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Finding Secular Growth in a Cyclical Market

Companies that are poised to capitalize on transformative secular trends have outsized potential to sustainably generate above-average earnings and revenue.

June 2021

We don’t try to predict where the market will head. To us that seems a fool’s errand. Instead, we look beneath the surface in an effort to seek companies that have the potential to sustainably generate above-average earnings and revenue growth in the years ahead.

Most often, we believe those opportunities are in businesses that are poised to capitalize on powerful secular trends that are transforming industries regardless of the direction of the broader economy

The Appeal of Durable Growth

We seek to own businesses that can make their own weather, instead of those that are driven by the wind. Often, this means investing in businesses that are driving or benefiting from secular change that’s agnostic to the economic cycle. Cyclical businesses can see their fortunes rise and fall due to factors outside their control, such as commodity prices or interest rates. Conversely, secular change can occur regardless of what’s happening in the real economy, and can underpin earnings growth across economic cycles.

This dynamic can be seen during times of economic and market stress. For example, the secular growth businesses in our Select Growth strategy displayed resilience during the 2008–2009 Great Financial Crisis, the most challenging global economic shock in the twenty-first century before the 2020 pandemic. Many of the businesses continued to produce strong business results—generating positive earnings growth for the strategy on a weighted-average basis—while the broader Russell 1000 Growth Index saw its weighted-average profits decline.

While the share prices of Select Growth’s businesses were no less susceptible to the market selloff in the short term, the durability of their business results remained intact in subsequent years. We saw a similar situation in 2020, as the global pandemic brought the world’s economy to a grinding halt.

Sands Capital Management, FactSet; Data as of 12/31/2020; Select Growth Annual EPS Growth based on Factset estimates for portfolio holdings as of 12/31 each year, excluding any portfolio holdings outliers +/- three standard deviations from the mean. Russell 1000 Growth Index (R1000G) Annual EPS Growth based on FactSet Market Aggregates methodology to derive per share values on an aggregate level.

We are confident that our portfolio businesses can become much larger over the next five years as their earnings growth compounds. We will accept short-term volatility in their share prices so that our clients have the potential to benefit from the opportunity they present to create wealth over the long term.

Our conviction in the portfolio comes from our selection of businesses that we believe drive or benefit from powerful secular shifts and have highly scalable business models.

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The secular growth businesses we prefer to own tend to fall in one of two categories:

Innovation and disruption: businesses transforming industries through new products and services

Needs over wants: businesses that serve critical needs, regardless of market environment.

These businesses’ capacities to increase earnings tend to be organic and independent of economic factors. We like to say they’re capable of making their own weather.

Secular Trends Driving Growth Today

Most of our businesses benefit from one or more of the following secular trends:

Emerging Internet Leaders

We believe companies with large, proprietary pools of data—and tools that use this data to create targeted content—have sizable monetization opportunities. Advertisers have been using data to target customers for years. Other large markets, such as business-to-business selling, remain more nascent opportunities. Companies are beginning to use predictive analytics to generate insights from their own pools of data.

Financial Services Digital Revolution

The combination of modern technology and disruptive customer acquisition models are fundamentally rearchitecting how financial products are designed, manufactured, and distributed, with software displacing paper and bank branches in each stage of the process.

New technologies are enabling broader access to basic financial products and adding innovative layers of intelligence and automation.

We see value accruing to both companies creating a new generation of digitally native financial infrastructure as well as companies leveraging that infrastructure to build differentiated experiences for end users.

Life Sciences Innovation

Over the next decade, we view genes and genomics, minimally invasive technologies, consumerization of health care, the humanization of pets, and globalization of innovation as the most important secular trends in life sciences.

We focus on investing in businesses that are changing the standard-of-care, providing best-in-class “picks and shovels” to biopharma and life science researchers, and meaningfully improving access and cost in healthcare delivery.

Local Companies Serving Large Consumer Markets

Over the next decade, nearly two billion people are expected to enter the middle class. 1 Most reside in emerging markets.

We expect many of these consumers will be served by local companies that have  established leading market shares.

As industries formalize and consolidate, we expect share leaders to be natural  beneficiaries, particularly those with capable management teams, dominant brands, local market knowledge, and scale.

Shifting IT Spend from Maintenance to Agility

Information technology spending continues to shift toward innovations that make enterprises more agile and efficient.

Unlike the last decade—where suboptimal legacy processes were replaced by cloud-based software—the next generation of SaaS leaders are enabling new businesses and processes through component functions and ecosystem integration.

Fast deployment, scalability, lower total cost of ownership, and easy/frequent updates create a compelling customer value proposition.

Long-term View

These foundational underpinnings of future growth don’t make our businesses’ share prices immune to volatility in the short term. However, history shows us that earnings growth drives long-term value creation,2 and our ability to remain steadfast in our research approach and to maintain a long time horizon should enable us to realize our businesses’ growth potential over time, regardless of temporary disruptions.

1 Source: https://www.brookings.edu/blog/future-development/2018/09/27/a-global-tipping-point-half-the-world-is-now-middle-class-or-wealthier/
2 Source: FactSet. From 12/31/97 through 12/31/20, 89% of the Russell 1000 Growth Index’s cumulative price return was attributable to EPS growth, with the balance attributable to P/E expansion.

Disclosures:

The views expressed are the opinion of Sands Capital Management and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as of the date indicated and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. All company logos and website images are used for illustrative purposes only and were obtained directly from the company websites. Company logos and website images are trademarks or registered trademarks of their respective owners and use of a logo does not imply any connection between Sands Capital and the company. GIPS® reports and additional disclosures for the related composites may be found at Sands Capital Annual Disclosure Presentation.

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