Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 416

Best-in-class, ‘pure-play’ companies give clearer focus

Growth stocks have driven global equity markets higher over the past few years, but greater volatility in early 2021 may suggest that growth investors face a more challenging environment ahead. Successful growth investing will require greater selectivity to deliver attractive risk adjusted returns over the market cycle.

Competitive advantages and long-term growth trends

A deep understanding of what drives a company’s business and its markets is crucial to long-term success as a growth investor. We look for high-quality growth companies that have both the technological and operational prowess to build lasting competitive advantages. The businesses should benefit from long-term secular growth trends such as e-commerce adoption, vehicle electrification, cloud computing, and financial technology.

Businesses in such growing markets tend to be dynamic, always adapting to the needs of their customers and innovating to bring new technologies and services to market. We have found that investing in either best-in-class ‘pure-play’ companies, or those that operate in a small number of complementary businesses, is one way to stay ahead of changes in the business and the broader industry.

Unlike conglomerates, these focused companies offer growth investors the following three significant advantages:

  1. Deeper analysis of dynamic, fast-growing underlying markets
  2. Focused capital allocation
  3. A clear understanding of company-level economic exposures that can help with portfolio risk management.

Three examples of these insights

1. Deeper industry analysis: Intuitive Surgical vs Medtronic

The trend towards robotic-assisted minimally-invasive surgery is one place where a pure-play company can provide investors a deeper understanding of market dynamics than a more sprawling enterprise. We expect the penetration of robotic surgeries will increase over time, with worldwide procedures to grow from 2% to ~15% of surgeries over the next decade to ~US$18 billion (sourced from Goldman Sachs, Company Data).

Source: Intuitive Surgical

Intuitive Surgical Inc. is a US-based company that pioneered the robotic systems used in minimally invasive surgical procedures. Its da Vinci surgical system strives to make surgery more effective and less invasive, while also improving patients’ recovery times. The company currently has about 90% of an ever-expanding market as more types of surgeries are approved to be performed with the system.

Given its dominant position, Intuitive Surgical can provide investors with a better understanding of the trends in surgical systems than many of its competitors, such as Medtronic PLC.

Medtronic is a medical device conglomerate. Their robot-assisted surgical system remains under development and the division in which this product is being developed also includes several other surgical tools. Given the diversity of its product portfolio, analysing Medtronic may not give investors a clear picture of the trends at play in the specialised robot-assisted surgical market.

Additionally, within Medtronic, it can be difficult to assess which products and systems are being prioritised with research spending, and even then, this may change significantly over time. At Intuitive Surgical, by contrast, all its research and development efforts go into improving and expanding the capabilities of the da Vinci system which can further widen its lead over competitors.

In a growing, highly technical field such as robotic assisted surgery, changes in manufacturing, intellectual property, and the regulatory landscape can make large differences in relative market-share and future profitability potential.

To accurately analyze the competitive position of our portfolio with respect to this attractive market, we value Intuitive Surgical’ s direct exposure and market-leading position.

2. Focused capital allocation: Zebra Technologies vs Honeywell

Capital allocation is also often more efficient and better understood in pure-play companies than in conglomerates. For example, Zebra Technologies Corp. which makes barcode printers and scanners to help companies manage their inventories and assets, can more efficiently and effectively allocate capital than its largest competitor Honeywell International Inc.

Honeywell is a conglomerate, with business lines that span aerospace, building technologies, performance materials, and safety and productivity solutions. While Honeywell competes in the barcode scanner space, the division makes up just 5% of total revenue. It is inevitable that a company with such diverse operations, politics and persuasion may lead management to stray from the most efficient capital allocation strategy and potentially underinvest in attractive growth opportunities.

Source: Franklin Templeton, Honeywell Company Filings, 2020

Zebra’s management, by contrast, is focused on its one business, allowing it to be more effective, strategic, and proactive in real-time, by our analysis. A real-world consequence of this advantage was Zebra’s introduction of a mobile device based on the Android operating system, which has now become the industry standard. Competitors like Honeywell have struggled to get customers to switch to their later entries.

Source: Company reports.

A management team concentrating on one business gives us greater confidence in Zebra’s ability to remain nimble to take advantage of new market opportunities that arise in its dynamic industry.

3. Improved risk management: Aptiv PLC vs Infineon

Best-in-class companies with focused business models allow us to better understand risk at the portfolio level, particularly given our focus on building a concentrated growth portfolio that is still highly diversified.

In a 40-stock portfolio, for instance, understanding where potential investments may share a source of revenue or have similar expenses is critical in ensuring the portfolio is diversified. Since growth businesses often change over time, being able to keep ahead of these changes can help avoid instances where companies that once had little overlap begin to see greater exposure to a common market.

For instance, on the surface, Germany-based semiconductor manufacturer Infineon Technologies AG might not appear to have much in common with global auto parts manufacturer Aptiv PLC. But as cars and auto components have become more sophisticated and as the number of chips powering these systems have increased, Infineon’s business increasingly overlapped with Aptiv, given their exposure to auto production.

Two Sectors, One End-Market Exposure

Our experience has been that changes such as this can be more evident in companies that operate a single business or set of highly complementary businesses. 

Concentrating on the long term

The universe of growth stocks is large and diverse and finding opportunities that can outperform across a market cycle is challenging. Our experience as growth managers has reinforced our view that a focus on pure-play companies can help to build a concentrated, yet still highly diversified portfolio of best-in-class growth stocks. Often this can lead us down the market cap spectrum toward lesser-known names, however we also believe that there are plenty of large cap names which operate highly focused businesses, capable of generating attractive returns over the long term.

Though the world has become more uncertain in the past year, high-quality companies tied to long-term secular growth trends should produce compelling shareholder value, regardless of the macroeconomic environment. 

 

Francyne Mu is a Portfolio Manager of the Franklin Global Growth Fund. Franklin Templeton is a sponsor of Firstlinks. This article contains general information only and should not be considered a recommendation to purchase or sell any particular security. It does not consider the circumstances of any individual.

For more articles and papers from Franklin Templeton and specialist investment managers, please click here.

 

RELATED ARTICLES

We have many world best practice companies

Changing landscape of US large and mid caps

Single-period measures do not work for great growth companies

banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Among key trends in Australian banks, one factor stands out

The Big Four banks look similar but they are at fundamentally different stages as they move to simpler business models. Amid challenges from operating systems, loan growth and neobank threats, one factor stands tall.

Why mega-tech growth are the best ‘value’ stocks in the market

They are six of the greatest businesses ever and should form part of the global portfolios of all investors. The market sees risk in inflation and valuations but the companies are positioned for outstanding growth.

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Latest Updates

Superannuation

Retirement income promise relies on spending capital

The Government has taken the next step towards encouraging retirees to live off their capital, and from 1 July 2022 will require super funds - even SMSFs - to address retirement income and protect longevity risk.

Superannuation

How retirees might find a retirement solution in future

Superannuation funds need to establish a framework that offers retirees a retirement income solution that lasts a lifetime. It will challenge trustees to find a way to engage that their members understand and trust.

Investment strategies

Dividend investors, your turn is coming

Dividend payments from listed companies, depended on by many in retirement, have lagged the rebound in share prices over the past year. Better times are ahead but sources of dividends will differ from previous years.

Investment strategies

Four tips to catch the next 10-bagger in early-stage growth

Small cap investors face less mature companies with zero profit that need significant capital for growth. Without years of financial data to rely on, investors must employ creative ways to value companies.

Investment strategies

Investing in Japan: ready for an Olympic revival?

All eyes are on Japan and the opportunity to win for competing athletes. After disappointing investors for many years, Japan is also in focus for its value, diversification and the safe haven status of its currency.

Fixed interest

Five lessons for bond investors from the Virgin collapse

The collapse of Virgin Australia not only hit shareholders, but their bond investors received between 9 and 13 cents in the $1. A widely-diversified portfolio can tolerate losses better than a concentrated one.

Investment strategies

The 60:40 portfolio ... if no longer appropriate, then what is?

The traditional 60/40 portfolio might deliver only 1.5% above inflation in future without diversification benefits. Knowing an asset’s attributes rather than arbitrary definitions is better for investors.

Retirement

Two factors that can transform retirement investing

Retirees want better returns but they have limited appetite to dial up their risk exposure in order to achieve it. Financial advice and protection strategies in portfolios can enhance investment outcomes.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.