The importance of growth potential

Steve Clayton - Fund Manager

3 October 2017

When I look at a business, my first thought is not ‘what is the share price?’ but ‘what growth prospects does it have?’

The reason is simple. Stock markets push the value of shares up and down in an almost random pattern in the short term. But in the long run if a business makes far more money today than it did ten years ago, the share price will very likely be a lot higher now than it was back then, whatever the impact of market sentiment along the way.

In the HL Select UK Growth Shares Fund, we are trying to build a portfolio of growth stars that will deliver rising profits for years and years to come.

Buyers and sellers in the stock market will set the price in the near term. But it is the scale of the company’s profits and their expected future growth that determines where the shares will head over the long term.

Great track records

We hold lots of global consumer goods companies in the HL Select UK Growth Shares Fund, like Unilever, Diageo and Reckitt Benckiser, precisely because they have great track records of delivering growth in almost all conditions. Remember past performance isn’t a guide to future returns. The value of investments can fall as well as rise in value so you could get back less than you invest.

Technology innovators

We don’t confuse long-term growth investing with new technology. Tech companies can be extraordinarily risky, if the technology they possess is not yet fully commercialised or is itself at risk of being usurped by something even newer.

Betamax video tapes lost out to VHS, which itself succumbed to DVD, whose own reign is fast failing at the hands of Netflix and Amazon Prime. But even their position is at risk, with Disney exploring the prospect of selling direct to consumers over the web.

So our technology investments are not the inventors, but rather the appliers of proven technologies.

Just Eat uses the internet to link hungry people to kitchens, GB Group uses it to provide e-commerce companies with the confidence that potential customers are bona fide. Each identified a market with strong growth potential and used newly proven technology to create winning products, building a moat around themselves as their scale grows.

Paying the right price for growth

Whether our growth companies are busily adding new takeaways to their networks, or persuading new consumers to try their ice creams, they are all relentlessly adding scale. In the long run, that creates value. We think the key is to own these businesses over the long run. The best returns are made by acquiring long-term growth businesses at prices that are fair or better.

Once we are clear on the growth prospects, we want to make sure we don’t overpay. We are great fans of comparing a stock’s current and historic valuations. We look at this in terms of both earnings and cash flow.

Our sweet spot is a business whose growth prospects we rate highly, where the valuation looks sensible relative to its own history.

Right now for instance, Reckitt Benckiser can be bought for pretty much its average rating over the last few years. Yet it has recently completed the biggest deal in its history which should offer plenty of growth potential to a portfolio that already has a phenomenal track record.

Or take Burford Capital, the fund’s largest holding with a weighting of around 5%. This specialist financier of commercial litigation has been building its portfolio of law suits at a rapid pace, delivering high returns from those it has settled along the way. Yet it trades on earnings multiples not far off the market averages, despite what we believe to be exceptional potential for delivering higher profits in future.

Superior insight and low charges

The HL Select UK Growth Shares Fund provides investors with a high level of additional insight and information and insight, for less than the cost of the average fund.

View our fund charges

We keep our investors regularly updated about the portfolio: News, results, changes to holdings, our view on the market. If we feel it’s important to our investors, we will let them know through our regular fund blogs.

And you can see exactly what we hold in the fund and find out why on Fund Breakdown page.