1、Credit Suisse HOLTWealth Creation PrinciplesExplaining Growths Modern Dominance of ValuePart 2Technological Renaissance, the Reinvention of Quality, and OligopolyHOLTGreater clarity. Confident investing.HOLT provides an objective comparison of over 20,000 companies, giving you greater clarity to mak

2、e more confident investment decisionsMay 12, 2020ContactsBryant Matthews HOLT Research+1-312-345-6187 HYPERLINK mailto:bryant.matthews bryant.matthewsKey PointsOver long investment horizons, research shows Value stocks have outperformed Growth stocks. But over the last thirty years, Growth has domin

3、ated Value on two separate occasions for periods of ten or more years.What explains Growths modern dominance? Is it just a case of “bad luck” or poor timing for Value investors? Is the Value premium dead?In Part I, we argued that Technological Renaissance is the foundation of Growths modern dominanc

4、e of Value. Technological Renaissance marks the transition between status quo technologies and the introduction, broad dispersion, and eventual total disruption by newer and superior technologies that benefit the many, not just a select few. A technological revolution linked to personal computing de

5、vices, the Internet, and communications began in the late 1980s and fresh waves continue to this day.But Technological Renaissance alone cannot fully explain the outperformance of the Growth style over Value from 2007 onwards. What helps?An unfortunate offshoot of technological revolution is the pot

6、ential for increasing monopolistic and oligopolistic outcomes. And these outgrowths find their greatest expression within Growth style companies. This paper explores how Technological Renaissance increases the potential for oligopoly concentrated in the Growth style and how large firms may be earnin

7、g undue excess profits that upwardly biased Growth stock returns since 2007.Table of ContentsGauging the Outperformance of Growth 3 HYPERLINK l _TOC_250018 Explaining Growths Dominance over Value beginning in 1990 3 HYPERLINK l _TOC_250017 Idea 1: Technological Renaissance 5 HYPERLINK l _TOC_250016

8、Idea 2: Increasing Oligopoly 6 HYPERLINK l _TOC_250015 How is Technological Renaissance related to Oligopoly? 6 HYPERLINK l _TOC_250014 Idea 3: Qualitys Favorable Returns Favor the Growth Style 7 HYPERLINK l _TOC_250013 Quality What is it really? 7 HYPERLINK l _TOC_250012 How Does Quality Favor the

9、Growth Style? 9 HYPERLINK l _TOC_250011 Why Quality Isnt Growth 10 HYPERLINK l _TOC_250010 The Reinvention of Quality and Distortion of Growth Returns 12 HYPERLINK l _TOC_250009 Detecting Industry Concentration and Potential Oligopoly 13 HYPERLINK l _TOC_250008 Quantifying the Impact of Oligopoly on

10、 Size-Weighted Style Portfolios 15 HYPERLINK l _TOC_250007 How Can Investors Navigate a Way Forward? 17 HYPERLINK l _TOC_250006 Conclusion 18 HYPERLINK l _TOC_250005 APPENDIX 20 HYPERLINK l _TOC_250004 What is Technological Renaissance? A Quick Review of Part I 20 HYPERLINK l _TOC_250003 Profitabili

11、ty Charts by Size and Style 21 HYPERLINK l _TOC_250002 Operationalizing a Quality-Detection Framework 22 HYPERLINK l _TOC_250001 4-Firm Ratios for Concentrated Industries 23 HYPERLINK l _TOC_250000 Time-series of 4-Firm Ratios by Industry 24Gauging the Outperformance of Growth1For simplicity, we def

12、ine Growth and Value as top and bottom 30th percentile of US equities by HOLT P/B multiple.2 We categorize large cap stocks as greater than $10 billion market capitalization, small caps less than $3 billion market capitalization, with mid-caps are in-between.Traditionally, Value stocks have been reg

13、arded as riskier than Growth stocks. Well-documented research supports this view with recorded annualized returns to Value stock portfolios typically 200-300 bps higher than Growth portfolios. Similar results have been documented across numerous countries. In the US, annualized returns to Value from

14、 1926-2016 were 12.2% versus 9.6% for Growth.3Chart 1 shows the cumulative and relative performance of Value and Growth portfolios from January 1976 through December 2019 (left chart) and for differing start dates (right chart). We highlight that there have been two long episodes of Growth outperfor

15、mance in the last thirty years, each lasting ten or more years.How is it possible that less risky stocks (Growth) outperformed riskier stocks (Value) over a span of a decade or more?Chart 1: Cumulative Returns and Cumulative Returns by Phase to Value and Growth PortfoliosSource: Credit Suisse HOLT.

16、US equities, all sectors, largest 1,000 stocks by market cap, January 1976-December 2019.Explaining Growths Dominance over Value beginning in 1990The simplest explanation for Values underperformance during these two phases is that its just an unlucky coin toss (for Value investors). Robert Arnott, i

17、nvestment practitioner and researcher, writes:“even accounting for intangibles, which have eroded the relevance of book value, the drawdown Values underperformance relative to Growth is almost entirely explained by Value becoming exceptionally cheap.”41 Other frameworks employ a multi-factor approac

18、h to better distinguish between stocks with higher and lower expected growth. Our extensive testing of these multi-factor models does not yield, in our opinion, significantly different results from the simpler single-factor P/B model. Therefore, we choose the parsimonious model for its simplicity in

19、 interpretation and replication.2 HOLT P/B Multiple is equal to Enterprise Value divided by Inflation Adjusted Net Assets. It is similar in concept to Tobins Q and highly useful in distinguishing between Value and Growth stocks.3 Elroy Dimson, Paul Marsh, Mike Staunton. Factor-Based Investing: The L

20、ong-Term Evidence. The Journal of Portfolio Management Special QES Issue 2017, 43 (5) 15-37; DOI: /10.3905/jpm.20154 Arnott, Robert D. and Harvey, Campbell R. and Kalesnik, Vitali and Linnainmaa, Juhani T., Reports of Values Death May Be Greatly Exaggerated (January 30, 2020). Available at SSRN: /ab

21、stract=3488748By “exceptionally cheap”, Arnott implies this is a tail event. The good news if you subscribe to this view is that if Chance intervened, then Growths recent dominance is just a lucky roll of the die, and it is quite likely that the Value premium will soon re-assert.Others have argued t

22、hat declining interest rates explain Growths dominance over Value because of a cash flow duration effect (see the cut-out for an explanation). This logic has some merit, but we reject it as a complete description.Cut-out: The Cost of Equity and its Duration Effect on Value and Growth Style FirmsFall

23、ing interest rates typically benefit Growth stocks more than Value stocks because of the longer cash flow duration effects of Growth style firms. What does this mean?Think of a see-saw with a fulcrum underneath. The fulcrum represents the cost of equity. On either end, a cash pile sits, which is the

24、 present value of future cash flows discounted at the appropriate cost of equity.Imagine a simple case of a Value stock that earns a single cash flow in period 1 of $100 and a Growth stock that earns a single cash flow in year 10 of $211.The Value stocks cost of equity is 12%, the Growth stocks cost

25、 of equity is 9%. Both firms have the same present value of $89, so the see-saw rests in a state of (horizontal) equilibrium.CFVALUE= $100CFGROWTH= $211PV 12%= $89PV 9%= $89Notice the see-saw is longer on the Growth stock side. The length of the see-saw on either side of the fulcrum represents cash

26、flow duration. The Growth stock has longer cash flow duration because the “weight” (timing and amount) of cash flow(s) occur at later dates. In fact, in our example, the Value stock has cash flow duration of one year, the Growth stock has cash flow duration of ten years.tim e12345678910 Value st ock

27、 cash f low s100 -G row t h st ock cash f low s-211 What happens if the cost of equity declines for both companies by 100 bps? In our example, the fulcrum moves leftward. A decline in the cost of equity of 1% barely changes the Value stock price (+0.9%) but inflates the Growth stock price by 10%. Th

28、e see-saw falls to the ground for the Growth stock because it is now more heavily weighted than it is for the Value stock.CFVALUE= $100PV 11%CFGROWTH= $211PV= $90 8%= $98Source: Credit Suisse HOLT, stylized example onlyDeclining interest rates are an important contributing factor to Growths outperfo

29、rmance of Value in recent decades but cannot fully explain Growths dominance.Falling interest rates cannot explain the emergence and rise of firms like Facebook, Google, Twitter, Amazon, or Tencent. If declining or low interest rates alone explained Growths dominance, then Growth stocks would have o

30、utperformed from 1990 through today. Instead, Chart 2 shows that Value and Growth performed similarly since 1990, both delivering annualized returns of 10.5% per year with annual volatility of 16%. It is noteworthy that Growth performed as strongly as Value over such a lengthy horizon. But observe c

31、arefully: Growths outperformance over the last thirty years wasnt continuous, it was episodic.2520151050199019952000200520102015ValueGrowthChart 2: Cumulative Size-Weighted Shareholder Performance to Value & Growth PortfoliosSource: Credit Suisse HOLT. US equities, all sectors, largest 1,000 stocks

32、by market cap, January 1976-December 2019.We reject chance or falling/lower interest rates as the dominant explanation for Growths modern dominance of Value and instead suggest three interrelated ideas. We think these concepts better explain the true causes of Growths outperformance and lead to a su

33、perior framework for assessing the future prospects of Value and Growth stocks.Idea 1: Technological RenaissanceTechnological Renaissance marks the transition between status quo technologies and the introduction, broad dispersion, and eventual total disruption by newer and superior technologies that

34、 benefit the many and not a select or privileged few. Technological Renaissance alters the socio-economic landscape.In Part I, we suggested that the convergence of critical and revolutionary technologies resulted in a Technological Renaissance that began in the 1990s. Successive waves of technologic

35、al innovation brought fresh changes and further spurred Growths dominance. The first wave was the personal computer, followed by the Internet, and then the marrying of personal computing devices with ever-advancing communications technologies that have resulted in iPhones, iPads, and other handheld

36、and technological marvels.Robert Gordon, professor of economics from Northwestern University, emphasizes the transformative power of this convergence in tecnology: “The most important event of the digital age was the marriage ofpersonal computers and communications in the mid to late 1990s in the fo

37、rm of the Internet, web browsing, and email.”5Instead of focusing on bad luck or declining interest rates as explanations for Growths dominance over Value, investors should perceive that the outperformance of Growth stocks has been episodic and catalyst- driven. The episodes were the 1990s and 2007

38、to the present; one of the catalysts was Technological Renaissance (facilitated by declining interest rates) which we articulate in detail in Part I. If you did not read Part I, and would like a short review of Technological Renaissance, please jump here in the Appendix.In recent years, a different

39、and disturbing feature contributes to Growths excess shareholder returns: increasing market power of large firms and oligopolistic profits.Idea 2: Increasing OligopolyHow is Technological Renaissance related to Oligopoly?Technological Renaissance originates from transformative technologies like the

40、electric lamp, the first steam engines that powered locomotives, the combustion engine, and the personal computer.Ex ante uncertainty about the ultimate profitability of new technology encourages many incumbents to continue to use older and better-understood technology. This exacerbates the risk and

41、 reward potential to first-adopters. It is also typically the case that the rules, regulations, and policies related to nascent technologies are emergent. Sufficient guidelines are often lacking at the outset to protect consumers and various stakeholders. Paradoxically, this context is actually fert

42、ile soil for adventurous risk-taking to occur because it allows for large excess profits as offset to potentially significant losses. This loose framework acts as an incubator for experimental risk-taking but can also pave a pathway for monopoly and oligopoly.In his analysis of the automobile tire i

43、ndustry, Stanley Warner explored the role of technological change in shaping market structure. The U.S. tire industry experienced considerable technological change and ultimately evolved to be a tight oligopoly after experiencing a severe shakeout of producers. Warner found that the cost of staying

44、at the technological frontier is prohibitive for all but the leading firms, suggesting that technological change plays an important role in shaping market structure.6Professor Steve Klepper, influential economist from Carnegie Mellon, expanded on Warner and argued that in industries with emergent te

45、chnologies, “innovators are always larger than imitators that entered in the same period because they have lower average costs and therefore greater profitability. Ultimately,” claims Klepper, “the industry is dominated by the earliest-entering innovators. In every period, they are the largest firms

46、 in the industry.”7 He also observes that early-entering innovators are the largest investors in R&D. His next comments are particularly noteworthy: “increasing returns associated with technological change appear to have had a major influence on firm survival and the emergence of the industry as an

47、oligopoly.”A review of the software industry during the 1990s and 2000s leads to many of the same conclusions as Klepper.85 Robert Gordon. “US Economic Growth is Over: The Short Run Meets the Long Run.” Brookings Institution.6 Warner, Stanley L. “Innovation and Research in the Automobile Tire and Ti

48、re Supporting Industries.” Ph.D. dissertation, Harvard University, 1966.7 Klepper, Steven and Simons, Kenneth L., The Making of an Oligopoly: Firm Survival and Technological Change in the Evolution of the U.S. Tire Industry. Available at SSRN: /abstract=2353908 Jiandong Ju. Oligopolistic Competition

49、, Technology Innovation, and Multiproduct Firms. Review of International Economics, Vol. 11, Issue 2, May 2003, pp. 346-359.For dynamic free markets, an increase in oligopolistic tendency may well be the price of Technological Renaissance.If a Technological Renaissance began in the 1990s, concentrat

50、ed in the Information Technology and Telecommunications sectors, how do we pull the thread from Technological Renaissance through oligopoly and the disruption of the Value premium?Perhaps, surprisingly, by also looking at the role of Quality.Idea 3: Qualitys Favorable Returns Favor the Growth StyleQ

51、uality What is it really?HOLT offers a novel definition of Quality: firms that earn persistent profitability above 8% CFROI over five years or more. In contrast to many measures of Quality, which are often ad hoc designations, our metric has been extensively tested and demonstrates remarkable predic

52、tive power, precision and accuracy.9Chart 3: LVMH Moet Hennessy Louis Vuitton SE (LVMH)Economic ReturnCFROI (%)151050200420082012201620202024202830Asset Growth(%)20100Cumulative Rel. TSR(%)400200420082012201620202024202830020010002004200820122016202020242028Source: Credit Suisse HOLT LensTM 9 Bryant

53、 Matthews and David Holland. “Was Warren Buffet Right: Do Wonderful Companies Remain Wonderful?” Credit Suisse, June 2013. See also, “Wonderful Companies and the Quality Edge”. Credit Suisse, September 2015 and “The Measure of Quality”. Credit Suisse, February 2016.Chart 3 highlights LVMH, a luxury

54、goods firm with a long history of earning exceptional and stable profitability. The market has significantly rewarded this company, principally because earning high and persistent profits is downright difficult. Less than 5% of publicly-traded companies earn such profitability. HOLTs designation of

55、Quality is ECAP, an acronym whose letters stand for Empirical Competitive Advantage Period. ECAPs are firms that have a demonstrated history of persistent profitability. We will use HOLTs ECAP designation synonymously with Quality hereafter.The role of Quality in investing is significant. Quality st

56、ocks act as shock absorbers during bad times. With typical downside beta close to 0.88, a 1% drop in the broad market is matched by a 0.88% decline by Quality. These stocks tend to out-perform benchmark indices during economic turbulence. For that reason, contemporary asset pricing theory suggests t

57、hese are less risky stocks, and should underperform during good economic times. But remarkably, at least during the initial stages of economic recovery, Quality stocks reveal average Beta close to 1.0, pacing benchmarks during the first 12-18 months of recovery.Thereafter, as theory proposes, Qualit

58、y lags the broader market with typical Beta close to 0.92.For risk- and loss-averse investors, Quality represents a crucial hedge against downside portfolio exposure. And because of the crude distinction between Value and Growth, Quality resides largely within the Growth style category.But Quality i

59、s neither Growth nor Value, it is a distinct risk factor.Consider carefully that most Quality companies do not exhibit high growth rates in sales, assets, or earnings. Why are they considered Growth? Their high P/B multiples are indicative of their safety and sustainable cash flows. But Quality isnt

60、 Value either, because Quality firms do not trade at a deep discount.Quality firms have tended to earn higher returns than Growth over longer investment horizons, suggesting a latent or distinct risk that places them on a risk scale somewhere between Growth and Value.Although Qualitys benefit is its