the very long term, US equity markets – the spiritual home of ‘quality growth’ companies – endured prolonged periods of stagnation or underperformance in the 1930s (post Wall Street Crash), 1970s and 2000s.
In the 1970s – a decade characterised by oil shocks, inflation and higher bond yields, as well as higher unemployment and lower growth – it was value and small-caps that performed best, while the technology sector underperformed materially.
Prior to the oil crisis in 1973, the so-called ‘Nifty Fifty’ stocks that propelled US markets in the preceding decade shared a similar trajectory to that followed by the Magnificent Seven more recently – after which they underperformed considerably.
Similarly, in the period after the dot-com bubble (the 2000s), US equities produced negative returns. Microsoft – now the world’s second-largest company, with a market cap of $3.7tn, and an outstanding performer over the past 15 years – was also under water during that period. Other areas – such as emerging markets and, again, value – outperformed significantly.
It is hard to predict when leadership is changing amid the ebb and flow of markets, but the argument for diversification at points like this is stronger than ever. And diversification is certainly not what is offered by the average passive portfolio. These are usually heavily exposed to the dollar and US equities and, if you count the tech-like sectors of communications and consumer discretionary, have around 40% of their holdings in technology.
Active management arguably offers better alternatives, but even here many global funds are still heavily weighted towards ‘quality growth’ stocks and the US.
The US has been – and likely always will be – home to some exceptional businesses. However, investors should only ever be interested in good investments. Strange though it may sound, good companies are not always good investments.
Three classic stocks seen in many actively managed global portfolios – Apple, Coca-Cola from the US and Europe’s LVMH – help illustrate this point. These are companies that still trade on ‘quality growth’ multiples but look more challenged today than in the past.
Apple has struggled to grow its cashflow since 2023. Several factors are to blame – unfavourable currency moves, production issues (strikes at facilities in China) and sales growth that has slowed materially in recent years.
The company has been in the tariff crosshairs of the Trump administration so far this year and is feeling the pressure from the President’s determination that iPhones should be produced in the US. This is unlikely to be helpful for Apple’s cashflow prospects.
Coca-Cola is on a 23x P/E for a stock that has grown dividends at a pedestrian annualised rate of less than 4% over the past five years. Like many consumer staples, it spent the QE period taking on debt and now finds itself more than twice levered.
LVMH, like other luxury names, has been a poor performer in recent years. It is still on a high valuation (24x P/E), but during ‘peak Covid’ this multiple went above 35x. Revenues shrunk 2% in FY24, and earnings per share fell almost 15%. Higher interest rates and weakness in China have challenged growth across the luxury industry – a sector many investors thought could grow faster than GDP in perpetuity.
Now let’s be more imaginative and look further afield. Japanese regional banks like Concordia are benefiting from inflation returning to Japan and interest rates finally turning positive. Cheap, under-owned and under-covered by analysts, Concordia has grown dividends at an annualised rate of 12% over the past five years.
Cement manufacturer Heidelberg Materials, based in Germany, is not glamorous. But it has good profitability and a good balance sheet and should benefit from the German government’s plans to significantly increase fiscal spending. It trades at a large valuation discount to global equities (15x P/E versus 24x for MSCI ACWI). It has grown its dividend per share at an annualised rate of more than 40% (you read that right) over the past five years. And it has doubled free cashflow since 2022.
People’s Insurance Co (PICC – China) sits in a very under-owned market but is also quietly delivering very strong returns. It is a beneficiary of an expanding middle class in China, as well as policy efforts to stimulate domestic demand. Despite its shares more than doubling in sterling over the past 12 months, it still trades on a single-digit earnings multiple and below book value.
Some investors are waiting for ‘quality growth’ stragglers to rebound. They may. They may not. It is time to be more diversified. The good news is that those prepared to look can find compelling investment opportunities elsewhere – companies growing strongly and available cheaply. But investors won’t find tomorrow’s winners if they can’t look beyond yesterday’s.
By Josh Passmore, investment director on Artemis equity income strategies.
