Riding The Growth Train

For most of the last 10 years, value investors have waited patiently in a growth-centric market for their turn to outshine, but they have only been disappointed. In the decade ending June 30, the S&P 500 Growth index had an annualized return of 11.70%, while the S&P 500 Value index returned 8.44%.

Recently, the performance gap between growth and value has not only persisted but widened. During the first six months of this year, the growth side of the index was up 7.28%, while the value side declined 2.2%. In the mid-cap universe, the value side of the Russell 1000 Index was up 7.38% for the year ended June 30, while the growth portion had risen 22.5%.

While some say it’s time for a rotation in leadership, growth’s dominance over value is poised to continue, according to Stephen DeNichilo, co-manager of the Federated Kaufmann Fund. “We believe earnings will continue to drive the market higher, which typically supports growth investing,” says the 42-year-old manager, who is part of the firm’s nine-person investment team for three Federated funds.

Tax reform should also be particularly beneficial for health care and technology, two growth sectors prominent in the fund. Companies in these sectors have billions of dollars in cash revenue held overseas, and if tax reform allows them to repatriate this money, they could invest it in their businesses.

Still, higher interest rates, trade war talk and wage and price inflation have increased market volatility since last year, and that is likely to continue. “In this type of environment, quality matters and selectivity becomes more important,” says DeNichilo.

Even with the stocks at historically high levels, it’s possible to find strong growth companies at decent prices. He says the big tech company “FAANG” stocks—Facebook, Amazon, Apple, Netflix and Google—account for nearly 30% of the Nasdaq index. Yet other solid companies in tech subsectors, such as health care and biotechnology, are less recognized by the market even though they are well-positioned for growth.

Some areas in the consumer discretionary and industrials sectors have underperformed relative to the mega-techs, but they also have room to run. To find stocks they like, the Federated Kaufmann team members look for companies with competitive advantages that can maintain strong profitability over a long period. The team likes companies with intrinsic values that exceed, or can exceed, their public value; team members participate in more than 1,500 meetings with management, employees, suppliers and other key players to find them. “We are constantly on the hunt for the next FAANGs,” DeNichilo says.

Many of the companies sell the products, services and technologies that big companies need to grow and compete. North Carolina-based Albemarle, for example, is a global specialty chemicals company and a leading producer of lithium, a key component in the manufacturing of batteries for electric cars. “We are at the beginning of a new era for electric vehicles,” he says. “Electric cars only make up 1% of all new car sales globally. We think that number could go to 10% to 12% over the next five to seven years. That kind of growth will require a lot of lithium.”

Another fund holding comes from the transportation and logistics space. XPO Logistics is piggybacking on the success of online sales by making “last mile” deliveries for items heavier than 50 pounds. The company operates in 32 countries and has over 1,400 locations and 95,000 employees. “XPO is a backdoor way to play e-commerce,” says DeNichilo.